Student debt is becoming an increasingly large problem for students, parents, and policymakers. There are over $1.6 trillion of student loans outstanding in the U.S., and student loan is the highest source of household debt after mortgage debt. Students are depending more heavily on student loans as the price of tuition and additional student costs continue to increase — average tuition at private nonprofit four-year colleges increased from $17,010 in the 1988-89 academic year to $35,830 in the 2018-19 academic year. As a result, around one-third of adults under the age of 30 have student loan debt, and roughly one-in-five adults between the ages of 30 and 44 have student loan debt. More students are exhausting their federal aid options — such as Pell Grants and Stafford subsidized loans — and moving toward private loans, which come with higher interest rates and less favorable terms.
These tuition increases have not necessarily been correlated with a significant increase in the quality of an education, though. In the past, starting salaries for college graduates would more than cover the full cost of four years of college — at the time, college was considered a ticket to higher earnings and better jobs. According to a report by the National Student Clearinghouse Research Center, fewer than 6 in 10 students will graduate within six years of going to college. For students in majors such as the humanities and liberal arts, their degree may not help them command a job with a high salary which they need to pay off their student debt. Despite the fact that tuition has increased so much, many colleges — especially smaller institutions with less resources — are having trouble yielding effective graduates who earn high salaries like college graduates of the past realized. Taking out a student loan is now a major risk for students. The degree a student gets may not pay off, or the student may not even graduate and will have to pay off their loan without the benefits of a degree. As the student debt crisis becomes a bigger problem, people are looking for ways to change the status quo.
What Are Income Share Agreements?
One of the most popular solutions has been to make college free for all students or forgiving student loans. Senator Elizabeth Warren, a Democrat running for president, has proposed giving all borrowers who earn under $100,000 per year loan forgiveness for up to $50,000; those who earn up to $250,000 would be eligible for partial forgiveness. Senator Bernie Sanders, another Democrat running for president, has proposed eliminating all student debt and making college free for all undergraduates at four-year public colleges and universities. Another proposal that has recently gained traction is to expand access to Income Share Agreements, or ISAs, as an alternative to student debt.
ISAs allow students to pay no tuition today in exchange for a certain percentage of their future income after they graduate. Students will only make payments if they earn over a certain amount, which means they are protected in the case that they become underemployed or unemployed after graduation. Therefore, the risk of pursuing further education is shifted away from students and onto the schools, who will bear the financial burden if a student does not succeed after graduation. In addition, a payment cap exists to ensure that successful students do not pay a disproportionate amount of money back in exchange for their education — this is typically between 1 times and 2.5 times the initial amount borrowed. ISAs are being used by both colleges, such as Purdue University and the University of Utah, and skills academies such as FlockJay and Lambda School, to align the incentives of the schools and the students, and increase access to their offerings. There are also a number of companies betting on ISAs as a financial product, too.
Income Share Agreements (ISAs) as an Asset Class
ISAs offered by universities are typically funded through their own funds. Purdue University, for example, established the Back a Boiler ISA Fund in 2016, which has since issued more than 850 contracts to students, worth over $10 million. Students will borrow money from the ISA fund and make payments in exchange for a percentage of their income after graduation. Vocational schools such as Lambda School often sell their ISAs to third parties so that they can raise the money they need to cover operational costs in the interim. This has opened up an opportunity for a new group of startups to help connect schools to investors so that they can create their own ISA program and offer an alternative to traditional upfront payment or debt-based financing.
One of the most popular startups in this space is Blair, which aims to connect students directly with investors. Blair, a startup that has recently graduated from the prestigious Y Combinator program, pools together students and gives them the money they need to cover their tuition or cost of living for up to $50,000. After students graduate, they will pay back that money over a period of around six years as a percentage of their income. Students will only make payments when they earn over a certain amount, and payments are capped at 2.5 times to protect successful students from making unreasonably high payments. Blair has raised their first fund for 50 students and has disbursed money for their first 10. In a recent interview for TechCrunch, co-founder of Blair Mike Mahlkow said “In the last two weeks, we received applications for funding totaling more than $4 million”, which demonstrates a high level of interest in their offerings.
Unlike through student loans, an ISA aligns the incentives of the school and the institution. In the case of Blair, however, the incentives are aligned between the investor and the student. This has led Blair to work with their students on hiring placement. Blair provides career support and advice to students in a variety of different fields who borrow money through the platform, which will help increase their earnings prospects and find a job quicker after they graduate.
Blair is not the only startup taking this approach. Avenify is another company that offers peer-to-peer lending for students looking to finance their education through an ISA. Like Blair, Avenify allows students of any college to raise capital through an ISA — this is different to other ISA offerings which are traditionally only available to people who attend a certain school or bootcamp. Avenify has started to issue contracts on their platform, and has received a high degree of interest from investors who are looking to capitalize on the trend toward ISA-based financing models. Avenify recently announced that they are experimenting with a new progressive payment cap term, which will automatically reduce as the student continues to make payments. Both Blair and Avenify have realized the potential in ISAs, and are working to develop a new capital market around the financial instrument.
