When I was in business school, back at the turn of the millennium, a team from my New Venture Strategy class proposed an innovative way to pay for school: sell shares of your future income to investors.
I was pretty skeptical, and so, as I recall, were the venture capitalists brought in to judge our proposals. We all worried about the same thing: adverse selection and moral hazard. Who, after all, would be most interested in selling shares in their future income? People who didn’t think that their future income would be all that high. And once they had sold shares, wouldn’t they have an incentive to work less and consume more leisure? After all, the investors can’t take 5 percent of your extra vacation days.
Fast-forward a decade or so, and the market seemed to be proving us wrong: Multiple companies were pursuing this business model, now known as income share agreements. Republican Senator Marco Rubio of Florida and Republican Representative Tom Petri of Wisconsin even introduced a bill to regulate the use of these innovative financing mechanisms and formalize their terms.
Fast-forward to now, however, and the market once more seems to be in doubt. Upstart Networks Inc., one of the industry leaders, has announced that it’s abandoning the ISA model in favor of a more traditional loan product, albeit with more intensive underwriting.
What happened? Information seems to be scanty. But we can certainly list the problems with the business model: Adverse selection and moral hazard are still an issue. Perhaps even worse is something my classmates and I didn’t foresee: competition from the government. People with federal student loans can now opt for increasingly generous income-based repayment programs. For the student, it’s a heads-I-win, tails-you-lose kind of deal: If you’re making good money, you can repay the loan at the regular rate and, as your income goes up, you get to keep all raises above the amount of your loan payment. If your wages are puny, opt for income-based repayment and keep your payments at a fixed percentage of your paycheck, albeit at some risk of a future tax hit.1
I’m skeptical that these startups would have had much success anyway -- at least, not to the tune of actually financing a full education. The amount you can recoup on a five- or 10-year contract, at any reasonable percentage of income, is unlikely to be as much as tuition at a good school. And longer contracts run into all sorts of problems, from complaints about “indentured servitude” to forecasting difficulties. It’s hard to see these businesses as anything but a niche product. And it’s hard to see a niche product as a good bet in a market so dominated by a government that doesn’t really care whether it gets its money back.
1 When the loan is forgiven after 25 years, the Internal Revenue Service is supposed to treat the amount forgiven as taxable income to the student. But it’s hard to imagine this actually happening; what's more likely is that the government will change the law sometime before the first person ages out of income-based repayment.
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