This is what Pa. can do to rally investors around its new pay for success projects

Last month, we broke the news that Pennsylvania would become one of a handful of U.S. states to launch pay for success (PFS) projects (and the only one to launch two simultaneously).

The twin projects will aim to reduce recidivism rates across the state by scaling programs offered by nonprofits Center for Employment Opportunities and Youth Advocate Programs.

PFS is an innovative, unproven and complicated funding strategy designed to tackle public sector problems like recidivism by employing private sector solutions — and private sector capital.

That’s what makes it exciting. The strategy is ultimately structured to save taxpayers and their governments money not only by cutting spending on things like incarceration, but by shifting the financial risk to investors like foundations, financial institutions and venture capitalists.

But private sector investors want measurable outcomes. Quantifying social impact, conversely, is an unproven science. Therein lies the rub.  Not knowing exactly what the results of your investment is not particularly appealing for venture capitalists and financial institutions, and it’s why traditionally risk-averse foundations have played vital roles in PFS deals to date.

“We run into issues with government about being really crystal clear and specific about which outcomes they’re trying to achieve,” said Jeff Shumway, VP of advisory services at Social Finance, the nonprofit tapped to broker Pennsylvania’s PFS projects.

Pennsylvania’s pay for success projects, like those before it, will have a hard time luring private capital without a shared understanding of what “success” entails.

“How can an investor, with no formal training in social science, be in a position to interpret fairly dense academic literature and make a judgment about the likelihood of success for a particular intervention?” writes Mission Measurement CEO and social sector data scientist Jason Saul in a Huffington Post essay.

“They can’t.”

Those who are familiar with PFS funding and structure like Philanthropy Network Executive Director Maari Porter and former Michael Nutter Policy Director Maia Jachimowicz have said securing funding is typically the easiest part of the PFS equation — especially from foundations.

But what about private capital? In his post, Saul proposed three ideas to remove some of the risk that has kept many private investors away from PFS, but one rings true for Pennsylvania: “Success” needs to be defined and standardized, ideally by an independent evaluator.

“But the only way that [PFS] or any form of social finance can attract true risk-capital is if investors are able to pre-determine the likelihood of success for an investment,” he writes.