Minnesota Explores ‘Pay for Performance’ Bonds

To Steve Rothschild, a nonprofit leader in the Twin Cities, the writing is on the wall: As states face mounting health-care costs and lower tax revenue because the number of older Americans is growing so fast, they will have less and less money to spend on nonprofit groups that provide social services.

Philanthropy can’t fully cover the gap, he says, so that leaves one untapped revenue source—private investors.

With that in mind, Mr. Rothschild helped devise a plan, now being considered by the Minnesota Legislature, to raise money for state programs by issuing bonds that would offer investors a 4-percent return on investment.

The state would use the money to pay nonprofit providers that provide job training, help addicts kick their habits, or other such services—but only if they produced specific results that would save the state money. For example, helping people find jobs would bring in taxes and getting them off drugs now would avoid further treatment costs later.

The idea bears some resemblance to social-impact bonds, a new financial tool that is attracting interest from foundations and the Obama administration.

However, there is a key difference: With social-impact bonds, the private investors take all the risk. They contribute money upfront and the government repays them plus a bonus if the programs they back meet specific goals. If the programs don’t meet those goals, they get nothing.

Under the Minnesota plan, nonprofits carry the risk. The investors get their return on investment no matter what, but nonprofits get paid only if they succeed.

That approach has won widespread support among nonprofit groups and think tanks in Minnesota, and state lawmakers have introduced legislation in both the Senate and the House to set up a “pay for performance” pilot project.

Mr. Rothschild—a former General Mills executive and the founder of Twin Cities Rise, a nonprofit job-training program—has started a new group to promote his idea, Invest in Outcomes. He says a fresh approach is needed to counter the expected decline in state funds.

“Nonprofits understand that the future looks bleak,” he says. “We’re dying a death by a thousand cuts.”

So what’s in it for the nonprofits? Why should they take the risk and how would they pay for expenses while waiting to get their bond money?

Mr. Rothschild says high-performing groups should have no problem earning their payments. In fact, he says Twin Cities Rise for 13 years has had good success with pay-for-performance state contracts.

Minnesota gives the group grants for each graduate of its job-training program who gets a job meeting certain income requirements, and additional grants for those who keep their jobs for at least a year.

But he acknowledges that nonprofits that do not have endowments or reserves may need a way to raise revenue while they are waiting to get their state money. So he and others are exploring ideas like allowing groups to borrow money from the state bond pool at a low interest rate or tap into a fund that foundations would create with program-related investments.

Frank Forsberg, senior vice president of the Greater Twin Cities United Way, has publicly endorsed the new approach. He says it would help nonprofits quantify the value of their service to the state and get paid the true cost of providing it. “So many government funding streams intentionally underfund,” he says. “I don’t think that’s the intent here.”

Watch a video of the press conference announcing the legislation to create the pilot project:

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