Last week we shared our “4 Ps” framework for underwriting the credit worthiness of Pay for Success (PFS) transactions. Similar to the 4 Cs of Credit, the 4 Ps of PFS serve to break down the complexities of Pay For Success deals and provide a simple and systematic method for investors to understand the risks of any PFS transaction.
Today, we’ll explore the first of the 4 Ps of PFS we identified: “Partnership”.
We’re kicking off with partnership because PFS projects are necessarily a team effort.
There are many players involved in every PFS transaction and no one organization can fly solo. There’s the payer – often a government, but it could also be a hospital, an insurer, or another institution. Then there is the service provider, the third party evaluator assessing performance and the investor(s). And there are usually a bunch of advisers, attorneys and so on around for good measure. It makes for a pretty crowded room.
These kinds of partnerships are an important strength of the PFS model, because they bring varied skill sets and resources to bear to solve complex problems. However, complex partnerships carry their own risks. Disparate priorities lead to conflicts over decision-making. Competition for turf can arise. At the human level, people working hard in stressful situations may lose their cool. Hurt feelings and damaged egos may start to make clear communication difficult. To assess the strength of a PFS project, these risks must be taken into consideration as they can significantly impact the likelihood of repayment.
Of course, underwriting these kinds of risks isn’t as neat as assessing financial strength or return on investment (ROI). But that doesn’t mean it is in any way a “soft” part of the inquiry that goes into the investment decision making process. On the contrary, it is important to have a deliberate and probing approach for “stress testing” the partnerships that underlie the proposed project.
In the PFS transactions we have underwritten, there were a few things we consistently looked for from the partners, and some specific questions we sought answers to that helped us understand whether the partnership had what we were looking for:
Alignment: Are the partners clearly aligned on the goals, methods, and processes to be used to do the work? Do they articulate these things with a shared vocabulary?
Flexibility: Do the partners have the ability to be flexible, to accommodate new learning, changing circumstances, and each other? If the partners have worked together before – a good sign in and of itself – do they have concrete examples of times they have come together to problem solve in the face of a tough challenge? Have they made trade-offs to accommodate each other.
Compatibility: At the organizational level, are cultures compatible? Do the leaders and staffs of the organizations evidence shared values? At the individual level, do the key players get along?
Passion: Is there clear passion for the work and faith in the proposed project?
In all of these instances, actions speak louder than words. We found it was often helpful to probe for concrete examples from past efforts that illustrate these points, rather than simply asking participants about them outright.
Unsurprisingly, we both value meaningful face time with the partners, individually and as a group, as part of the underwriting process. To the extent that underwriting partnership comes down to formulating a judgment about a group dynamic, there’s just no substitute for getting to know the team.
So, at the very least, underwriting a PFS transaction is definitely a good excuse for a field trip…