Structuring a Transaction
PFS Financing projects require significant collaboration and resource commitment from 3 key stakeholders: investors,service providers, and government. Field data increasingly suggest that each potential way of doing PFS Financing involves a number of potential risk/benefit trade-offs for each of the key stakeholders. This is particularly the case with the proof-of-concept pilots under discussion and development in a number of locations across the U.S.
Factors affecting stakeholders:
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measurable social impact potential
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the ease of identifying and capturing the economic value of social impact
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financial risk and return to each stakeholder
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reputational risk for each stakeholder
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transaction execution and due diligence costs cost of capital to the government
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funder and service provider(s) transaction management and governance structures
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legislative requirements procurement and contracting systems change
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the potential for transaction structure replication and scalability
PFS Financing Structures
There are many structures that can support PFS projects. These structures offer different tradeoffs for each stakeholder and flow capital between stakeholders in different ways.
Human Capital Performance Bond: PFS Financing is executed through state moral obligation bonds issued in the U.S. municipal bond market. Read more on Minnesota's HUCAP bonds here. 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.
Social Impact Bond: PFS Financing is executed through the private equity structure utilized in the UK Peterborough transaction. Read more on SIB here. 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.
Social Impact Bond with a Full Guarantee, or Social Impact Bond with a Partial Guarantee: PFS Financing is executed through the SIB structure above with success payments to 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 for outcome performance, with this risk sharing apportioned up front in the contracts. Working capital for intervention delivery comes from investors at no cost to providers. Government has no financial risk.
Hybrid: HUCAP and SIB with Private Guarantee: PFS Financing is executed with a hybrid HUCAP/guaranteed SIB structure in which providers receive working capital upfront from private investors at no cost via HUCAP bond proceeds. Providers shoulder all outcome performance risk, but are backstopped by a private guarantee. Government has a small financial risk through negative arbitrage.
Risk Continua: PFS Structures in Comparison
Risk trade-offs continua for each of the three main stakeholders in a PFS Financing are revealing. These diagrams demonstrate why each stakeholder—investor, provider, and government— may have a distinct perspective on which structure best suits their particular needs.
A 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, SIB with a Full Private Guarantee might represent the lowest combined risk trade-off position for all three parties.
