1. Risk Trade-off Continuum for Different Structural Approaches to Pay-
for-Success Financing
April 2012
Nonprofit Finance Fund’s work in the Pay for Success Financing field is generously supported by the
Rockefeller Foundation, the William and Flora Hewlett Foundation and The Joyce Foundation.
Over the past 18 months, Nonprofit Finance Fund (NFF) has served as the recognized, independent voice in the
emerging Pay-for-Success financing (“PFS Financing”) field in the United States. This objective role has given NFF an
unbiased platform for education and information dissemination on the potential benefits and challenges of PFS Financing
in the United States.
In this and future reports, NFF will present our views on the significance of the trends and developments we are
observing in the strategic path of the PFS Financing field. NFF’s views on these issues will be informed by the:
• diverse field data we have collected over the past 18 months and will continue to collect;
• insights derived from this data through our unbiased perspective; and
• trends we have observed through our system-wide rather than transactional perspective.
PFS Financing: 3 Key Stakeholders, 3 Unique Perspectives
PFS Financing projects require significant collaboration and resource commitment from 3 key stakeholders: investors,
providers, and government.
Field data increasingly suggest that each potential way of doing PFS Financing [for example, the Social Impact Bond
(“SIB”) and the Human Capital Performance bond (“HUCAP”)] involves a number of potential risk trade-offs for each of
these stakeholders. Oftentimes, these trade-offs impact each of the three stakeholders differently. They also can make
one way of doing PFS Financing or another more effective in meeting the needs of investors, providers and government
involved in a given project. This is particularly the case with the proof-of-concept pilots under discussion and
© 2012, Nonprofit Finance Fund®. All rights reserved.

2. development in a number of locations across the U.S. Because of this, these trade-offs need to be identified, understood
and managed collaboratively in developing PFS Financing proof-of-concept pilots. This will help the three stakeholders
achieve an acceptable collective balance of advantages and disadvantages in a more timely and productive fashion.
Among these trade-offs are factors such as:
• measurable social impact potential
• the ease of identifying and capturing the economic value of social impact
• financial risk and return to each stakeholder
• reputational risk for each stakeholder
• transaction execution and due diligence costs
• cost of capital to the government funder and service provider(s)
• transaction management and governance structures
• legislative requirements
• procurement and contracting systems change
• the potential for transaction structure replication and scalability
To date, NFF has observed that the comparative trade-offs between and among various ways of doing PFS Financing
have not been thoroughly examined in the United States. Also, to NFF’s knowledge, there has not been significant
consideration or analysis of possible HUCAP or SIB hybrid structures or alternative ways of doing PFS Financing
suggested by HUCAP and SIB. Such alternative and hybrid structures have the potential to provide stakeholders with a
blend of trade-offs that can help them reach agreement on launching proof-of-concept pilot projects more easily. They
also have potential to support a wider range and type of PFS Financing projects.
As a first step to address this current knowledge gap, NFF has developed a series of infographics. These infographics,
all of which are referred to under the general heading, Risk Trade-off Continuum for Different Structural Approaches to
PFS Financing, are designed to:
• depict and initiate a dialogue about NFF’s current assessment of the diverse trade-offs for investors, service
providers and governments that are inherent in different execution structures or “ways of doing” PFS Financing,
such as SIB and HUCAP; and
• suggest some alternative and hybrid transaction execution structures for PFS Financing.
Transaction Execution Structures or “Ways of Doing” PFS Financing
NFF uses the term “PFS Financing” to describe the broad category of innovative structures and approaches to financing
social programs that have the following characteristics:
• they finance prevention and early intervention services;
• they access private sources of working capital and/or risk capital to finance these preventative and early
intervention services;
• they reduce both the cost and risk of government funding for social programs by virtue of their focus on prevention
and early intervention;
• they direct private capital to social programs that “work” by achieving independently measured, positive outcomes
for individuals, families and communities of need; and
• they provide private investors with satisfactory and inextricably blended social and financial returns, i.e., they are
impact investment vehicles.
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3. To illustrate the extent to which a particular way of doing PFS Financing can affect the trade-offs for various stakeholders
and, thereby, the potential effectiveness of PFS Financing in a given location, NFF has selected five types of transaction
execution structures or “ways of doing” PFS Financing that we believe achieve fidelity to the concept of PFS Financing
as we have described it here. Brief summary descriptions are provided below of the five ways of doing PFS Financing
depicted in the infographics.
Core Structures Depicted in the Infographic
HUCAP (Human PFS Financing is executed through state moral obligation bonds issued in the U.S. municipal
Capital bond market—the structure Minnesota is planning to pilot in Minneapolis/St. Paul under
Performance) Bonds legislation passed in the State last year. (For more information on HUCAP bonds visit
http://www.institutionalinvestor.com/Popups/PrintArticle.aspx?ArticleID=2958534.) Private
investors purchase Minnesota moral obligation bonds. Working capital for intervention delivery is borrowed by providers
from a loan pool established as part of the HUCAP structure. Providers shoulder all of the financial risk for outcome
performance. Government has a small financial risk through negative arbitrage that arises from the investment of
HUCAP proceeds at a rate that is expected to be lower than the rate on the bonds.
