From Harvard Business Review Blogs:
If you care about social innovation and haven’t already heard about social impact bonds, let us be the ones to tell you about them. In fact, we’ve written about them before, and they’ve been well described by others, so we’ll keep this description brief: The social impact bond is a new financing approach that lets societies benefit from risk-taking on new ideas for social programs, without asking their governments to foot the bills for experiments that don’t pan out. Instead, the risk is born by private investors, often including NGOs. Using those investors’ funds, a real-world test of the concept is done (not a trivial undertaking for a social innovation). If the hoped-for level of impact is achieved, the concept is embraced by the public sector and the investors get paid back with a respectable but not lavish return. If not, the investors are simply out the cash.

 

Clearly, it’s not a hot investment arena for speculators hoping to maximize the return on their capital. But for those motivated to use their capital to make the world better, it’s a terrific mechanism for driving change at scale.

We bring the subject up today because we were surprised to read in The New York Times the story of the brilliant innovator behind the Civil War ship USS Monitor. The Monitor, you may know, was finally raised not long ago from the sea floor near Cape Hatteras. A new round of preservation work on it was the occasion for John Tierney of the Times to recount its colorful history (drawing on James Nelson’s fine account Reign of Iron). He underscores for readers how challenging the Monitor was to the Navy establishment when its inventor John Ericsson and his partner Cornelius Bushnell asked them to approve its design: not only was it “ironclad” unlike the wooden ships of the era, it sailed almost wholly submerged, with only its strange gun turret cresting the waves.

Here’s the key passage for our purposes:

Only after more deft politicking by Mr. Bushnell and more explanations from Mr. Ericsson did the board approve it, and only then with special conditions protecting the Navy. It doled out the $275,000 cost in installment payments, and made them all conditional on the Monitor proving itself in a “test”—meaning an actual battle with the enemy. It was a terribly unfair contract to Mr. Ericsson…”Such an arrangement would be risky for the contractors of any vessel; for one so utterly novel as the Monitor, it represented an extraordinary risk,” Mr. Nelson writes. “If Monitor could not stand up to the Confederate guns, the four contractors would be left with a useless, battered ship, perhaps even sunk or captured by the enemy, and a huge debt to the U.S. government.”

Clearly this wasn’t a common arrangement. But it did occur to someone as the way to sell the “Ironclad Board” of the Union Navy on a solution it considered a longshot. Not only was the Monitor’s design seriously newfangled, they knew the designer behind it as someone associated (wrongly, but nevermind) with a spectacular earlier failure.

And the happy outcome was that everything worked out. The Monitor passed the test, its design was embraced, and its public-minded investors earned their returns.

So why, a century and a half later, does the funding approach seem so novel? Why didn’t this type of arrangement become more commonplace in the meantime — and why would its time come now?

Arguably, today’s public sector has become so generally risk-averse that an arrangement designed for an extreme risk situation —dire military threat, drained war chest, dodgy inventor — now is needed for even the surest bets. Meanwhile, perhaps the ranks (and wallets) of socially-minded investors have swelled so dramatically that it’s much easier to round up private capital to take flyers on potential game-changers.

For whatever reason, the funding innovation that floated the Monitor is finally reappearing in the form of the social impact bond. Its pioneers in London used it to prove the merit of a new approach to reducing recidivism by ex-convicts. Here in Massachusetts, Social Finance is sizing up new ideas in supportive housing for the chronically homeless, for example, and aging-in-place programs for elders. May they all fare as well as the Monitor, and their funders and social beneficiaries along with them.