Anatomy of a Pay-for-Success Deal to Keep Men From Returning to Jail

Pay-for-success deals—in which private investors front the money for a government program and receive a return from the government if certain benchmarks are met or exceeded—are rising in popularity. Fans of the funding mechanism say taxpayers are on the hook for social programs only when they achieve favorable results.

Although a number of private investment firms and foundations are warming up to the pay-for-success approach, and pending legislation on Capitol Hill would encourage its growth, the process remains relatively untested. For a deal to succeed, leaders in the field stress that the nonprofits carrying out the work must be prepared to have their efforts measured.

That was the case with Roca, a Chelsea, Mass., nonprofit that works with young men in the criminal-justice system. Roca’s program encourages the development of social relationships and includes vocational training and education. In 2014, the group participated in a $27 million deal in Massachusetts to reduce recidivism and increase post-incarceration employment.

Roca provided peace of mind to both the state government and the investors because it was used to having its impact calculated, says George Overholser, co-founder of Third Sector Capital, a consulting firm that is managing the Massachusetts deal.

“They are very measurement-oriented,” he said. “They had done a lot of evaluation.”

For example, the nonprofit provided data that show that in 2013, the 115 young men who participated in Roca’s program experienced fewer arrests, fewer parole violations, and higher employment rates than other young male ex-offenders in Massachusetts.

Mr. Overholser hopes that as the pay-for-success deal allows Roca to include 929 young men in its program over the next few years, many more will permanently exit the criminal justice system.

Eileen Neely, director of capital innovation at Living Cities, an investor in the project, believes the program has potential because Third Sector and Roca have “skin in the game.” The two organizations have placed 15 percent of their fees “at risk,” meaning that if the intended results are not attained, they will receive only 85 percent of their fee. “If they weren’t as committed as the government and the funders were, everything would fail,” she says.

It helps, she says, when all of the partners in a pay-for-success deal have an incentive for it to work: The government wants to save taxpayer money; the investors want to see a return; and the service providers would like to be paid in full.

“The beauty of pay-for-success when it’s structured really well is that all interests are financially aligned as well as morally aligned,” she says. “We all say we want the same thing, but with pay-for-success, there’s a contract that says we want the same thing.”

The past year has seen a flurry of pay-for-success deals. On February 16, South Carolina Gov. Nikki Haley announced the completion of a deal designed to improve the health of poor mothers and their children. The same day, Connecticut Gov. Dannel Malloy announced a pay-for-success effort to expand family-based recovery projects to 500 people suffering from substance abuse. The two deals follow programs started in Santa Clara County, Calif., in August, and in the Boston area in April.

Each deal is different. Here, an infographic from Living Cities explains how investors envision the seven-year plan to reduce juvenile recidivism working in Massachusetts.

For more information on pay-for-success deals, watch this series of video discussions.