Future of Student Lending: Income Share Agreements and Career Impact Bonds

Building an Impact VC Fund

As an innovative financing enthusiast, I have been following up on new forms of student lending models for almost two years, whether it's Prodigy Finance, SoFi, or Lambda.

Problem

In the United States, student loan debt has hit $1.2 trillion, with the average 2014 graduate owing $33,000. In the United Kingdom, higher education was free until 1998, but today costs up to $14,000 annually.

The need in developing countries

The demand for student finance is exploding in developing countries with growing middle classes and increased demand for higher education and skilling programs, such as Vietnam, South Africa, Brazil, Morocco, and India. Access to tertiary education is strongly correlated to increases in GDP and can be transformative for individual life chances and national economic growth. For example, India has a large market gap between industry demand and skilled workforce. 15 Mn joins the workforce every year, but only 3 Mn are gainfully employed, despite the need for 120 Mn+ qualified professionals by 2022.

The financial mechanisms providing student lending that have been implemented in large developed economies are not providing models that emerging economies should emulate. The student lending space needs a serious reboot, as many developed as well as developing markets are in crisis, requiring new approaches to continue providing responsible student loans, the keyword is "responsible." Further, more innovative solutions are needed.

ISAs - An answer to a new form of student lending

I think there is a stronger case of Income Share Agreements or Career Impact Bonds than ever before, as the education is going through some severe reform, where the results matter more than degrees and badges, e.g., Lambda School.

Isn’t it obvious that a student as a consumer should pay for the results and not just for the badge? The new forms of financing, especially pay for success models proving that case to make it a reality.

An income share agreement (or ISA) is a financial structure in which an individual or organization provides something of value (often a fixed amount of money) to a recipient who, in exchange, agrees to pay back a percentage of their income for a set number of years. When the ISA is tied to the future-income potential of the student, it creates the right kind of incentive structure for the education service providers like universities, Bootcamps, skilling institutes, etc. ISAs are only successful if the borrower can achieve a higher income after completing their education, increasing their ability to repay on time and in full. Lenders, therefore, have a vested interest in identifying "employable" degrees that will meet market demand, and hence screening out education-service providers whose courses don't produce good outcomes in terms of employability.

Milton Friedman originally proposed the concept in 1955, in his essay "The Role of Government in Education," in which he argued that students might beneficially be funded through an "equity investment" such 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.

Every ISA has five core components to it:

  • Income Threshold: Students below the certain-minimum income threshold will not be required to pay.

  • Income Share: The percent of gross earnings an individual pays, once above the income threshold.

  • Payment Duration: The length of the ISA agreement

  • Payment Cap: The maximum, aggregate student ISA payments, typically listed as multiple of list price (i.e., 1.3x or 2.5x)

  • Total expected payments: ISA terms dictate the student payment curve, which determines total expected student payments

CIB - A new form of an ISA

An impact bond, also known as pay-for-success financing, is one form of outcomes-based contracting. When the ISA is married to Impact bond kind of structure, it is called Career Impact Bond (CIB). CIBs are an organic extension of PFS (Pay For Success) as an impact financing tool where students pay for their career success, repaying a portion of their incomes for a fixed period, once they find meaningful, sustained employment. The CIB is a form of an ISA for high-quality, industry-recognized skilling programs for low-income populations.

E.g., Social Finance - Career Impact Bond Structure

The impact-bond pioneer, Social Finance, has built its first CIB to enable 1,000 low-income students to access best-in-class computer programming training. To read more about it, click here [1] and [2].

I am personally extremely bullish about the ISAs in general. Because of that, I see the massive potential of CIB in emerging economies like India, Vietnam, etc. where there is a growing need for student loans. I believe every fixed-interest loan product should be converted into an ISA or CIB.

Are you interested to learn more about ISAs or CIBs? Please do write to me in that case.

Curated Resource:

  1. [Podcast] Interview with Tracy Palandjian, co-founder and CEO, Social-Finance, US

  2. [Podcast] James Gallagher on Income Share Agreements

  3. [Podcast] Founder Interview - Justin Potts (Avenify) On Investing in Human Potential

  4. [Article] The role of government in education by Milton Friedman

  5. [Article] Lambda School's For-Profit Plan to Solve Student Debt

  6. [Report] The Potential Market for Income Share Agreements Among Low-Income Undergraduates


I am continuously looking for first-time fund managers who are looking to create their first-time impact funds with an edge or a differentiated value proposition in emerging economies. If you are building one, please do write to me. I would love to learn more from you and would be happy to help in any way.

With Love,

Sagar


About

"first followers" is founded by Sagar Tandon, a founding member at Moonshot Ventures. You can reach him at sagar@moonshotventures.org.

Occasionally, he blogs about the responsible investing, tech for good, venture capital, investment thesis, conscious capitalism, collaborative consumption, community, and humane lifestyle.