Pay for Success “Construction Loan” Aims to Scale Innovative Model

Written by Amanda Maher

Government agencies are sometimes criticized for funding grant programs that allow social service agencies to administer programs such as community health care, affordable housing and job training. Policymakers must often counter accusations that many of these programs are financially unsustainable.

This is one reason that Pay for Success models are gaining so much attention.

Pay for Success (PFS) uses private investment capital to fund the delivery of specific social services, and those investments are repaid by government agencies if – and only if – the social service agency delivers on the results it promises.

One of the largest and best-known models has been led by a Massachusetts-based nonprofit organization, Roca. In 2014, Goldman Sachs teamed up with five local and national foundations to invest  $18 million in loans and grants to Roca, whose mission is to reduce recidivism among young men at high risk of re-offending in several inner city communities by providing life skills, education and employment. If Roca is successful in helping the targeted 924 “high-risk” young men over the seven-year program period, Massachusetts will pay back the investors, with interest. If Roca fails, investors may lose their principal investments.

The crux of the PFS model is that the outcomes of these social service programs will generate new revenue or cost savings for government agencies, which government agencies will then be able to use to repay investors with interest.

Two years ago, we profiled Twin Cities RISE (TCR)’s Pay for Success program. Since 1993, TCR has been working with men of color to 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 receives an additional $9,000 from the State if the graduate stays in his position for at least one year. The state ultimately benefits financially when a graduate is successful, because they are less likely to be receive state subsidies and more likely to be contribute through state taxes. It’s a win-win for the agency, the clients it serves and the State.

The PFS framework, proponents believe, could serve as a new way for holding social service agencies accountable while ensuring programs are sustainable over time.

Yet as Roca learned, these models are still relatively new and require significant upfront investment of both time and financial resources to ensure they are set up properly.

“Part of the problem is that each pay for success project — and there are only eight up and running across the country — is unique,” wrote Liz Farmer for the Council of State Governments Justice Center. “That means that project designs aren’t easily transferrable from one government to another. So each project requires a nonprofit to surrender their best talent for great lengths of time.”

Living Cities and Third Sector Capital Partners, both of which were involved in the Roca Pay for Success program, have responded to this challenge by launching the “Pay for Success Construction Loan”. The loan program is designed to pay for the upfront costs of developing (or “constructing”) PFS projects and to help move them from conceptualization to completion.

“If early PFS efforts are effective, they will spark additional interest in opening up capital inflows from commercial institutions and private investors,” said Eileen Neely, Director of Capital Innovation at Living Cities, in a press release. “This loan will help get more PFS projects underway, so we can advance our goals beyond the dollars that grants can supply and prove that PFS is a viable model for investing in human capital.”

The construction loans would only be repaid by the social service provider if a PFS project moves forward. At that point, the cost of the construction loan would be included in the project’s overall project budget to be funded by private investors.

PFS projects in Illinois, New York and Utah will be the first to receive construction loans, for which $350,000 is available in total.

“This is another way to make sure we are being honest about the entire cost of pay for success,” Neely says.

To be sure, PFS is unlikely to be a silver bullet. As noted in a recent Stanford Social Innovation Review article, the model is often only appropriate when the nonprofit agency can meet two criteria: 1) that they are able to effectively measure social impact; and 2) that they are able to translate that impact into financial benefits or cost savings.

That notwithstanding, that Living Cities and Third Sector Capital Partners are willing to invest in the upfront planning and development needed to launch PFS projects indicates that there is a growing desire to explore this unique model.