IMPACT INVESTING AND NONPROFITS - Blog | Wishesandblessings

The Relationship between Nonprofits and Impact Investing

Nonprofits have typically been active longer than impact companies and have developed cost-effective mechanisms for delivering products and services and implementing business plans. Impact investors could be seen as strategic investors in nonprofits, which in turn play a role in scale-up, talent attraction, and the delivery of financial and operating leverage. One impact investor, for instance, built a sister organization to coach microfinance founders as they set out, and helped them build skills⁽¹⁾

The nonprofit sector can call on unique expertise to contribute to the impact investing space, including local relationships that enable strong risk assessments and the ability to provide technical assistance. What sets nonprofits apart and establishes them as important actors in the impact investing ecosystem is that they are driven by impact, not financial returns⁽²⁾

“For impact investing, people are not deploying because there’s either not enough deals that are ready or not enough technical assistance to really protect investments,” said Ben Wihebrink, Heifer’s director of impact ventures⁽²⁾

NGOs can provide technical assistance, and some can help create a pipeline of deals. In the long run, impact investing can be another tool or service NGOs can be counted on to provide⁽²⁾

Why do NGOs Consider Impact Investment?

The principal reason NGOs consider getting into impact investment is to increase their access to private capital or to leverage their own assets more effectively to create greater impact and to generate investment returns to further their mission. NGOs cannot issue equity, although they can issue charitable debt securities to supplement the charitable donations that generally provide their funding⁽³⁾

Whether for purchasing property, working capital to invest in the community, or just trying to refinance a loan that is coming due, nonprofits have historically had to turn to the banking industry to address financing needs. Impact Investing can create a win-win solution bringing socially-minded individuals together to address these needs, realize a financial benefit, and drive social impact as more of the nonprofits resources can then be available for mission purposes⁽⁴⁾

Impact investing is not a replacement for philanthropic contributions, but rather a complement, helping organizations to grow once they have proven the success of their model using, frequently, philanthropic contributions.

How Impact Investing can help Nonprofits using ‘Patient Capital’

The markets alone cannot solve the problems of poverty; nor are charity and aid enough to tackle the challenges faced by over two-thirds of the world’s population living in poverty⁽⁵⁾

Impact investors often use ‘Patient capital’ that seeks to bridge the gap between the efficiency and scale of market-based approaches and the social impact of pure philanthropy. Patient capital has a high tolerance for risk, has long time horizons, is flexible to meet the needs of entrepreneurs, and is unwilling to sacrifice the needs of end customers for the sake of shareholders. At the same time, patient capital ultimately demands accountability in the form of a return of capital: proof that the underlying enterprise can grow sustainably in the long run. Exciting new business models capable of bringing affordable, life-changing products and services to the poor, these businesses have the power of transforming the lives of their customers, and creating jobs that lead directly to economic growth⁽⁵⁾

Nonprofit organizations face pressures to focus spending on external operations and pull back on central administrative costs, but this emphasis can undermine the ability of the organization to effectively deliver its services. The concept of “patient capital” offers another point of view⁽⁶⁾

Turbulent financial times and increased competition for funding have brought nonprofits’ challenges into sharper focus. Internal investment, for example in the implementation of a new IT system to improve service delivery, is typically overlooked. Expectations regarding the balance between operational and program funding are reflected in the policies of funding sources; there is usually a limit on the portion of a grant allocated to administration, for example. Further, grants are often short-term in nature, restricting a nonprofit’s ability to plan ahead for financial sustainability. The notion of patient capital brings a different perspective to short-term funding and limited support for operations.

Investors deploy patient capital with an expectation that returns will take a long time to materialize, and may be lower than the market average. Patient capital combines aspects of venture capital and philanthropy. Like venture capitalists, providers of patient capital commit to a lengthy period of support for their investees, and they have a higher tolerance than traditional investors for the risk of capital losses. Like philanthropists, patient capitalists have the aim of increasing societal value, sometimes known as a social return, when disbursing funds. The attributes of patient capital therefore make it an investment instrument that is naturally aligned with the missions of nonprofits.

For nonprofits, patient capital may offer a more sustainable alternative to short-term, restrictive funding options. Instead of spending time on the continuous quest for grant funding, which may have to be set aside for specific programs, nonprofits may take on patient capital to build the operational and strategic capability of their organization. This type of funding can help nonprofits plan for the future and develop functional support for front-line programs.

Nonprofits may also benefit from the management support that accompanies the investor’s patient capital. This can be useful for organizations that are operating in challenging markets and providing goods or services to typically underserved customers. Whereas a traditional investor might find such an investment opportunity unattractive (too much risk for too little return), a patient capitalist not only provides the financial investment but also advice on how to improve the operational model and increase chances of success.⁽⁷⁾

Case Study 1: The Educate Girls Development Impact Bond⁽⁸⁾

The world’s first development impact bond in education

The Educate Girls Development Impact Bond was launched in 2015 and concluded in July 2018 with Educate Girls surpassing both of the impact bond’s educational outcome targets. As the first development impact bond in education and the first development impact bond in Asia, lessons from this project are vital to the viability and design of future results-based financing models.

Development impact bonds

Development impact bonds (DIBs) are an exciting new tool for financing social programs. Traditional grants are often conditional on organizations delivering on predetermined inputs or activities. DIBs, on the other hand, shift the focus in development away from inputs to outcomes by tying funding to demonstrated social impact. In a DIB, an investor invests capital in a social program. If the program meets pre-determined impact targets, their investment is repaid, plus a return, by a donor*. As a result, the outcome payer only has to pay for results achieved, and the implementer receives funding that gives them the freedom to innovate and adapt their program to maximize impact.

