Venture philanthropy can look hideously complex. It may involve private investors, governments, nongovernmental organizations, and community groups—not to mention the recipients of the funding. And each of these groups has a different way of measuring success. It’s a process with several different bottom lines, including both financial return and societal impact.

But it is precisely this diversity that makes venture philanthropy a hothouse for innovation. The traditional models for both business and charity fall short, and on their own, neither can be easily tweaked to create an appropriate mechanism. Instead, venture philanthropists must blend the various interests of governments, societies and investors as they look to forge self-sustaining, or even profitable, enterprises from such unlikely “markets” as disaster relief or treating drug addicts in rehab. Without innovation, venture funding and philanthropy naturally gravitate toward their separate realms.

However, when innovative ideas bring the two sides together, the results can be compelling. Consider the new Social Impact Bonds (SIB) in the UK. These bonds channel private funding into social programs, with the British government paying interest that rises or falls with the measured success of the venture. The first SIB investment, managed by St Giles Trust, bankrolls a rehabilitation program for ex-convicts. If the program meets its goals of steering the target group away from crime, interest rates on the bonds will rise. This no doubt benefits the British exchequer, which saves funds on policing, processing, and jailing offenders. The greater the success of the program, the greater the return for investors, and British society reaps the rewards in lower crime.

The benefits of such philanthropic ventures extend broadly into the nonprofit realm. By establishing the means of measuring their impact, the funds create markets where there were none before, and monies migrate to the most promising ventures. If the rehabilitation program in Britain, for example, comes up short, investor funds will pursue other opportunities. Investors thus reward success, as in traditional markets, and reap rewards from it. The SIB model will soon be introduced in the United States, with the Obama Administration adding $100 million for SIBs in the 2012 federal budget .

Interest in market-focused philanthropy is perking up on both sides of the Atlantic. California recently introduced so-called Low-Profit Limited Liability Companies, better known as L3Cs. L3Cs clearly state that financial performance, while important, counts for less than societal impact. Meanwhile, the Obama Administration’s Social Innovation Fund is offering a one-to-three match for funding for VP partners, such as pioneers Venture Philanthropy Partners, REDF (Roberts Enterprise Development Fund), and New Profit Inc. A similar fund is expected soon in Europe. In France, so-called Solidarity Funds (Fonds Solidaires) are on the rise. These are normal investment funds that must place a certain level of their assets, usually 5 to 10 percent, in social investments. Investors receive preferential tax treatments and other incentives.

The danger, of course, is that unreasonable promises made by the promoters of some social finance products could lead to an imbalance, with too many assets chasing too few bona fide programs, creating a pool of investors disappointed to find that their investment resulted in little societal impact. In such a social finance “bubble,” excess funds could end up piling into investments, from microlending to private equity in emerging markets. This could damage the reputation of the entire sector, defining social finance as little more than new packaging for traditional finance.

How to avoid this? In the short-term, it’s up to investors, government officials, and regulators alike stay on top of the industry, culling out pretenders masquerading as philanthropies. At the same time, the best growth strategy for the industry is to come up with greater supply—more imaginative programs that blend investment opportunities with government funding for social good. The key, naturally, is continuous innovation.

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