PFS Financing is executed through the private equity structure utilized in the UK
SIB (Social Impact
Peterborough transaction. For additional information on SIB go to
Bonds)
http://www.socialfinance.org.uk/sites/default/files/sf_peterborough_one__year_on.pdf.)
Investors purchase a project-specific SIB under customized contractual arrangements. Working capital for intervention
delivery comes from private investors at no cost to providers. Investors shoulder all of the financial risk for outcome
performance. Government has no financial risk.
SIB with a Full PFS Financing is executed through the SIB structure above with success payments to
Private Guarantee investors fully or partially guaranteed by a private (non-government) enterprise. With a full
guarantee, the private guarantor shoulders all of the financial risk for outcome performance.
Under a partial guarantee, private investors and the private guarantor share the financial risk
SIB with a Partial for outcome performance, with this risk sharing apportioned up front in the contracts. Working
Private Guarantee capital for intervention delivery comes from investors at no cost to providers. Government has
no financial risk. (N.B. A full or partial guarantee from government is also a possible, albeit potentially controversial,
structure. For the purposes of clarity, NFF chose to leave a depiction of that potential adaptation for a subsequent
version.)
PFS Financing is executed with a hybrid HUCAP/guaranteed SIB structure in which providers
Hybrid: HUCAP and
receive working capital upfront from private investors at no cost via HUCAP bond proceeds.
SIB with Private
Providers shoulder all outcome performance risk, but are backstopped by a private
Guarantee
guarantee. Government has a small financial risk through negative arbitrage. Although this is
not yet a mainstream structure under consideration for a specific proof-of-concept pilot, there is an effort afoot to develop
a workable, hybrid SIB and HUCAP structure.
The Risk Trade-Off Continuum: Breaking Down the Three Perspectives
Disaggregating the risk trade-offs continuum for each of the three main stakeholders in a PFS Financing is revealing.
The continuum demonstrates why each stakeholder—investor, provider, and government— may have a distinct
perspective on which structure best suits each of their particular needs. This, in turn, would imply that aligning these
stakeholders on a single, prepackaged way of doing a PFS Financing might be difficult. Indeed, field experience to-date
has tended to support this assessment.
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4. Lower Risk Higher Risk
Lower provider performance risk High provider performance risk
Lower expected financial return Higher expected financial return
Low transaction due diligence and execution costs High transaction due diligence and execution costs
Published public ratings No published public ratings
High liquidity Low liquidity
Lower political risk Higher political risk
Indirect impact investing incentive and blended return metrics Direct impact investing incentive and blended return metrics
Higher market scalability potential (pace and scope) Lower market scalability potential (pace and scope)
Lower Risk Higher Risk
Requires no working capital or risk capital Requires both working capital and risk capital
High readiness and capacity barriers to access High readiness and capacity barriers to access
Higher provider reputational risk with private investors Lower provider reputational risk with private investors
Higher third party management and oversight of program delivery Lower third party management and oversight of program delivery
for investor risk mitigation for investor risk mitigation
Higher dependence on collaborating providers Lower dependence on collaborating partners
Low Risk High Risk
No intervention funding risk – pay only for what works Low intervention funding risk (negative arbitrage on payment pool)
Higher cost of capital Lower cost of capital
High requirement for ‘lock-box’ recoverable cash savings to pay Low requirement for ‘lock-box’ cash savings to pay private
private investors investors (ROI driven)
High reputational risk High reputational risk
High procurement and contracting systems change High procurement and contracting systems change
Unfamiliar execution infrastructure that needs to be built Familiar, pre-existing execution infrastructure
Potential requirement for full faith and credit legislation No requirement for full faith and credit legislation
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5. Combining Stakeholder Perspectives
When we look at the three
stakeholder perspectives
combined, we get a fuller
picture of how certain
stakeholders might favor some
ways of doing PFS Financing
over others in terms of the
perceived risk trade-offs. This
combined view also suggests
that there might be ways of
doing PFS Financing that
could be more acceptable
than others to all three
stakeholders.
For example, the combined
perspective implies that
SIB with a Full
Private Guarantee
might be the PFS Financing execution structure most acceptable to all three stakeholders for a proof-of-concept pilot: it
represents the lowest combined risk trade-off position for all three parties.
By using graphic structures to model out stakeholder perspectives in this fashion, these infographics can provide a useful
tool for facilitating productive conversations in both the initial and ongoing planning stages of PFS Financing. Having said
this, NFF recognizes that these infographics are works in progress that will be influenced by ongoing commentary from
market participants and observers, as well as future developments in the PFS Financing field. NFF also recognizes that
we:
• may not have captured the full extent of the trade-offs involved in each of the structures depicted,
• may not have fully captured the order of magnitude or relative importance of some trade-offs, and
• may have captured some trade-offs that other participants or observers of the PFS Financing field feel lack
sufficient materiality.
With these factors in mind, NFF enthusiastically invites commentary, suggestions and proposals for refinements to these
infographics as well as for other ”ways of doing” PFS Financing that we can:
• share with the entire PFS Financing community of interested parties;
• evaluate and discuss in a public forum; and
• where applicable, incorporate into updates of the infographics on an ongoing basis.
