SCALE FINANCE Industrial-Strength Social Impact Bonds for Mainstream Investors Steven H. Goldberg April 2017 A Special Report from the Center for Community Development Investments Federal Reserve Bank of San Francisco SCALE FINANCE Industrial-Strength Social Impact Bonds for Mainstream Investors Steven H. Goldberg [email protected] April 2017 The views expressed in this paper are those of its author and do not necessarily represent those of the Federal Reserve Bank of San Francisco or the Federal Reserve System. Steven H. Goldberg is the founding principal of Caffeinated Capital LLC. Previously, he was the first Panaging Girector and Jeneral Founsel for Social Finance, Inc., where he helped bring Social Impact Bonds to the U.S. In 2009, he published Billions of Drops in Millions of Buckets: Why Philanthropy Doesn’t Advance Social Progress (Wiley), which explores the economics of scaling social innovation. Mr. Goldberg has worked in government, business, law, and nonprofit organizations for some forty years, developing expertise in regulatory compliance, legislation and public policy, government procurement and contracting, infrastructure finance, public- private partnerships, program evaluation, venture philanthropy, and social entrepreneurship and investment. He is a graduate of Boston College Law School (J.D., magna cum laude, 1982), Northwestern University (M.A., Economics, 1980) and the University of Massachusetts, Amherst (B.A., Economics, magna cum laude, 1975). SCALE FINANCE: INDUSTRIAL-STRENGTH SOCIAL IMPACT BONDS FOR MAINSTREAM INVESTORS Social Impact Bonds (SIBs) have demonstrated significant growth potential within their defined boundaries, but the standard model has not yet developed “mainstream” investment transactions capable of expanding certified evidence-based programs (CEBPs) commensurate with unmet population needs. This paper proposes an enhanced SIB model called “Scale Finance” in which asset owners and fund managers would work with CEBP developers to expand these proprietary programs at their maximum feasible growth rates. Repayment of principal plus risk-adjusted, market-rate returns would be predicated upon the achievement of agreed social impacts and governmental savings that substantially exceed program and financing costs. The paper then applies the framework to show how Scale Finance SIBs could dramatically reduce the mass incarceration of juvenile offenders, which dispatches some 60,000 at-risk youth into the “school-to- prison pipeline” every year at an annual cost of approximately $5.7 billion. A SIB pro forma is presented for a prototypical state that currently spends $100 million annually on juvenile detention and other custodial placements. In this example, by raising $65.6 million from mainstream investors, a Scale Finance SIB could replicate the successful Florida Redirection project to provide Multisystemic Therapy and other CEBPs to 5,000 at-risk families over five years, cut placements in half, pay investors a 10% annualized return, and return net savings of nearly $91 million to the state. If successful, Scale Finance would offer a financially self-sustaining way to effectively solve certain pervasive social problems we already know how to fix. Special thanks to Tamar Bauer, Erica Brown, Roger Bullen, Laura Callanan, Paul Carttar, Lori Cohen, Dan Edwards, Jed Emerson, Ian Galloway, Steven Godeke, Megan Golden, Isabel Gregory, Andrew Levitt, Alex Nicholls, James Perry, Neil Powling, Karl Richter, John Roman, Karla Sainz, Marya Stark, Keller Strother, Teri Weathers, and Clay Yeager for their spirited comments and obliging feedback, without which this paper would have been much shorter. An earlier draft of this paper was partially funded by MST Services, Inc., to which the author has also provided nominal consulting services. The author has also developed unavailing business proposals with MST Services, Inc. and Evidence-Based Associates, and has provided formal and informal advice to some of the other organizations referenced in this paper. The author does not speak on their behalf. SCALE FINANCE: INDUSTRIAL-STRENGTH SOCIAL IMPACT BONDS FOR MAINSTREAM INVESTORS 1. PREFACE ................................................................................................................... 5 1.1 Social Investment .................................................................................................... 5 1.2 Standard SIBs .......................................................................................................... 6 1.3 Scale Finance SIBs for Mainstream Investment ................................................. 10 1.4 Dismantling the School-to-Prison Pipeline ......................................................... 13 2. SCALE FINANCE ....................................................................................................... 15 2.1 Attracting Mainstream Investment ...................................................................... 15 2.2 Meeting Fiduciary Standards ............................................................................... 17 2.3 The Scale Finance Model ....................................................................................... 18 3. SOLVING PROBLEMS WE ALREADY KNOW HOW TO FIX ..................................... 21 3.1 Fiscal Realities ......................................................................................................... 21 3.2 Understanding “Evidence-Based” Programs ..................................................... 23 3.3 Raising the Evidence Bar for Mainstream Investment ...................................... 27 3.4 Nurse-Family Partnership: The 3% Solution ..................................................... 29 4. CROSSING THE CAPITAL MARKET CHASM ........................................................... 31 4.1 Barriers to “Scaling What Works” ....................................................................... 31 4.2 Overcoming Fragmented Funding ...................................................................... 32 4.3 Overcoming Adoption Risk .................................................................................. 33 5. CASE STUDY: DISMANTLING THE SCHOOL-TO-PRISON PIPELINE ...................... 38 5.1 Custodial Placements of Juvenile Offenders ...................................................... 38 5.2 Juvenile Justice Reform .......................................................................................... 40 5.3 Evidence-Based Programs for “Deep-End” Youth ............................................ 41 5.4 The Rise and Fall of the Florida Redirection Project ......................................... 43 5.5 The UK’s MST SIB .................................................................................................. 46 5.6 A Pro Forma Model for Scaling MST/FFT .......................................................... 47 5.7 Euthanizing White Elephants ............................................................................... 51 6. DEVELOPING SCALE FINANCE SIBS ...................................................................... 52 6.1 “Reverse Procurement” ......................................................................................... 53 6.2 Public Finance for “Social Infrastructure” .......................................................... 57 6.3 Measuring “Post-Counterfactual” Outcomes and Savings .............................. 60 6.4 Appropriations Risk ............................................................................................... 64 6.5 Implementation Fidelity ........................................................................................ 65 7. CONCLUSION: ADDING COMMERCIALLY-VIABLE SIBS TO THE MIX ................ 70 8. ENDNOTES ............................................................................................................... 75 SCALE FINANCE: INDUSTRIAL-STRENGTH SOCIAL IMPACT BONDS FOR MAINSTREAM INVESTORS 1. Standard SIB Model ............................................................................................... 7 2. Illustrative SIB Math .............................................................................................. 8 3. SIBs Worldwide (Million US$ as of Nov. 30, 2016) ........................................... 8 4. Comparison of SIB Models ................................................................................... 12 5. Addressable Market for Scaling MST/FFT ........................................................ 12 6. Florida Redirection Project Savings .................................................................... 14 7. Summary of Scale Finance Pro Forma Cash Flow for Juvenile Offending ..... 15 8. Investors in Eight U.S. SIBs .................................................................................. 17 9. Impact Investing Ecosystem ................................................................................ 18 10. Scale Finance Model .............................................................................................. 19 11. Levels of Evidence ................................................................................................. 25 12. WSIPP Evidence Decision Tree (Adapted) ........................................................ 26 13. Urban Institute’s Evidence Pyramid ................................................................... 27 14. “Crossing the Chasm” (Modified) ...................................................................... 35 15. Generic Whole Product Solution ........................................................................