In an era of strict municipal budgets, more cities and states are exploring the use of “social impact bonds“

in order to fund programs that address social disparities. The model, which originated in the United Kingdom, offers investors a chance to earn profits on programs that successfully benefit the community.

For instance, a government may enter into a Pay for Success contract with an intermediary and social services provider in which the government only pays if high school graduation rates increase. The intermediary then raises money through its investors to provide the working capital needed to run the social services tied to increases the graduation rate. If the graduation rate does not improve, then the

government does not pay and investors risk losing their capital. Massachusetts and New York are among the first states experimenting with social impact bonds.

But while the use of social impact bonds is relatively new in the United States, the concept of tying payment for performance is not.

Since 1993, nonprofit organization Twin Cities RISE! (TCR!) has been working with men of color to help train them for local employment. Under an agreement with the State of Minnesota, the state pays TCR! $9,000 when TCR! demonstrates that it has placed one of its graduates into a job that pays at least $20,000 annually. TCR! can then secure an additional $9,000 from the State if these graduates stay in their positions for at least one year.

The amount the State pays TCR! may seem high – up to $18,000 per placement – but the rewards for the State of Minnesota are even greater. Data indicates that the State reaps $31,000 in total benefit when a person’s income increases from $10,000 to $20,000, simply because he is no longer eligible for state subsidies, and instead actively contributes to tax rolls. Importantly, TCR! has the motivation to ensure their training program is a success; if a person drops out of the TCR! program, TCR receives no payment. In order to ensure the sustainability of TCR!, the workforce development training must be narrowly tailored in order to help this hard-to-hire population find long-term, meaningful employment.

Using this pay-for-performance model, the State of Minnesota has netted a 671% return on its investment into TCR!

Massachusetts’ experiment with social impact bonds is along these same lines: earlier this year, Goldman Sachs teamed up with five local and national foundations to invest $18 million in Roca, a Chelsea-based nonprofit whose mission is to reduce recidivism among young men. If Roca is able to do so, the state will pay back the $18 million to investors, and then some. If Roca fails, investors will lose their money.

“We’ve got a new fiscal reality in government and we have to change the way we do business,” said Jay Gonzalez, then-Massachusetts State Secretary of Administration of Finance.

Minnesota has led the way in changing the way it does business, and TCR! is case and point.

Read more about TCR! and its impact on the Saint Paul and Minneapolis communities.