Three insights for using impact bonds to scale social enterprises

August 2020 saw the launch of The Skill Mill, for which Social Finance provided advisory support. In this blog we explore how and when impact bonds can be a suitable source of investment to scale a social enterprise, using The Skill Mill as a case study.

In 2010 Social Finance launched the world’s first social impact bond (SIB), to reduce reoffending in Peterborough. Since then the market has been shaped by central government support through thematic areas — for example, the Innovation Fund used SIBs to help disadvantaged young people re-engage in education and employment, and the Fair Chance Fund focused on improving outcomes for young homeless adults. The most recent support has been through the Life Chances Fund, which supports locally commissioned SIBs across issue areas. As such, the focus of SIBs has been on how they can be used to drive change in government commissioning.

In the SIB model, investors provide upfront capital to pay for a service. An outcomes payer, generally a public body, commits to funding positive social outcomes achieved, passing on some savings to investors if the project is successful.

In a social enterprise-led SIB, an additional element is the enterprise’s commercial revenue. The social enterprise’s customers pay for services or products, which can be a second income source, alongside outcomes payments. A SIB can provide social enterprises the capital they need to scale, enabling them to monetise their social outcomes, while they build their ability to generate commercial income. 

Case study: The Skill Mill

The Skill Mill is an innovative social enterprise helping people aged 16–18 with a history of criminal offence into employment. It runs six-month paid training programmes, led by youth support workers, during which the cohort performs outdoor work for clients such as utility companies and water authorities and receive mentorship, qualifications and personal support.

The Skill Mill’s unique model is effective: it has managed to reduce the one year reconviction rate among its participants to just 9.5%, compared to 72% in the wider comparison group. They also manage to get the majority of participants into work within three months of finishing training. This success is particularly impressive as they work with very vulnerable young people: 45% of participants have substance misuse issues and 71% have been excluded from school. 

In 2019, The Skill Mill began exploring opportunities to scale, and needed upfront funding to launch in new areas. They decided to use a social impact bond to fund their services in eight locations over a four year period, for a total of 252 young people.

Social investors provide capital to pay for The Skill Mill to run training sessions for young people. The two streams of revenue for the impact bond are:

• Income for achieving social outcomes (e.g. entry into employment, no reconvictions for a year), paid for by public payers including local authorities and the Life Chances Fund;
• Income from local clients for completing outdoor work.

During the SIB period, 2/3 of income will come from achieving successful outcomes and 1/3 will be from sales revenue.

With support from Social Finance, The Skill Mill raised investment from four social investors: Northstar Ventures, Big Issue Invest, CAF Venturesome and Resonance (who contributed a social investment tax relief (SITR) investment). The SIB launched in seven local authorities in August 2020 with West Sussex launching in February 2021.

The SIB faced some big challenges to launch — most significantly the Covid-19 pandemic, and the logistics of coordinating four investors, seven local government funders and a national commissioner. Nonetheless it has performed very well against targets and has to date provided employment to 60 individuals.

Under what conditions is a SIB a suitable scaling mechanism for a social enterprise?

1. Knowing your impact as a social enterprise

Evidencing impact is key to attracting SIB investors and outcomes funders.

Investors — When UK social investors make traditional loans or equity investments into an enterprise, they look closely at that enterprise’s evidence of sales or growth. Investing in an outcomes-based contract like a SIB requires an additional type of evidence: the enterprise’s ability to deliver social outcomes.

Showing this can be complex. A key factor that enabled The Skill Mill to launch a SIB was that they’ve measured their social impact thoroughly, through years of regular monitoring and even commissioning an independent academic study. This helped social investors support Skill Mill to deliver social outcomes on target, and meet outcomes-based revenue projections.

Outcomes funders — Public funders typically commission on a ​‘fee-for-service’ basis — paying for services to be delivered as opposed to outcomes achieved. In an outcomes-payment contract like a SIB, outcomes (and therefore payments) can be unexpected, which can cause difficulties for local authorities’ predetermined budgets. This can be a barrier to launching a SIB. However, local authorities were confident The Skill Mill could achieve the desired outcomes, which helped them estimate, and budget for, a payment profile over the life of the programme.

2. Deliver commercial and social value

While social enterprises target social impact — ​“doing well, by doing good” — they also need to be commercially viable to survive. This can lead to a focus on the commercial side, on the delivery of services or goods to business, government, or individuals. It is rare for social enterprises to be paid for the social value they create.

One of the benefits of an impact bond is providing the route for enterprises to monetise their social value. In the impact bond structure, a public payer enters a contract to pay for specific social outcomes. This public payer is generally the one for whom these outcomes translate to savings or additional revenue. For The Skill Mill, employment outcomes and reduced re-offending will generate savings for local youth offending teams, the Ministry of Justice and the Department for Work and Pensions. There was also a strong value for money case for local authorities in this impact bond: typically they’d be responsible for all outcomes payments in an impact bond, but the central government top-up (via the Life Chances Fund) and the enterprise’s commercial sales revenue mean they capture the full social value of the programme at a third of the cost.

For a social enterprise that delivers reliable value on both the commercial and social side, an impact bond can diversify revenue streams by monetising social value created. The payments for social outcomes can be a valuable supplement to income gaps while the enterprise builds commercial partnerships and sales channels. For The Skill Mill, the social outcomes payments provided in the SIB will cover costs while they launch in new sites, and establish new relationships with local clients.

3. Tolerance for risk

The Skill Mill originally planned to launch a traditional, fully outcomes-based SIB. Changes to the planned set of outcomes payers required a total redesign of the fund flows model, which Social Finance assisted with. The new model required an innovative structure, where its commercial sales revenue needed to be included in the SIB to make the deal’s economics stack up. Moreover, the SIB had no lead commissioner, instead working with eight local authorities across the country. It had cohorts much smaller than what you typically find in an impact bond, due to the intensive nature of the service.

Davie Parks, Managing Director at The Skill Mill, worked relentlessly to ​‘make the impact bond model work’. This meant building strong cross-sector partnerships on which the model could be adapted. It also meant coming up with a structure for the impact bond with a small team. In fact, all the SIB stakeholders — from the commissioners to the investors — demonstrated their own flexibility, healthy risk appetite, and thought leadership. The cross-sector collaboration was successful because all actors were squarely focused on a shared vision of creating opportunity and change for young people across the country. Their willingness to take risks in the name of innovation was key.

Conclusion

Funding and scaling up are some of the biggest challenges third sector organisations face. Social enterprises that are focused on impact face the added challenge of effectively monetising their offer. The Skill Mill SIB is a great example of how a forward-thinking organisation used outcomes-based contracting to address both the scale and monetisation challenges at once. The challenges The Skill Mill faced to bring investors and local funders on board with an innovative model structure were both significant and time-consuming. Still, it is our hope that their experience will pave the way for, and inspire other enterprises to adapt existing models to work for them, ultimately growing their impact.