Different types of new models of financing impact

In addition to the differentiation made in the previous video, this article offers some best practice cases and further information on prerequisites and time horizons of the three types of new financing models: debt/guarantee models, pay for success models, and conditional conversion models.

Debt/guarantee models

Debt is a simple financing model, where assets are transferred to the investee, with clearly defined repayment expectations. In most cases there are also additional interest payments. Loans issued by nonprofit organizations (NPOs) are often provided at a lower interest rate or have more flexible repayment terms than conventional bank loans.

A specific form is layered funding. It combines funders with different financial models and priorities regarding risk and return, united around a clear social objective. More traditional philanthropic funders provide grants and subsidies which form the first layer; social investment the next layer. Such cross-funder collaborations expect a financial as well as a social return.

Debt models have a mid to long-term time frame as the beneficiary first has to be able to earn enough revenues to repay the funds. In the case of guarantee-models short (under a year) to long-term (5y+) time frames are common. This specifically depends on if only short-time projects are backed up or organizations as a whole are supported. Market guarantees by design only work on a long time scale, as products first have to be developed, tested, and produced (for instance pharmaceutical drugs).

Best practice

The Global Health Investment Fund (GHIF) is a USD 108 million social impact investment fund to finance global health innovations through a diverse investor base. The purpose of the GHIF is to attract investors from the private sector to solve global health and other societal issues. The Bill & Melinda Gates Foundation and SIDA of Sweden provide a risk loss warranty to minimize the financial burden of investors. This partial capital warranty covers the first 20% loss and 50% of any subsequent loss.

Pay for success models

Pay for success models aim to attract new private money for social initiatives. In order to function well, performance goals must be precise and measurable. Performance-based payment systems can only work when programs can be evaluated using reliable measuring instruments. The right choice of representative indicators is therefore of great importance.

Furthermore, the parties need to agree on the time frame for reaching the performance goals, the matching ratio, how funds will be released, and what happens if the goals are not met. A further necessary prerequisite for implementing a Social Impact Bond (SIB), which is a specific type of the pay for success model, is the assumption that through the delegation of certain services to private organizations the principal is able to save money, which then is partially shared as return to the investors.

Best practice

Social Impact Incentives (SIINC) is a funding instrument that combines private investments and social enterprises. The approach resembles a SIB but with one difference: the principal (ie the state) does not repay the private investor, but offers a premium payment to the social initiative when previously agreed goals are met. The private investor is repaid by the social initiative without a direct connection to the premium payment. The advantage of this concept compared to a SIB is a less complex and thus cheaper structure, and that scaling can happen without a delay caused by the time lag of the final repayment after the evaluation.

Conditional conversion models

In defining conditions of conversion from loans to grants NPOs may incentivize beneficiaries to meet certain goals. Similarly to pay for success models, if the goals aren’t met the grant-giver may still get the money back; otherwise it is converted into a grant, as it would have been anyway.

By converting grants as early stage startup financing into equity for later stage developments, a NPO may participate actively in the success of its initial beneficiaries while still supplying them with risk capital. The terms for conversion may also include immaterial services from successful grantees.

Best practice

The CDA Foundation launched a student loan repayment grant, in which recent dental school/specialty graduates are awarded with grants toward repaying their educational loan of up to USD 35,000 per year for a maximum of USD 105,000 over three years. In exchange, the recipients are committed to provide quality dental care in underserved communities regardless of the patients’ financial status. Since 2002, the program and its recipients helped more than 75,000 underserved patients to receive USD 20.5 million in care.

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This article is from the free online course:

Entrepreneurship in Nonprofits

University of Basel