NB Financial Innovation
Filling the Funding Gap in ‘Pay for Success’
Experimentation and social change go hand in hand. At a time when government resources are constrained, we need to experiment with new approaches to finance and scale promising social programs.
At Living Cities, we are exploring new ways to unlock private capital for social good, harnessing the collective power of 22 of the world’s largest foundations and institutions to develop, implement and evaluate strategies geared toward improving the lives of low-income people in America’s cities. As Director of Capital Innovation at Living Cities, I focus on leveraging private capital and philanthropic resources to achieve both financial and social returns.
A Promising Tool to Address Funding Gaps
My experience in this work has shown that Pay for Success (PFS) is a promising tool to measurably improve the lives of people in need and address the gap in funding for social programs. In the PFS model, private and philanthropic funders invest money in preventative social programs, and the government only repays them for successful outcomes. This allows governments to be more responsible stewards of taxpayer dollars by only funding projects that work. To date, PFS has driven private capital to areas such as improving education and health outcomes and reducing juvenile recidivism and chronic homelessness.
Eight PFS projects are already underway in the U.S., and there are over 50 more in the works, many of which will be raising capital in the next year or so. The potential to apply the PFS model to new issue areas is tremendous, but will require exploration by more players. Living Cities is working to accelerate the launch of more PFS projects to increase learnings and ultimately deliver better results for low-income people.
Concerns with the PFS Model
But looking back at our experience working on Living Cities’ first PFS investment, which was aimed at reducing youth recidivism in Massachusetts, I had some concerns. Although I was confident the time and money needed to put a PFS project together would go down, in the meantime I worried that the upfront costs necessary to put the transaction together could limit the scalability of the model.
Traditionally, grant money has been raised to fund these upfront activities, including target population selection, data gathering and analysis, economic modeling, evaluation design, program training and scaling. I wondered if the need to secure grant capital so early on would stall PFS deals before we had the chance to test and strengthen the model. Would reliance on grant money limit the scale and impact of PFS work?
When looking for a solution to this problem, my colleagues and I saw similarities between PFS and affordable housing deals. After all, to put an affordable housing deal together, a lot of work must be done before the project can break ground, from environmental studies to permitting and architectural design. While some of these costs are paid through grant money, most are funded through predevelopment loans.
One Solution for Upfront Costs
Living Cities drew inspiration from this analogous situation to design the PFS “Construction Loan,” in collaboration with Third Sector Capital Partners, a nonprofit advisory services firm focused on accelerating America’s transition to a performance-driven social sector. The PFS Construction Loan is a first-of-its kind loan product designed to cover the upfront costs of constructing PFS projects. The loan aims to build the foundation for successful PFS outcomes by offering an alternative to fundraising grants so more projects can get underway and begin delivering results.
Funding for this new loan product is already underway. Living Cities secured $350,000 in investments from Deutsche Bank Americas Foundation and The Chicago Community Trust that will support the construction of projects in New York, Illinois and Salt Lake County. The loans are made to the project’s special purpose vehicle (SPV) and are repaid by the funders of the PFS projects once they officially launch and start delivering services. Third Sector Capital Partners is providing advisory services to help structure and close the projects.
The PFS Construction Loan is one of the newest experiments in harnessing private capital to solve social problems. By encouraging more PFS projects, Living Cities ultimately aims to increase the number of impactful programs that are measurably improving the lives of people in need.
Photo credit: John Ashley
Eileen Neely is Director of Capital Innovation at Living Cities.