When Social Enterprises and Their Funders Contract (Relationally) for Impact

Abstract

This article reviews how two distinct types of business dealings for funding social enterprises—outcomes-based contracts and intercreditor “handshake” agreements among lenders to microfinance providers—have taken relational approaches to contracting. In doing so, this article considers the larger question of when might a relational contracting approach overcome the challenges of contractual incompleteness that often prevails where parties are seeking to achieve financial and societal returns. It looks at how relational contracting can be used to maintain an alignment of multiple interests and return expectations of contracting parties, and create more resilient transactions that are able to navigate unexpected or unforeseen events like the COVID-19 pandemic. It then proposes a research agenda for future investigation of the role relational contracting might play, or not, when funding social enterprises.

Executive Summary

The business dealings of social enterprises and their funders require a continual alignment of multiple interests and expectations. This alignment needs to hold not only when things are going to plan, but also in the face of unforeseen shocks that threaten to derail the delivery of all or some of the parties’ financial and impact objectives.

It is in circumstances like these, when contracting parties face unexpected and unforeseen events, that the contractual arrangements that underpin these business relationships often reveal their incompleteness, as they offer little useful guidance about how the contracting parties should respond to the event, to each other, and, importantly in this context, to the target beneficiaries that sit at the heart of this business relationship. While all contracts are incomplete, those that are created for parties that are seeking to marry financial and impact returns are likely to be more incomplete than commercial contracts that more singularly focus on achieving financial goals.

As seen and analyzed in more commercial contexts, relational contracting offers an approach to confront the challenge of incomplete contracts by establishing at the outset and then maintaining an alignment of interests and expectations among contracting parties over the life of their business dealings. ¹ Far less attention has been paid in academic literature or in practice as to how a relational contracting approach similarly could be used by social enterprises and their funders to establish and maintain an alignment of interests and expectations in their long-term, interdependent dealings. Additionally, a relational contracting approach may help social enterprises and their funders to not only create more resilient contracts capable of responding to unforeseen challenges, but such a contracting approach holds promise for making room for parties to innovate and find additional opportunities for generating positive social impact.

This article investigates the broad question of when might a relational contracting approach overcome the challenges of contractual incompleteness where parties are seeking to achieve financial and societal returns. It draws on practitioner experiences with two very different types of impact-seeking transactions where relational contracting approaches were tested by or used to respond to the unexpected challenges raised by the COVID-19 pandemic—(1) outcomes-based contracts, and (2) “handshake” intercreditor agreements used by impact-driven lenders to providers of microfinance. It then concludes by highlighting hypotheses for further research to determine the context and extent to which relational contract approaches—formal or informal—would be appropriate for other dealings of social enterprises and their funders.