In 2014, the state of Massachusetts, the nonprofit Roca, the financial intermediary Third Sector Capital Partners, and a group of investors entered into a contract under which Roca was funded by the investors to operate a program to keep formerly incarcerated young people from returning to prison (known as recidivism). If Roca meets the contract goals, the state will repay the investors their principal plus interest. If the program fails, investors risk losing some or all of their money, as the state would not be required to pay.
Massachusetts is willing to pay if the program succeeds because it saves money in the long run by keeping people out of prison. Additionally, it will lead to more contributing members of society and the overall safety of the community at large. Investors are willing to put their capital at risk because of the potential returns as well as the social benefits resulting from Roca’s program. Roca is eager to have access to capital and showcase its program’s effectiveness, which could lead to significant amounts of additional funding if proven successful.
This case illustrates the motivations of pay-for-success (PFS) contracts, also known as social impact bonds, which have the potential to fill the funding gap between social programs and return-seeking capital.
Career Impact Bonds
Career Impact Bonds are a subcategory of social impact bonds in which people who face barriers to education and employment (such as low income, a criminal background, and immigration status) receive access to industry-recognized career training. This form of financing is based on an income share agreement (ISA) that allows students to enroll in training with no upfront costs.
- Impact investors provide capital to training providers to cover training costs and support services.
- Students enroll free of charge and graduate from the programs.
- Those who gain meaningful employment repay program costs as a fixed percentage of their income, which is capped at a set dollar amount and a certain period of time. Those who don’t find employment pay nothing.
- Impact investors and training providers share any payments received from students.
The need for accessible career training and reskilling is greater than ever. Positions in many industries are disappearing daily as new, specialized jobs take their place. For many, lack of economic mobility is a serious problem. CIBs may be the answer.
CIBs are built in three parts: 1) Finding in-demand job opportunities in industries poised for growth based on labor market data, 2) Designing interventions to ensure maximum impact and helping students overcome barriers, and 3) Collaborating with proven training providers with high job-placement rates and existing relationships with employers.
CIBs are not the average ISA, they’re much more than that. Their structure enables them to have a holistic, career-based approach to job training. This structure is built on a people-centered design, complete support services, flexible repayment terms, pay-it-forward funds, and aligned incentives across all parties.
Although the benefits for social impact bonds in general are great, challenges still exist. The ability to quantify costs and benefits relating to a variety of social issues both by government agencies and nonprofits remains as the most glaring roadblock. Additionally, the use of the PFS model will likely result in a few institutions receiving the vast majority of investments as certain programs and organizations prove to be more effective than others, meaning an aggregation of funds and an inability to impact a broad spectrum of social issues.
Nevertheless, PFS’s ability to attract return-seeking capital and align its interests with those of government agencies and nonprofits is an exciting development. Significant headwinds must be conquered before this type of philanthropic investment becomes mainstream.
Pay-for-success contracts offer yet another alternative form of impact investing and, regardless of its exact results, shows the creativity and brain power dedicated to solving some of humanity’s biggest challenges.