Social impact bonds

Boston company is looking for capitalists willing to invest in government social programs

tracy palandjian looks and acts like many of the other hotshot dealmakers in Boston. She dresses in upscale chic, occupies a 14th-floor office on State Street with panoramic views of the city, and peddles bonds to private investors. What sets her apart from most of her colleagues is the type of deals she’s pursuing. She’s not schmoozing with high-flying Internet startups or cultivating public officials trying to borrow money at low interest rates. Instead, she’s trying to entice private in­vestors to put money into projects that benefit society—keeping drug dealers and thieves from going back to their old ways after prison, and getting the homeless into permanent housing.

Think of it as do-gooder capitalism, a way of marrying the power of markets with the challenge of tackling longstanding social problems by getting investors to bet on the ability of private social entrepreneurs to perform government services more effectively and efficiently than the government does now.  

Palandjian’s company, Social Finance Inc., is an independent, information-sharing ally of a British firm by the same name that pioneered the sale of so-called social impact bonds—bonds that pay a healthy return if the privately-run government service exceeds expectations or pay nothing if it doesn’t. Social Finance and a Boston–based rival, Third Sector Capital Partners, are trying to jumpstart the business in the United States, acting as intermediaries bringing investors, social service entrepreneurs, and government officials together. President Obama is already on board, calling for seven test projects, and Gov. Deval Patrick is also looking to test the concept in Massachusetts.

“Boston seems like the ideal place to incubate these three-way partnerships. There’s money, there’s a broad culture of social services, and there’s a government that has no problem with setting precedent,” says Palandjian, who left Parthenon Capital Partners a year ago to launch the Social Finance startup in office space provided by Parth­enon. Palandjian built her resume managing money for Parthenon’s nonprofit and foundation clients.

Jeffrey Liebman, a professor of public policy at Harvard’s Kennedy School of Government who crafted the federal approach to social investing while working at the US Office of Management and Budget, says government tends to spend a lot on ineffective social programs because it doesn’t do a good job of measuring outcomes.

“This is to finally make it so the government only pays for what works, something that isn’t happening because government isn’t designed to operate that way,” Liebman says. “The question is whether there are interventions that will generate high benefits that will both bring savings to taxpayers and generate a return on the investment.”

Social Finance launched its business in the United Kingdom with a program designed to reduce recidivism among former prison inmates. Currently, the bulk of the UK’s 40,200 prisoners cycle in and out of prison at an alarming and costly rate, with about 60 percent of first-time offenders returning to jail within a year after their release.

Social Finance spent a couple of years convincing 17 investors, including the Rockefeller Founda­tion, to buy $8 million worth of social impact bonds to fund a program providing just-released inmates from a prison in Peterborough with assistance in finding housing and employment as well as financial, family, and addiction counseling. Peterborough holds more than 800 men and women prisoners, most of them first-time offenders.

The British Ministry of Justice agreed to refund the investors their original $8 million investment if the Peterborough re-entry program succeeds in reducing the recidivism rate at the prison by 7.5 percent over an eight-year period. If the recidivism rate drops even more, the investors and the British government agreed to split the savings.

In the United Kingdom, Social Finance spent months working with the Treasury and the Ministry of Justice to tightly define the exact population for the test drive. “This is why it’s a good idea to have an intermediary like Social Finance,” says Kippy Johnson, associate director of the Rockefeller Founda­­tion, which invested nearly $1 million in the UK experiment. “Not only do they put all the players together and do the negotiations, but they are going to have to drive the social service provider hard to ensure [good] outcomes get a return on the investment.”

The UK experiment tapped mostly nonprofit foundations as investors, but the Rockefeller Foundation thinks the program has broader appeal. It intends to spend $54 million to develop a plan to convince US for-profit investors to put money into programs attacking social and environmental problems. “The idea is to unlock private capital to invest in social problem solving,” says Johnson.

In his budget address earlier this year, Obama em­braced social impact bonds, using the name Harvard economist Liebman gave them—Pay For Success contracts. If Con­gress approves, $100 million will be set aside for seven pilot programs. “Instead of spending first and asking questions later, we’re rewarding folks inside and outside of government who are delivering results,” Obama said.

The Patrick administration is already angling to participate in one of the seven federal pilot programs and launch state ones as well. “We have to change the way we do business,” says Jay Gonzalez, the governor’s secretary of finance and administration. “What we’re doing is unsustainable. There are lots of good reform efforts, but I’m definitely excited about this one.”

The Patrick administration’s primary focus is to come up with ways to reduce the state’s homeless population and keep released inmates from winding up back in prison. “Is it going to be simple?” asks Gonzalez. “No. It needs some real rigor to make it right, but we’d be fools to not explore this, and the exploration has definitely begun.”

Patrick says the idea has tremendous potential. “It shows our willingness to invite new people to the table to solve old, intractable high-cost social problems,” he says. “To me, this is really, really appealing.”

Meet the Author
Molly Baldwin, the founder and executive director of Roca Inc., says her 23-year-old Chelsea–based program for high-risk kids could flourish with the use of social impact bonds.  It currently receives only 12 percent of its funding from the state.

“When I read an article about what’s going on in the UK, I went berserk,” says Baldwin, who is already trying to line up investors for a project. “I’m in a business in which we all talk about how much money is being wasted on failure and never invested in success. We carefully track what we do. Meanwhile, our criminal justice system, which doesn’t track or ever adjust, is a miserable failure that’s ridiculously expensive. After all the talk of evidence-based practice, it’s time for the government to put its money where its mouth is.”