Executive Summary
As with traditional loans, a performance-based loan is a debt that an enterprise takes on which comes with a set of terms and conditions concerning interest, fees and repayment. The parties are also similar and involve a lender – in our case an impact-minded investor – and a borrower – which would be you as the service provider. Sometimes, an outcome funder can get involved who would cover the repayment and return in the case of positive outcomes to the intervention. What makes a performance-based loan special is the fact that the terms of the loan are directly linked to impact, which is why it is also often referred to as an “impact-linked loan” or a “social success note” (YunusSB). The better the performance in terms of pre-defined social and environmental criteria, the more favorable the loan terms will be for the borrower. In some cases, if the activities lead to exceptional results, the interest and debt can even be forgiven. In other words, the enterprise is incentivized to maximize its impact by receiving financial rewards ranging from discounted interest payments to partial or even full remission of the loan repayment.
When is a Performance-based Loan a suitable financing option?
A performance-based loan is especially relevant for enterprises with a strong focus on impact and a good trajectory towards reaching and even exceeding their impact goals. It is particularly suited for enterprises that have a proven model and are able to service debt, in accordance with their obligation to pay regular interest.
Due to the fact that financial returns can essentially be compensated by impact, a performance-based loan could even be relevant for a non-profit organisation without the ability to fully cover its cost. This is particularly the case if there the lender is a philanthropic or donor organization that is using a performance-based loan instead of a grant and will forego repayments and interest in return for impact.
The following (non-comprehensive) characteristics and implications provide you with an overview to analyse the pros and cons for this investment instruments:
| Enterprise Lifecycle | All stages |
| Amount | Depends on scope of intervention |
| Pay-back period (Maturity) | Depends on the loan terms, usually 3-5 years |
| Use of funds | Mostly unrestricted |
Source: Based on (Roots of Impact, 2020)
The following table summarises some key characteristics of a Performance-based Loan and implications you should consider:
| Characteristics | What does this mean for your enterprise |
| The higher the impact, the better the rewards. | If the service provider achieves high impact, the loan conditions, repayment terms or interest rates can be designed to reflect that, providing further incentive for outstanding results. |
| Profit is not the goal. | Usually, the return for investors is lower, which means that impact-oriented investors should be your first go-to, rather than those who value return over impact. However, investors who prioritise impact over return are still rather hard to come by. |
| Impact is verified independently. | An external party will be put in charge of measuring and verifying your intervention’s impact and outcomes. Make sure that you have a full grasp on the metrics they will be applying. |
| High risk/low return. | An investor who supports an impact-linked or performance-based loan may not prioritise financial return, yet the risk may be relatively high. An outcome funder and/or blended finance approaches can alleviate this risk and make an investment more worthwhile for the lender. |
| No mission drift. | Your organisation will not be forced into a situation where it needs to change its values or mission in order to generate revenue to repay the loan. |
| No equity is acquired and there is no board representation. | You can continue to manage your enterprise without having to engage and manage a(nother) shareholder. |
Key features
- Due to the “higher impact/higher reward” nature of a performance-based loan, the lender is actually fully on board with the idea of receiving less financial return in exchange for better loan conditions for you as a service provider. This means that they prioritize impact over profit and would rather see you outperform your envisioned impact, than just meet the goals you set out.
- As a variant, performance-based loans open up the option for an outcome funder, such as a philanthropic organization, government entity or aid agency, to get involved by paying back the financial investment and potential interest to the lender on your behalf. This is of course especially relevant if your intervention overlaps with that potential funder’s priorities. This involvement also lowers the risk for commercial investors who may be put off by currency fluctuations and political instability in many relevant target markets where social and environmental enterprises operate.
- Building upon the previous point, you can also incentivize investors by going for a blended finance approach, which will help de-risk an initial investment, for example grants designed to cover initial loss, and other (partial) credit guarantees. Also, if you are the recipient of zero-interest capital that can be coupled with an interest-based investment, your total interest rate will be lower than in the case of only a traditional loan.
- Also consider performance-based convertible loans and performance-based revenue share agreements. In the case of the former, your loan will convert into equity once you’ve unlocked predefined milestones. The discount your lender receives will depend on your achieved impact and again be tilted in your favour the higher your impact is. The latter implies that within a predefined range (regular rule-based adjustment), the level of revenue share is linked to the social enterprises’ impact performance – the higher the social outcomes, the lower the revenue share or the total amount to be paid back by the enterprise (Roots of Impact).
Tips to build your investment case as an early-stage water-related enterprise
Basic requirements
The requirements for a performance-based loan are quite similar to other loans: You need to be able to pay back what is put in and pay an interest. The difference is that the pay back can occur in the form of impact, so, environmental and social benefits that are exercised through your enterprise’s intervention.
Leveraging your impact profile to access a performance-based loan
In order to be able to unlock a performance-based loan, you need to demonstrate a solid management structure that is able to oversee and respond to investment requirements, will stick to repayment schedules, and can work with an evaluator to translate your impact into quantifiable numbers. As performance-based loans in the development world are often tied to blended financing approaches, you should be able to manage multiple financiers at once and keep control over their differing priorities as well as your respective deliverables. A performance-based loan will be of interest to you if…
…you have a business model or growth scheme in which the impact is tangibly traceable.
Want to find out whether you can prove your impact sufficiently to fulfil the criteria of a performance-based loan? Think of it this way – can you argue your funding needs like this: “By investing x (amount of loan) into my solution, we will be able to improve the lives of y (number of people) through z (activities – e.g., extending piped services to underserved villages)”? Or alternatively: “By investing x (amount of loan) into my solution, we will be able to treat and reuse y liters of water / divert y tons of organic waste from landfills / CO2 emissions have been reduced by y…, leading to (better environmental conditions)”? In short, your impact goals should be tangible, to-the-point and measurable. Your investor wants to see clear results, and ideally wants you to exceed them.
… you want to attract blended finance.
Blended finance is a great solution for impact-oriented enterprises and is increasingly gaining traction in the development sphere. OECD defines it as “the strategic use of development finance for the mobilisation of additional finance towards sustainable development in developing countries”. Investors are often still reluctant to invest into social or green enterprises as they do not believe in their profitability. Yet, due to public funding restrictions, private finance is key to fill the financing gap in the developing world in order to tackle growing global challenges and achieve the SDGs. With development and governmental actors acting as outcome funders or financing partners backing interventions up, some risk is diverted away from the commercial investor, thus increasing the latter’s willingness to “experiment” by investing into sub-commercial or non-commercial approaches such as yours. For you as an entrepreneur or service provider, more financiers also mean more responsibility. Make sure that you have the capacity to absorb and coordinate different sources of funding.
… you do not possess assets that could serve as collateral for commercial loans.
In the traditional world of finance, you will need to demonstrate to your investor via a balance sheet what assets your enterprise possesses. These assets may serve as collateral in case you default on your debt and/or go bankrupt. Unfortunately, water related assets often do not work as collateral (it is hard to sell a distribution network or treatment plant to another buyer), making regular bank-loans difficult to access (PORIES et al. 2019). Due to the impact-oriented nature of a performance-based loan, however, the financing terms in this case are usually only tied to the cashflow generated throughout the intervention. However, that does not mean that you would not need to subject your enterprise to thorough due diligence processes and cash flow analyses (GIZ). These traditional control mechanisms will still be in place in the case of a performance-based loan.