Other startups are taking a different approach to this model. Edly is a company that is working on an ISA marketplace for schools and investors. Through edly, schools can raise the money they need to offer ISAs to students from investors, and investors will earn a return as students start making payments toward their ISA. Unlike through Blair or Avenify, edly is focused on providing schools with access to the capital they need to launch their own ISA programs. The advantage of this model is that it ensures that schools interested in ISAs do not have to worry about managing investor relations or raising capital from outside institutional or individual investors — the school can raise all the money they need through edly. Holberton School earlier this year announced that they have raised $2 million from edly to help finance their ISA program, which will give students access to a more flexible financing option to cover their tuition.
The Need For A Capital Market
In order for ISAs to scale past a certain point, more financial infrastructure will be necessary. Investors interested in committing capital toward an ISA will need to have access to dependable platforms like edly and Avenify so that they can reliably invest their money and have the prospects of earning a good return. Schools will also need to leverage startups like edly to access the capital they need to offer ISAs. Building a capital market around ISAs will also ensure that schools offering ISAs can scale their programs effectively and raise more money as more students enroll in their programs.
ISAs typically offer more favorable terms to students than traditional loans, which has been a core reason why ISAs have become so popular. A recent estimate by edly predicts that $500 million in ISAs will be originated and that 175 institutions will offer ISAs by the end of 2020. There are already over 100 companies and research organizations involved in the ISA space, with around 40 coding bootcamps and skills academies offering their own ISAs. Typically, students in an ISA will repay between 2 and 20 percent of their income for a period of between nine months and ten years. Lower income-share percentages are typically offered with longer terms; high income-share percentages are offered with short terms.
The repayment amount of an ISA is usually no more than 2.5 times the initial amount borrowed, although many programs are offering repayment caps at a lower rate of between 1.2 and 1.8 times the initial amount borrowed. Further, ISAs have a minimum income threshold, as aforementioned, which protect students who become underemployed and unemployed after graduation — this is typically set between $20,000 and $60,000, depending on the subject a student is studying. The details of these terms are very important in ensuring that ISAs are still favorable to students, and offer investors the chance to earn a good return on their investment. Because investors are accessing a students’ future income, particular caution has been taken by companies creating capital markets for ISAs — there is a real concern that a badly structured ISA could lead to a form of indentured servitude, and there is precedent to back this up from Yale in the 1970s.
Criticism of Income Share Agreements
However, critics and consumer advocates have a number of concerns about Income Share Agreements and building capital markets around the asset class. One of the most popular concerns has been that ISAs are currently unregulated, which opens up opportunities for bad actors to exploit this asset class. This concern has also led to many investors holding back on committing capital toward ISAs — they are not sure whether ISAs are a reliable investment as of yet. However, earlier this year the ISA Student Protection Act was introduced in the U.S. Senate, a bipartisan bill which would create a clear regulatory framework under which ISAs would operate. This ISA legislation would also institute standard consumer protections and borrower disclosures to ensure that both students and innovation are protected.
Another concern that critics have voiced is that ISAs would lead to a world where investors are looking to maximize returns, and so would discriminate based on which students showed the most potential. Strong legislation will go a long way toward dispelling this concern, and investors have started to see ISAs as more of an impact investment than a full security. Blair says that investors can expect returns of around 10 percent per year on their investment, but the returns are not the only benefit of investing in ISAs. Investors have the ability to provide capital to students who may otherwise have not been able to attend college. This is because ISAs are often positioned as an alternative to student loans for people who cannot access federal aid or unwilling to take out a student loan to pay for their education. That being said, investors are not discounting the fact that ISAs could be profitable in the future, so legislation will play a key role in protecting students from discrimination in the future.
Financial Markets Are The Future of ISA Financing
The current student financing space is bad for both students and the governments. Schools are not being held accountable for their students’ success, and have continued to raise tuition to higher levels which have made more students dependent on loans — both federal and private. Further, only 54 percent of student borrowers make consistent payments toward their loans, and 11.4 percent of student loans are in a period of default. ISAs open up the opportunity to introduce a new system of accountability whereby the school — or investor, for that matter — will be directly affected by the outcomes of students. In the case of schools, if they offer low-quality services, they will suffer severe financial consequences.
ISAs also provide more flexible financing terms for students, and do not require payments to be made if a student is underemployed or unemployed. As students continue to question the value of their college degree — and as the student debt crisis becomes an even bigger problem — ISAs look like a more attractive method of financing. And companies like Avenify and edly are in a prime position to capitalize on this trend and expand access to ISA-based financing for all students.