“Pay for Success” Experiment Launches in Massachusetts

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August 1, 2012; Source: Boston Globe

If given the opportunity, would your nonprofit be willing to stake its revenue on its ability to reduce specified state government expenses related to its target issues? The upside is that if you succeed, you’ll receive both direct compensation for your services and a share of the money saved by the government. You’ll also have a lot more freedom to design your program and allocate resources than one often finds with public sector funding. The downside is that if you don’t succeed, you’ll get little or no compensation. That’s the deal being offered by the Commonwealth of Massachusetts to two nonprofit organizations under a pilot “pay for success” funding model. The two pilot organizations, Massachusetts Housing and Shelter Alliance, and Roca Inc., focus, respectively, on helping chronically homeless people and juvenile offenders/at-risk youth.

Under what’s officially called the “Social Innovation Financing” program, participating nonprofits must raise the upfront costs of program delivery themselves, generally in the form of loans from foundations, individual donors and investors. If the programs can demonstrate that their services reduce state costs for serving the target populations, the state will reimburse the nonprofit’s expenses as well as a bonus based on cost savings. With these funds, the nonprofit can reimburse its investors and make money to invest in future programs. Should the nonprofit programs not deliver the desired results, however, the initial investors may lose their money and the nonprofit may lose credibility. A nonprofit financial advisory firm, Third Sector Capital Partners, is helping to oversee both initial pilots. Its founder, George Overholser, notes that the new program has attracted diverse allies. “This has political appeal, because it’s both socially progressive and fiscally conservative.” As NPQ recently noted, a similar experiment is also planned for New York City, though there, some of the risk is being absorbed by Mayor Michael Bloomberg’s personal foundation.

Yes, the “pay for success” funding model is risky, particularly for nonprofits and their investors. In fact, a key underlying principle is “to transfer the risk of failure from the state to the financial backers of nonprofits, and to insulate taxpayers from programs that don’t work.” At the same time, this funding model could also provide powerful flexibility and incentive for wise innovation that enables nonprofits to better accomplish their missions. The potential returns are by no means clear or guaranteed, but it’s an experiment that many are watching and hoping will yield some useful lessons for the field. –Kathi Jaworski