I blogged last year about an IPO for a football player – the public offering of a share of the right to receive 20% of Arian Foster’s future football-related income. There is a movement afoot now to introduce this concept in a much broader way: the sale of a share of future earnings as a means for college students to finance their education, as an alternative to incurring student debt. The current state of affairs is summarized in this Slate article.
The main advantage of using equity over debt is that payments automatically adjust to the student’s ultimate ability to pay. While student loans incorporate deferments and other elements of flexibility, inevitably some borrowers find themselves overwhelmed with repayment obligations because the monthly payment isn’t tied to the borrower’s current ability to repay. While paying an equity investor 15% of one’s current income (the maximum amount under the proposal) is not insignificant, by its construction it ensures that the payments at any time won’t exceed income.
I would urge you not to read the online comments to the Slate article (or really any online comments to any article), but for those of the commenters screaming that the arrangement constitutes “indentured servitude,” I would ask what they think a student loan is. Either way, the student is entering into a financing arrangement enabling the student to attend school now and pay for it later, the expectation being that the improved career prospects generated by the education will effectively fund the repayment. The difference is that the inflexibility of the debt repayment schedule can drive borrowers into bankruptcy, while the equity approach will not. Of course, you don’t get something for nothing, and what the student loses in the equity structure is some (but, importantly, not all) of the upside if the student has a highly remunerative career. (It seems likely that students expecting to have a high income – e.g., a computer science major entering Stanford – may opt for a student loan instead because that will likely result in lower payments to the financing source. But as noted in the article, the share of income to be paid would be more lower for candidates with a higher likelihood of financial success.)
From the perspective of the investor, you obviously wouldn’t want to put all your eggs in the basket of a single student, who could be a dud, but if the investments were structured like peer-to-peer lending platforms such as www.prosper.com and www.lendingclub.com, where each investor spreads small amounts around a variety of investments, there would be adequate diversification.