Income Share Agreements: Venture Capital for College Students
To get the gist of an “income share agreement” (ISA), look no further than the title of Kim Clark’s November 16, 2016 article in Money magazine: “Now You Can Sell Shares in Yourself to Pay for College.” As Clark describes it:
Instead of lending money to students, ‘investors’ essentially buy a ‘share’ in a student’s future for a limited period of time. If the student makes little or no money in that time, the investors lose out, and the student is free from obligation. If the student succeeds, the investors profit—and the student may pay more than he or she would have on loan. In other words, students can now sell a kind of stock in themselves.
The concept can be traced back to Milton Friedman, the Nobel Prize-winning economist. In “The Role of Government in Education” (1955), Friedman wrote that investors “could ‘buy’ a share in an individual’s earning prospects: to advance him the funds needed to finance his training on condition that he agree to pay the lender a specified fraction of his future earnings. In this way, a lender would get back more than his initial investment from relatively successful individuals, which would compensate for the failure to recoup his original investment from the unsuccessful.”
On February 2, 2017, to facilitate the proliferation of this innovative approach to paying for a college education, while also allowing students to graduate debt-free, Sens. Todd Young (R-Ind.) and Marco Rubio (R-Fla.) introduced S. 268, the Investing in Student Success Act, which would create a legal structure for ISAs. Students could finance their education while ensuring that taxpayer dollars are not at risk. This is a particularly timely concern, as Andrea Fuller’s Wall Street Journal January 18, 2017 article, “Student Debt Far Worse Than Believed,” revealed that, “…at more than 1,000 colleges and trade schools, or about a quarter of the total, at least half the students had defaulted or failed to pay down at least $1 on their [federally subsidized] debt within seven years.”
According to material provided by Sen. Young’s office, S. 268 is intended to provide the following:
… legal certainty for an innovative type of education funding called an Income Share Agreement (ISA). Under an ISA, a student receives private funds in exchange for agreeing to pay an affordable percentage of his or her income for a period of years after graduation. Unlike a loan, an ISA guarantees a student affordable payments over the payment term—regardless of whether the student’s payments ultimately repay the original amount. ISAs also share risk: the entity funding the student has ‘skin in the game’ in terms of the student’s success, which aligns the incentives of the student and the funder.
As described by Frank Chaparro in his April 8, 2017 Business Insider article for, “…it’s kind of like venture capital for college students. If they do well, the investors do well, but both sides have risk.” More importantly, unlike federally-subsidized student loans, ISA risk does not fall on taxpayers, because the money is fronted by private investors or, like Purdue University in Sen. Young’s home state of Indiana, the college’s own endowment.
Students who enter into an ISA do not incur debt, and they only make payments once they are employed and receiving an income above a certain threshold. Unlike a loan, an ISA has no principal and does not accrue interest, nor does it remove existing school financing options. Instead, payments are based on a student’s payments on income earned after graduation. In a sense, investors are gambling on outcomes (i.e., the student’s future earnings), rather than a fixed amount more often associated with amortized repayments. If a graduate earns a higher-than-expected salary, then the investor profits. By the same token, the struggling graduate is held harmless for the initial investment.
The “Investing in Student Success Act” renews a previous effort from the last Congress, when Sen. Rubio introduced the bill in the Senate, while then-Rep. Young carried the companion bill in the House. The senators cite the success of Purdue’s “Back a Boiler” program (mimicking the university’s nickname, Boilermakers), which provides ISAs to approximately 400 juniors and seniors. The initiative has the backing, in turn, of former Indiana Gov. Mitch Daniels, the current president of Purdue. He has also testified before Congress on behalf of the effort.
“Income share agreements are an innovative debt-free financing option for students,” said Sen. Young. “Students and their families should not be forced to make a choice between a quality education and financial hardship. I’m excited to work with my colleague Senator Rubio and have the support of Purdue President Mitch Daniels in this effort.”
“It’s getting harder and harder for American families to afford the rising costs of college, and students are often forced to run up thousands of dollars of debt,” said Sen. Rubio. “This innovative legislation would empower students to leverage their future income today and access the financial resources of businesses, individuals and nonprofit organizations in order to achieve their higher education goals.”
The legislation includes the following provisions: individuals with annual salaries less than $18,000 (adjusted for inflation) are exempt from making payments; payments cannot exceed certain caps (15 percent of income for shorter contracts of 15 years or less, decreasing to 7.5 percent of income for 30 years, the longest contract allowed); and funders must provide cost comparisons for monthly payments for the same amount of money, under traditional loan programs (at various hypothetical income levels) for the same “repayment” period.
In the absence of legislation, there is uncertainty about the legal and regulatory ramifications of these contracts. Writing for the Brookings Institution in her October 16, 2014 report, “How Income Share Agreements Could Play a Role in Higher Ed Financing,” Beth Akers articulated the need for congressional action:
Regulatory obstacles that could be easily addressed by Congress are the primary reason that ISAs have not been employed more broadly. These obstacles would be eliminated if Congress would pass legislation that would provide adequate protections for individuals engaging in ISAs as well as regulatory clarity that would give private institutions the certainty necessary to justify investments in this industry. … Enabling ISAs to operate more broadly in the United States will enable policy makers, advocates and researchers to explore their potential for improving the well-being of those who choose to finance investment in higher education.
“After our successful launch of ‘Back a Boiler’, we have been hearing from schools around the country interested in pursuing their own program,” said former Gov. Daniels. “We thank Senators Young and Rubio for their work to clarify the framework for Income Share Agreements. With Congressional action, widespread use of ISAs can be a reality for students nationwide.”
Purdue University, the first institution of higher education to offer ISAs on a large scale, is putting its money where its mouth is. By using its own endowment to finance the education of its own students, Purdue is gambling that its product (a quality education) will pay dividends when its graduates get good-paying jobs. If S. 268 is enacted, ISAs could be expanded nationwide.
