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Challenges and opportunities in social investing: A conversation with Sir Ronald Cohen

A cofounder and former chairman of Apax Partners, Sir Ronald Cohen pioneered the British venture-capital industry. Over the past decade, he has also stood at the vanguard of social investing. When Britain established its first social-investment bank, Big Society Capital, in 2011, Sir Ronald was named its chairman. In a conversation with Ian Davis, McKinsey’s former managing director and a board member of the bank, he describes the opportunities and challenges of financing social investments and the parallels he sees between these activities and the rise of the venture-capital industry.

From potential to action: Bringing social impact bonds to the US

A new "pay for success" model is designed to help scale social programs and assist the underprivileged people who benefit from them, the governments that provide social services, and investors.

You are the CEO of a nonprofit organization focused on a critical social issue—say, homelessness. Your organization has developed a program that has helped 100 people in your city move into stable living situations and get their lives back on track. Over time, you have tested and refined your approach and assessed the results. You can demonstrate that your program prevents chronic homelessness, and you’d like to expand it to help more people in your state—but you don’t have the funding to do so. The foundations that have supported the development and testing of your program don’t have sufficient resources to help you take it to scale.

Or perhaps you are a government administrator. You are frustrated at the lack of progress the government has made in eradicating homelessness. You realize that some government programs are tackling the problem too late—they are largely remedial and aren’t making a sustainable impact; the statistics refuse to budge. You think it’s time to try new programs, especially preventive solutions, and you have both the reach and the resources to make a meaningful difference. It is difficult to replace existing programs with alternatives—but, given the opportunity, that’s exactly what you’d like to do.

These scenarios are playing out every day, on almost every social issue. Nonprofits with successful preventive programs struggle to scale them; government continues to spend money on some ineffective remedial programs; society loses out. What’s to be done?

Enter the social impact bond (SIB)—a new tool for scaling programs that help poor and vulnerable people. A SIB is a multistakeholder partnership in which philanthropic funders and impact investors—not governments—take on the financial risk of expanding proven social programs. Nonprofits deliver the social program to more people who need it; the government pays only if the program succeeds.


Social Impact Bond exhibit

Despite their name, SIBs are not bonds or debt instruments but rather partnerships managed through a series of contracts. In fact, the original idea was to call them “social impact partnerships,” rather than bonds. SIBs bear some resemblance to the multiyear contracts governments already enter into, which are subject to annual budget appropriations.

Today, philanthropic donors fund pilots that demonstrate the efficacy of preventive programs, but that’s as far as it goes. Programs that work aren’t always expanded to the entire population that needs them because only government has the reach and the resources to provide the multiyear funding required for scale-up. But government’s existing legacy systems tend to focus on remediation, and fiscal constraints can make it tough to introduce alternative approaches.

SIBs offer a new option for expanding proven preventive programs. They can facilitate the critical handoff from philanthropy, which provides the “risk capital” of social innovation by funding and testing new programs, to government, which has both the capital and policy influence to take programs to scale.

SIBs are in use (see below, “The first SIB”) and are generating interest at the local, state, and federal levels in the United States for several reasons. One reason is that public-private partnerships and other multistakeholder arrangements have proven to be effective at addressing complex, dynamic problems that exceed the capacity of a single sector or actor. SIBs, if executed well, can spur cross-sector collaboration and cooperation.

Another reason is that governments are already familiar with the concept of paying for results—but have yet to apply it to social issues. Governments at the city, state, and federal levels use pay-for-performance contracts for construction projects, environmental cleanup, and other activities. In some cases, the contract includes a fixed payment coupled with a bonus for meeting specified performance targets. In other cases, contractors bear the financial risk: they must secure up-front working capital from investors or other sources to fulfill the contract, and they recoup their costs only if they meet performance targets.

With SIBs, all the financial risk involved in scaling up a social program rests with the investors, who will be paid only if performance targets are achieved; government pays for results rather than paying for activities. SIBs can give government a risk-free way to transition from existing remedial efforts to higher-impact, less costly preventive solutions.

A third reason: SIBs help scale proven programs. Funding what works—driving more dollars to high-performing nonprofits and their programs—seems obvious but has not always been the reality in the social sector. The recent recession has focused funders and service providers on the need to do more with less and on the benefits of putting resources behind programs that have demonstrated success. The 2011 publication of Leap of Reason: Managing to Outcomes in an Era of Scarcity by philanthropist Mario Morino reignited the discussion of “results-based management.” SIBs build off this philosophy and reward those who have invested in developing programs and proving that they work.

Lastly, SIBs are attracting interest because of the growing community of “impact investors,” or private foundations, family offices, individuals, and others who use their investment capital not just to reap financial returns but to benefit society. Over the past ten years, more investors have begun to let their values guide their financial investments, seeking ways to do well while doing good.

While all the potential applications have not been fully explored, SIBs appear best suited for behavior-change programs requiring intense case management, and integrated assessment to ensure quality replication. Other methods for scaling, which tend to be more market oriented, lend themselves best to expanding access to products (vaccines, for instance) and services, such as health care. Early US interest in SIBs has focused on two social issues: chronic homelessness and criminal and juvenile justice. Near-term SIB uptake will likely occur in places where those two issues are among a governor’s or a mayor’s priorities.

The first SIB

The first SIB came into being in September 2010. After raising £5 million from philanthropic funders, Social Finance UK—a nongovernmental organization that develops financing structures and raises capital to help fund social-service organizations—launched a SIB to help rehabilitate 3,000 short-term prisoners at Peterborough Prison expected to be released over a six-year window.

Under the SIB contract, four UK nonprofits are implementing programs to help inmates increase their education levels, vocational skills, and confidence both during and after confinement. The reoffending rate of the Peterborough prisoners will be measured against a control group of 30,000 short-term prisoners from other jails who are not receiving these preventive support services. If reoffending rates among the Peterborough prisoners drop by 7.5 percent, investors get a minimum payout of 7.5 percent; if reoffending rates are even lower the payout could increase up to 13.5 percent. However, if these outcomes are not achieved, the investors will lose their entire investment.



Social impact bonds

Social impact bonds

Download the report and watch a replay of our webinar exploring a new "pay for success" model of financing social programs.

McKinsey on Society

McKinsey on Society

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