Reinventing Education Financing with Income Share Agreements
Overlooked #7
Hi, it’s Alexandre from Idinvest. Today, I’m looking more closely at Income Share Agreements as a way to solve the US college debt burden and to enhance the alignment of stakeholders in the higher education system.
Income Share Agreements (ISAs) are an alternative to traditional student loans to finance higher education tuitions fees. ISAs replace fixed interest loans independent from students professional outcomes by a percentage of the future income taken on the salary for a certain period when (i) students start working and (i) are paid above a certain threshold.
In 1955, Milton Friedman laid the ground for ISAs. In his essay The Role of Government in Education, he argued that students could be funded like an "equity investment": an investor could buy a share in individuals potential future by paying their tuitions fees in exchange of a fraction of their future earnings.
In the past few years, ISAs have been at the center of the stage in the US higher education system especially with the rise of alternative schools like Lambda and Holberton offering ISAs for their students.
In the higher education system, incentives between schools and students are completely misaligned. As a result, tuitions fees are rising while students exit salaries are stagnating.
ISAs could become a game changer to fix the higher education system flaws.
Solution to the US debt burden. US student debt is out of control (could be the next global financial crisis catalyzer) with $1.5tn burden for students. US high education is super expensive ($99.5k on average for a degree in the US) and it becomes all the more problematic when students drop out having the debt without the diploma. 80% of the worldwide student debt is located in the US. With ISAs, students' risks is reduced because they will start paying only when they get a sufficiently paid job and the amount they will have to pay does not change even if they delay their entrance in the job market.
Incentive alignment between the college and its students. Students will no longer be perceived as a cost that has to be downsized but has an investment that can be fructified in the future. Colleges will be incentivized to do their best to teach the right skills and to help their students build the best possible professional network to have the highest paying jobs at exit.
Future perspective vs. past history. Students are granted an ISA based on their future potential which completely changes the perspective from loans based on past income or employment history and requiring most of the time a co-signer or guarantor.
From debt to equity to finance students. Student financing is no longer a debt in which you have to borrow a certain sum that you will have to pay back with interests for a certain period of time. It becomes more like equity in the sense that you invest upfront to be entitled to earn part of their future incomes like dividends.
Access to higher education for students with low earnings or coming from a modest household.
Lambda School - The IT skills training school based on ISAs - 2017 - US
Lambda School is an 9-month long online school teaching IT skills in four different programs: full-stack web development, data science, iOS development and UX design. Students do not pay any upfront tuitions fees. Instead, the school is remunerated through ISAs: students will pay 17% of their income for two years capped at $30k once they are payed at least $50k annually in the field they are graduated in. The company was founded in 2017 and has raised $48.1m from prestigious investors like Y Combinator, Google Ventures, Stripe, Bedrock Capital, Bow Capital, Riverside and Vy Capital.
Lambda School positioning is amazing because it leverages a mismatch between demand and supply in the US IT job market. There are 500,000 open IT jobs in the US right now. But the supply is insufficient with only 60,000 computer science students graduating every year. At this rate, it will take 8 years to bridge this gap with the usual education system. Lambda School is therefore training students for positions that are actively desired in the job market meaning high salaries and low unemployment.
Traditional universities are not incentivized to get their students employed. A school based on ISA like Lambda will works backward to create the curriculum that will suit best current needs in the job market. Students are no longer perceived as stable revenue streams but as a portfolio of investments that has to be maximized. It's a better way to align interests between students and schools. For instance, Lambda is paying 20-25 people full time to place their students i.e. their job is to make sure that Lambda students will have interviews in top-notch companies.
The Lambda School model has strong network effects. As they enter in hiring roles, Lambda alumni will be more likely to favor other Lambda students. At the same time, employers satisfied with their first hires from Lambda School will not hesitate to hire other Lambda students. The Lambda school brand is also strong. The company was able to place its students in highly regarded tech companies like Uber, Bank of America, Clover, Amazon, Accenture, Cognizant, AT&T etc. and also has key employers as shareholders (Google, Y Combinator and Stripe).
ISAs used by Lambda School are performing quite well with: (i) a $75k average exit salary, (ii) a 54% placement rate after 6 months and (iii) a low 8.6% default rate.
Blair - ISA-based fund manager - 2019 - SF & Berlin
Blair is providing financing to students via ISAs. The startup gathers the students in batches and raise money from external investors to invest in these batches. Their business model is similar to an investment fund. They earn a management fees corresponding to a 2% cut on any repayments and then they have a form of carried interest by receiving share of the profits once the fund for the batch has reached a certain hurdle rate. On its website, it said it can offer a 10%+ annual returns for external investors.
Blair has an interesting approach. They go beyond funding by deploying a holistic approach to helping their students to get the best possible jobs (1on1 coaching, mentorship, CV builder, interview training, and industry insights). The startup went to Y-Combinator last summer. It raises its first fund for 50 students and has a long list of waiting interested students.
Privatizing a social good? It remains unclear how the public subsidies will work along with ISAs. It is possible to combine them. But it is also possible to see a reduction and even the end of public subsidies in the education system.
Only suited for the jobs with the highest demand in the job market? There is a risk to experience a two-tier higher education system in which the best paying jobs (e.g. computer science) will be easily funded through ISAs while investors will refuse to invest in lower paying jobs (e.g. teaching) or in minorities who tend to earn less.
Slackers. Agency issues could arise when students do not want to work in the field they have been trained for or avoid paying back part of the salary by remaining just under the minimum salary threshold.
What will be the regulation for ISAs? The regulation around ISAs remains opaque in the US. Students need to be protected through certain clauses to prevent abuses (limited duration, cap on the total amount that could be paid back) and combining ISAs with public subsidies for education is another issue that needs to be solved.
🗞A booming population is putting strain on Africa’s universities (The Economist, Aug. 2019)
🗞Income Share Agreements: An Alternative to Pay for College (Money, Nov. 2016)
🗞Launching out of YC, Blair is aiming to reshape the financing of college tuition (Techcrunch, Aug. 2019)
🗞StudentFinance.com, founded by the team behind Uniplaces, raises €1.15 million to reshape education financing using AI technology (EU Startups, Nov. 2019)
🗞Are Income Share Agreements The Future Of Higher Education? This Startup Says Yes (Forbes, Oct. 2019)
🎧 A New Way to Pay For College (Planet Money, Mar. 2019)
💌 The Future of Education (Nicolas Collin, Jul. 2019)
📙The Case Against Education (Bryan Caplan, Princeton University Press, 2018)
📙 The One World Schoolhouse: Education Reimagined (Salman Khan, Twelve, 2012)
Feel free to send me any feedback on this issue or on this newsletter at ade@idinvest.com. If you find this issue interesting do not hesitate to share it with your friends. See you next week! 👋