At British International Investment (BII), we are committed to structuring our investments in ways that maximise development impact. One of the innovative tools we use to achieve this is Impact-Linked Finance (ILF)— investment strategies and financial structures that explicitly tie financial reward to the achievement of defined social and/or environmental impact objectives. ILF is a versatile structuring approach that can be used across the spectrum of financing products, impact priority or sector.
ILF remains a niche practice in impact investing, despite being used by some practitioners for many years. Most evidence to date on the effectiveness of impact-linked incentives comes from public sector applications like social impact bonds. At BII, we have used ILF to ensure our goals are aligned with those of our investees, ensuring that both financial and impact performance are incentivised. For example, our recent report on lessons from six years of investing in women discusses how we’ve used ILF to incentivise Growth Investment Partners (GIP) Ghana to invest in 2X-qualified businesses, increasing women’s representation at all levels of the workforce. While other organisations have led the way in applying ILF to debt products alongside concessional or blended finance, our approach has been more experimental, applying ILF selectively across a diverse range of products (debt, funds and equity) using our Growth capital pool.
To better understand how ILF is being used in the market and to assess the effectiveness of our own ILF transactions, we commissioned Roots of Impact to speak with 11 DFI peers and impact investors about their ILF practices and conduct an evaluation of our ILF portfolio. While our ILF transactions are too recent to evaluate their impact, Roots of Impact assessed the quality of their design to provide early lessons for our future ILF investments.
What did we find?
Some of the key findings from this study include:
- While most practitioners have focused on using ILF through debt products using concessional or blended finance, BII is among the few applying ILF across debt, equity, and fund investments – and on more commercial terms through our Growth Portfolio. This includes innovative structures like impact-linked management incentives and impact carry.
- Our ILF transactions are well-aligned with emerging evidence on where ILF is most suitable. Our ILF deals generally met Roots of Impact’s ILF suitability criteria. Where gaps existed in investees’ impact measurement and management systems, we used technical assistance to build their capacity in these areas. Practitioners agree that technical assistance plays a critical role in helping investees build impact measurement systems, implement policies, and verify results.
- Understanding investee priorities and co-creation are key. Practitioners emphasised that ILF metrics should be aligned with investees’ existing impact and commercial strategies. Early engagement and co-creation of metrics help ensure relevance and buy-in. At BII, most of our ILF structures are developed in close collaboration with investees. This approach strengthens commitment and increases the likelihood of sustained impact.
- Simplicity and transparency matter, but ILF metrics should focus on outcomes, rather than outputs. Across the market, practitioners prioritise simple, transparent metrics that are easy to measure and verify for ILF structures. However, incentives are likely to be most effective at driving impact when they reward outcomes, not just outputs. This points to the careful trade-offs required to select outcome-level metrics, maintain simplicity, ensure alignment between investor and investee, and costs. It is important to ensure any output-level indicators have a strong link to intended outcomes, supported by evidence.
- Flexibility in setting and refining targets is important. Given the lack of historical data and dynamic market conditions, many ILF practitioners adopt adaptive approaches—setting targets after initial implementation periods or allowing for adjustments over time.
- Governance structures are important for ensuring effective management and strategic alignment throughout the lifetime of an ILF transaction. Governance structures are particularly valuable when metrics and targets require adaptation over time.
What could we do better?
The evaluation highlighted areas where we should strengthen our approach to ILF. These include:
- Develop more data-driven approaches to pricing ILF incentives, ensuring they are sufficiently attractive to investees while delivering value for money, noting that the use of evidence-based approaches for pricing is an industry-wide challenge.
- Consistently consider the potential for additional impact in ILF transactions. The evaluators found that while most of our ILF transactions were likely to generate additional impact, guidance should ensure that this is consistently considered and that incentives are sufficiently ambitious.
- Generate more evidence to a) verify data provided by investees and b) rigorously evaluate the impacts of ILF, to strengthen the evidence base on where ILF is most effective.
What’s next?
We are already applying the findings from this evaluation to strengthen our ILF practice and develop further guidance. We hope this report will support other DFIs, impact investors, and practitioners in designing and implementing ILF structures that are both impactful and commercially sustainable.