*Development impact bonds are similar in structure to social impact bonds (SIBs), in which the final outcome payer is a government body. SIBs were pioneered in the UK and have since spread to countries including the US, Canada, and Australia.

Educate Girls DIB – Putting the model to the test

The Educate Girls Development Impact Bond was launched in 2015 with the goal of improving education outcomes for primary school students in rural Rajasthan by funding programming by the nonprofit Educate Girls. In addition, this project provided an opportunity to test the DIB model and explore whether the proposed benefits outweigh the costs of setting up and maintaining this complex partnership.

UBS Optimus Foundation, acting as the investor, financed Educate Girls’ project implementation, while Children’s Investment Fund Foundation (CIFF) agreed to pay for educational outcomes as evaluated by IDinsight. Instiglio managed the project.

Educate Girls’ program

Educate Girls launched their program in Rajasthan’s Bhilwara district in September 2015. While improving public provision of education is a priority across India, Rajasthan presents particular challenges. 1 in 10 girls ages 11-14 in the state are not enrolled in school, and less than a quarter of rural children in Grade 3 can read a Grade 2-level paragraph or solve a subtraction problem. Educate Girls seeks to address these educational inequities by encouraging families to send their children to school and by improving the quality of the instruction they receive once enrolled. They train community volunteers to make door-to-door household visits and to deliver a child-friendly supplementary curriculum in classrooms to improve basic reading and math skills.

Final Evaluation Results

Educate Girls surpassed the three-year DIB targets for both learning gains and enrollment. These impressive results were not a foregone conclusion. While Educate Girls was consistently on track to meet the enrollment target throughout the DIB, progress against the learning target lagged behind. Two years into the three-year DIB, Educate Girls had reached just half the target. However, massive increases in Year 3 drove them to exceed the final target by 60%. The effects of Educate Girls’ program on learning gains were large and statistically significant over the three-year program: Students in Educate Girls schools gained on average 28% more than students in control schools.

1. Educate Girls’ program in Year 3 was particularly effective in increasing test scores: In the final year, learning levels for students in program schools grew 79% more than their peers in other schools – almost the difference of an entire additional year of instruction.
2. Prior to Educate Girls’ program, almost none of the students in treatment and control group were able to solve a division problem. After the three-year program, half the students in the treatment group, but less than a quarter of students in the control were able to do so.

DIB payments

UBS Optimus Foundation recouped its initial funding (USD 270,000) plus a 15% internal rate of return. The total payout of USD 144,085 will be reinvested in UBS Optimus Foundation’s grantee programs, including a grant to Educate Girls.

What can we learn from the Educate Girls DIB experience?

Lesson 1: DIB’s hidden superpower may be encouraging innovation

Although a DIB’s focus on outcomes is usually framed as a way to promote accountability, it may be equally important in stimulating innovation. The massive increase in the effectiveness of Educate Girls’ program in the final year suggests that the combination of implementer flexibility and rigorous evaluation can create conditions for rapid learning and improvements. For example, the first two years of the evaluation showed that children who were chronically absent from school were not benefitting from the program. In the third year, Educate Girls added home visits and remedial classes to better reach these students, and subsequently their gains were comparable to students who attended school regularly.

Lesson 2: Rigorous and responsible evaluation is key

The benefits of DIBs’ laser focus on outcomes can only be realized if those outcomes are measured correctly. Less rigorous methods, such as before and after studies, risk reaching the wrong conclusion about whether targets are met. This damages the core value proposition of a DIB in the following ways:

1. Incorrect payments: All parties must have full confidence that they will be paid based on actual performance, not other factors that affect outcomes. In the Educate Girls DIB, a control group was necessary to measure ‘business-as-usual’ learning gains in order to isolate the value-add of the Educate Girls program.

2. Ineffective or harmful program adjustments: Faulty data could lead implementers to course correct in the wrong direction. In the Educate Girls DIB, learning gains in the treatment group were largest in Hindi; in the absence of a control group, which showed that students typically perform better in Hindi, Educate Girls may have incorrectly doubled down on their least effective subject.

3. Perverse incentives: Everything from the type of assessment to choosing a sample shapes the incentives felt by the implementer. In the Educate Girls DIB, a simple decision to base targets on the average treatment effect (instead of the aggregate treatment effect) could have effectively penalized Educate Girls for their efforts to enroll the most marginalized children.

4. Reputational risk: At least one SIB faced public backlash when money seemed to be going to a failed program after the rigour of the evaluation was called into question.

There must be close coordination between the various partners when designing a DIB to minimize risk and maximize credibility and impact.

Lesson 3: The possibilities are endless

The launch of many new DIBs and several large outcome funds provides an exciting opportunity to experiment. While the Educate Girls DIB was expensive relative to the cost of the program, there are many opportunities to streamline and improve on the basic DIB model. Options currently being explored include creating much larger DIBs that benefit from economies of scale to keep administrative costs low; small DIBs engineered to rapidly refine a program that, if successful, can then be scaled up; and creative tools to reduce the set-up costs of DIBs, such as setting fixed payments for certain outcomes (rate cards) or standardizing contracts. We encourage creative thinking about how best to adapt DIBs to different contexts and needs, as well as careful documentation of lessons learned as this sector expands.

For more cases studies, please refer to links 9 and 10.

About the Author

Manik Bahl is a CFA® charterholder. He has 5+ years of work experience in the financial services industry. He is passionate about finance and has always wanted to help the society, thus he left his career in Investment Banking to pursue social work. He aspires to leverage these learnings to enter the Impact Investing sector. While at leisure, he could be seen spending time with his family, listening inquisitively to the stories his grandparents share.

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