To facilitate this dialogue, NFF will be posting this report and the series of infographics on the Pay for Success Learning
Hub website (www.payforsuccess.org and www.nffsib.org ) and soliciting your comments and suggestions through social
media.
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6. Top Ten List of Systemic Issues in the Development of the PFS Financing Field
in the United States
To accompany the infographics, NFF has also compiled the following Top Ten List of Systemic Issues in the
Development of the PFS Financing Field in the United States. This Top Ten list reflects NFF’s assessment of the
systemic issues most likely to shape and drive the development of the PFS Financing market in the U.S. going forward.
1. PFS Financing is accelerating the transition of the United States social sector from an output-driven funding model to an
outcomes-driven funding model. This has broad systemic implications for the U.S. social sector.
2. PFS Financing proof-of-concept pilots open the door to systemic change in the way governments fund social programs,
the way service providers deliver programs, the ways that capital flows into the social sector and the way that everyone
in the sector measures success or “what works”.
3. Cities, counties and states rather than the federal government will be the government entities that launch PFS Financing
proof-of-concept pilots in the U.S. The U.S. federal government can and is beginning to provide a variety of resources to
facilitate the development and launch of proof-of-concepts pilots by cities, counties and states. This federal government
support may also contribute to the development of further PFS Financing adaptations and innovations.
4. There are potentially many transaction execution structures or “ways of doing” PFS Financings successfully and with
fidelity in order to meet the unique needs of U.S. cities, counties and states.
5. The openness to and support of hybrid and alternative transaction execution structures or “ways of doing” PFS
Financings will provide more, and more diverse, ways of allocating and apportioning risks, returns and other material
trade-offs to private investors. This will accelerate the development of the PFS Financing market by presenting structures
that appeal to a broader pool of potential investors and increase the magnitude and pace of private, impact investing
capital flows into the U.S. social sector.
6. Although the success of PFS Financing is dependent on the performance of service providers, there is a limited number
of PFS Financing-ready providers in the U.S. Incubation of broad-based provider readiness is needed to build a pipeline
sufficient for the replication and growth to scale necessary to build a sustainable U.S. PFS Financing market.
7. Among the small number of PFS Financing-ready providers in the U.S., there are established, high-performing multi-
state service providers that can act as program intermediaries in their social issue areas. These organizations have
current capacity to act as first-mover providers in PFS Financing proof-of-concept pilots. They also have the capacity to
act as intervention intermediaries in partnership with financial/structuring intermediaries in PFS Financings and to take a
leadership role in building capacity for PFS Financing among other providers in their social issue areas.
8. The focus on using foundation capital as seed investments in PFS Financing proof-of-concept pilots in the U.S. is too
limiting and short sighted. A complete capital approach in which foundations provide, among other things: (i) guarantees
to facilitate investment from the broader private investment community and (ii) general operating support and change
capital to providers to build the capacity to become PFS Financing-ready can significantly accelerate PFS Financing
replication and market growth to scale.
9. Early attention to issues involving transparency, potential conflicts of interest and displaced incumbent constituencies
that are associated with PFS Financings can reduce potential barriers to the development of the PFS financing field.
10. The community of interest in PFS Financings will need to provide opportunities and a forum for soliciting the interests of
the individuals, families and communities of need who are the intended beneficiaries of PFS Financing and to involve
them in the ongoing dialogue on the development of the field.
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7. The Future - Diverse Local Needs Will Increasingly Shape New “Ways of Doing” PFS
Financing with Fidelity in the United States
The ability to adapt to the unique “local needs” of the social sector in the United States is essential in order for PFS
Financing to deliver on the promise of measurable improvements in the lives of individuals, families and communities of
need that is the source of so much enthusiasm for this still largely unproven concept. Local needs have clearly emerged
as key drivers of the shapes that proof-of-concept PFS Financings are likely to take as they continue to adapt to the U.S.
market.
By comparison to how PFS Financing has developed in the United Kingdom and how it is developing in, for example,
Australia and Canada, the development of the PFS Financing field in the United States is a “bottom up” phenomenon.
Because of this, cities, counties and states will undoubtedly launch the first wave of proof-of-concept PFS Financing
pilots. As a result of this bottom-up phenomenon in the United States, there will be local differences in, among other
things:
• the relative importance and impact of social issues for which PFS Financing pilots may be applicable;
• the political will, inclination and supporting infrastructure to advance PFS Financing pilots;
• private investor appetite for transaction-specific risk trade-off dynamics; and
• the availability of service providers with readiness for effective participation in PFS Financing pilots.
As is already proving to be the case, these local differences will suggest a unique set of requirements necessary for the
launch of PFS Financing proof-of-concept pilots. In each case, these local requirements will influence the blended array
of risk trade-offs and produce a way of doing the PFS Financing that satisfies all three stateholders. These local
variations will give rise to further ways of doing PFS Financing that NFF looks forward to capturing and analyzing with
you and adding to future versions of the Risk Trade-off Continuum for Different Structural Approaches to PFS Financing.
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