According to the Nonprofit Finance Fund, most nonprofit organizations orient their funding around outputs, not outcomes. As a result, they tend to focus on the measures of their operations and activities rather than on the issues underlying the challenges they’re trying to address. However, by zeroing in on outcomes—the tangible results of the outputs—organizations can prioritize resources on efforts that have a sustainable, long-term impact on the causes they champion.
Recognizing the deeper value of successful outcomes, a form of nonprofit funding called pay-for-success (PFS) financing has emerged over the past decade. Here’s a look at how it works and the important role impact investors play in driving its success.
What Is Pay-for-Success Financing?
Nonprofit project management firm Social Finance describes pay-for-success initiatives—also known as social impact bonds—as public-private partnerships built around performance-based contracts to support social programs. According to Social Finance, the PFS model follows several crucial steps and involves a number of key players, including government bodies, intermediaries, service providers, private investors, and third-party evaluators.
First, a government body identifies an issue with the help of an intermediary and outlines its goals for a solution. It then chooses a nonprofit service provider partner, who will employ an evidence-based approach to effectively address the issue. The intermediary develops the PFS project, solicits funds from the impact investing community, and contracts with the service provider. After the service provider has executed the program, a third party evaluates the project’s outcomes. If the objectives have all been achieved, the government pays back the investment to the impact investors (plus a modest return). If the program fails to achieve its goals, there’s no government payment.
Ultimately, PFS programs redirect much of the financial risk from government entities—which historically funded nonprofits directly—to investors. Impact investors within this model provide the up-front capital with no guarantee of repayment or gain unless the nonprofit achieves its goals.
What Does Pay-for-Success Look Like in Action?
First utilized in the United Kingdom in 2010, the initial PFS program in the US was implemented at New York City’s Rikers Island jail complex in 2012, according to the Corporation for National and Community Service. The Rikers Island project aimed to use a group therapy approach to cut adolescent repeat offenses but was terminated after three years—one year early—when a preliminary report showed that the program had no effect on recidivism. As a result, New York City did not pay back the investors.
The typical PFS project requires considerable planning, including the development of the investment note and feasibility studies, according to Project Evident. As a result, adopting the approach has been relatively slow, although about 25 PFS projects have launched since 2012, including:
- The 2016 Massachusetts Juvenile Justice PFS Initiative, which seeks to reduce recidivism and increase employment among young men both within the state’s probation system and leaving the juvenile justice system.
- The 2016 South Carolina Nurse-Family Partnership Pay for Success Project, which works to improve maternal and child health outcomes for low-income families. The program’s initial success has prompted the national nonprofit Nurse-Family Partnership to explore similar initiatives elsewhere, including in the San Francisco Bay Area.
- The 2017 Cuyahoga County, Ohio, Partnering for Family Success Program, which aims to help children from homeless families spend less time in the foster care system.
What Are the Pros and Cons of Pay-for-Success?
The PFS funding approach has both supporters and detractors.
Backers point to benefits identified by the US Department of Education. First, PFS nurtures an outcome-driven, evidence-based mind-set around developing new solutions to societal issues. It deepens the connections between service providers, investors, and government bodies while rewarding impact investors for their interest in improving society and building the body of knowledge around what makes an initiative successful.
Conversely, the Corporation for National and Community Service notes the prospect of an investment return has prompted researchers to worry that charitable giving levels will drop and profit-driven entities, instead of on-the-ground nonprofit service providers, will dictate what projects get done. Critics are also concerned that strategies will favor lower-risk solutions for lower-risk social problems, which tend to generate favorable results more easily. At the same time, some have argued that PFS contracts present a risk-to-reward ratio that may turn off private investors.
Project Evident also decries the substantial infrastructure and process requirements PFS programs demand. These requirements consume valuable time, energy, and resources that many nonprofits can’t spare. Furthermore, the evidence-based philosophy is built on proven practices and procedures, which risks inhibiting innovative thinking and may limit adaptability to localized issues and challenges.
It remains to be seen how the $100 million in support for pay-for-success initiatives designated by the federal Bipartisan Budget Act of 2018 will boost the acceptance of such programs. However, the growing awareness of the importance of outcomes versus outputs stands to bolster the benefits for anyone striving to improve society—impact investors, governments, nonprofit organizations, and most importantly, program participants alike.