WASHINGTON — Development impact bonds and blended finance may need to give up some of the spotlight as the latest innovative finance mechanisms gaining attention. Social impact incentives, which build off their predecessors in some ways, are being piloted to use donor funding to pay specifically for impact as a way to unlock transactions or focus private sector attention on development impact.
A social impact incentive, or SIINC, is a results-based financing mechanism focused on helping unlock impact gains from market-based solutions and companies by paying directly for impact achieved.
“It’s so far proven to be an effective pay-for-impact model.”— Katie Naeve, senior impact and partnership manager at Root Capital
SIINCs are the brainchild of Bjoern Struewer, the founder and CEO of Roots of Impact, and Peter Beez, a senior policy adviser at the Swiss Agency for Development and Cooperation, or SDC.
Struewer found himself frustrated that solutions such as blended finance rarely helped small businesses and wanted a tool that would better work to build markets and be more accountable for impact, he said. Struewer also saw the growth of social impact bonds, but he wanted to create a similar system that would support for-profit enterprises, rather than nonprofits or governments.
Beez was also interested in social impact bonds but wondered why something similar couldn’t be done more simply. SIINCs are quicker and cheaper than impact bonds, he said.
SDC funded several pilots of the new mechanism in Latin America. One of them, Clínicas del Azúcar, was given a social impact incentive to open one of their diabetes clinics in a slum area in Mexico. The business always intended to reach poorer segments of society but faced pressure from investors to focus on returns. It now serves double the rate of base-of-the-pyramid customers as it did before the SIINC, Struewer said.
“We have a few practical cases we’re doing now, we already have results … now we’re going to the next stage and doing SIINCs at a bigger scale,” he said.
Part of the way it’s doing that is through a collaboration with the Inter-American Development Bank and Root Capital, an agriculture-focused impact investor, where instead of investing in a single company or doing one deal at a time, they agreed on certain metrics or objectives to streamline the process.
Root Capital had seen that investing between $100,000 and $300,000 in agricultural cooperatives usually resulted in them losing about $20,000, but that after a few lending cycles those businesses would be profitable for the company, Beez said.
“They can’t do it because they would lose money, but they have metrics and experience,” he said, adding that by paying for the impact, the SIINC helps them cover their costs.
Small loan sizes are more costly because the revenue they generate doesn’t offset the costs, explained Katie Naeve, senior impact and partnership manager at Root Capital. But with the SIINC, Root Capital has been able to set a price for reaching those earlier-stage businesses that could have greater impacts.
In the past, when Root Capital has made these smaller loans, it has generally found that within three years and several funding cycles the businesses are stable and become profitable, she said. So the goal is that SIINCs will help Root Capital reach businesses that otherwise can’t access funds and help address the funding gap sometimes referred to as the valley of death.
“It’s so far proven to be an effective pay-for-impact model, because both the payment structure is directly linked to the impacts and the payment amounts were set up based on years [of] portfolio data and the costs to serve these high impact businesses,” she said, adding that it is a robust and simplified pay-for-impact model.
While it’s still early days in the three-year project, Naeve said it shows promise. About six months in, Root Capital has just submitted its first group of loans to Roots of Impact for the impact review, that if verified, would trigger the first SIINC payment.
The total number of loans that will qualify as part of the partnership is capped at 40 qualifying transactions, so the program is off to a quick start. The early numbers coincide with the coffee season and reflects businesses loan officers had already identified and had in the pipeline.
The SIINC-eligible investments go through a typical due diligence process and will be identified in part based on their growth trajectory, Naeve said. Root Capital hasn’t changed its impact measurement processes — it already had robust social and environmental due diligence systems and collects data — but it has changed the lending decision process and the size of loans that will be approved. SIINC-qualifying loans cannot be for more than $500,000.
While a SIINC with this structure works for Root Capital, which is big enough to be able to make the loans and receive the impact payment retrospectively, the model may not work as well for smaller organizations, or might have to be modified, she said. Like with any partnership, setting up the SIINC took some time — they had to set up systems and determine the outcome payment, but as it’s been operationalized staff are excited about the potential to work with downmarket businesses, she said.
To make SIINCs successful, it is first important to understand the impact that the partners want to have, and ensure there is a way to quantify that based on evidence and data, Naeve said.
As a donor, the model also appeals to Beez because he doesn’t need to be a specialist in different companies — investors conduct much of the due diligence and if impact is verified, the donor can support a project. There does need to be clear, concrete criteria but the evaluation can often be done using lean data, he said.
SIINCs and guarantees can allow public donors and philanthropists to use money more efficiently and they have an easier entry point “even with me as a bureaucrat,” Beez said.
SDC would like to go to scale with SIINCs and it is looking at doing a bigger initiative in Africa — putting together a fund that would provide SIINCs to a number of different impact investors working to support vocational skills businesses, he said.
“You cannot SIINC everything, but you can do much more than we’re doing now,” Beez said.