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The Hidden Cost to ‘Pay for Success’

Nonprofits have discovered a hidden cost in preventative social programs that's keeping many from even trying to start one.

Lili Elkins spends a lot of time planning and negotiating. It’s her job as chief strategy officer of the Boston-area youth nonprofit Roca. But nothing could have prepared Elkins for the project that came across her desk in 2012: It was to help design what is so far the country’s largest social impact bond.

The “bond” funds a program to help reduce recidivism and increase employment among young ex-offenders. Over seven years, Roca will provide counseling and job training to 929 young men in the probation system or exiting the state juvenile justice system.

In Elkins’ prior experience at Roca negotiating grants, project design was generally ironed out in a few meetings over the course of a month. The social impact bond project for Massachusetts, however, took two years of negotiating. “I teach financial management to graduate students and I’m a lawyer,” said Elkins,” and I still needed help understanding the financing.”

Social impact bonds, which many are now calling pay for success programs, work like this: Private funders pay a government to establish a preventative social program aimed at achieving a certain measurable result. The only way investors get their money back is if the program meets those results.

The Massachusetts project, which launched in late 2014, rounded up more than $20 million from investors. But the time and cost it took to design the project exposes a major, potential deterrent to other nonprofits interested in developing a pay for success project for a government.

Part of the problem is that each pay for success project -- and there are only eight up and running across the country -- is unique. 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. To help with the burden, Roca was able to utilize $250,000-worth of free legal aid to help with the negotiating. Still, Roca ended up devoting more of its top staff time than it bargained for when it started.

It's because of this that Living Cities, one of the funders of the Massachusetts recidivism program, is creating a new funding option for nonprofits interested in getting involved in pay for success projects. The foundation has secured investors for a revolving loan fund that would help nonprofits pay for designing a project, which includes things like data gathering, analysis of that data, economic modeling, evaluation design and program training.

Called a “construction loan,” it would be paid back by the nonprofit only if a pay for success project moves forward. The cost of the construction loan could be built into the overall financing of the project by private funders. If the project launches, part of the money the nonprofits receive in funding could be used to pay back the loan. Living Cities has so far advanced a total of $350,000 to support projects in Illinois, New York and Salt Lake County, Utah.

Eileen Neely, Living Cities’ director of capital innovation, hopes it will help governments recognize the full cost of paying for social preventative programs. “Currently they just assume the service provider will find grant money for the other costs and that’s part of the reason we don’t have as many projects,” she said. “This is another way to make sure we are being honest about the entire cost of pay for success.”

Liz Farmer, a former Governing staff writer covering fiscal policy, helps lead the Pew Charitable Trusts’ state fiscal health project’s Fiscal 50 online resource.
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