These financing programs offer students more flexibility than interest-bearing loans.
Shane Gring was barely scraping by. Saddled with nearly $50,000 in student loans and credit card debt, the 26-year-old Denver, Colorado, entrepreneur needed a way to supplement his income while getting his start-up off the ground.
So, Gring, who runs BOULD, a company that teaches people how to build green homes, decided to crowdfund himself.
Gring hopes to raise $20,000 on Pave, a crowdfunding platform where young American entrepreneurs, artists, students and other “prospects” raise money from accredited investors in exchange for a percentage of their future income.
So far, four investors, strangers to Gring, have pledged a total of $12,000 to him. In return, he’ll pay them 5% of his income for the next 10 years — whether he earns a few thousand dollars per year or a few hundred thousand dollars.
Pave, which publicly launched in June, differs from popular crowdfunding sites such as Kickstarter and Indiegogo in several ways: It doesn’t require prospects to deliver on a specific project, product or business idea. Instead, they can use the capital however they want.
Backers — who must prove that they are high net worth — invest in the prospect’s future earning potential, not a current project. Rather than accept donations in exchange for a token gift, prospects agree to a binding repayment contract, much as they would with a traditional loan.
Pave’s first 12 prospects to receive funding raised an average of $20,000 each. About 40% of the 4,000 prospects waiting in Pave’s queue are looking to refinance student debt, said Oren Bass, the platform’s co-founder and chief operating officer.
Pave is part of a small but growing financing effort around the globe, one that enables young people to fund their education or early professional efforts by selling equity in themselves to strangers for a small percentage of their future income. Some of the programs also offer mentorship, career counselling and job referrals to investees.
Another newcomer, Upstart, launched in November. To date, about 60 aspiring professionals and entrepreneurs — all college graduates — have raised more than $1.5 million from investors.
Outside the United States, such platforms have been around for more than a decade: Since 2002, the German company CareerConcept has helped thousands of European students finance college in exchange for a cut of their future earnings. In Latin America, Lumni has put nearly $100 million in investments into the hands of 4,500 students, many of them from lower-income families.
These financing programs offer students more flexibility than interest-bearing loans, said Alex Holt, an education policy researcher at the New America Foundation, a nonpartisan Washington, DC, think tank.
“For a student, taking out $35,000 in loans is a very big risk because you don’t know what your income will be,” Holt said.
These new financing programs can deliver strong returns for the financers, too. For instance, although it suffers a 10% default rate at any given time, investments have steadily generated a 9.5% return for CareerConcept investors, even through the credit crisis, said Vishal Garg, company chairman.
These “human capital contracts” are not without risk for the investee. Although most of the companies doing such financing have precautions in place to protect investees from becoming indentured servants, harassment for repayment could be a problem if, for instance, if an unscrupulous financing firm is unhappy about a promising engineering major going into a lesser-paid field or cutting her work hours.
Discrimination is also a potential issue, Holt said. For example, he said, an investor might decide to fund only men, who often draw higher salaries than women.
The future of student financing?
Alternative education financing programs made headlines earlier this month when Oregon’s state legislature approved development of a pilot program that would let students attend state colleges for free. In return, students pledge 3% of their future income for two decades — below federal student loan rates and well below rates for private loans that students can take out upfront to pay for school.
Critics of such programs worry about them taking advantage of students and graduates without other financial options. But the current batch of private sector programs has built-in protections against that.
With Pave, for example, prospects whose income falls 150% below the poverty line are relieved of that year’s payments. Should they strike it rich, Pave prospects can buy out backers for five times their initial investment. Lumni and CareerConcept cap repayment at 15% of an investee’s income. Upstart caps it at 7% and allows beneficiaries earning less than $30,000 per annum to defer repayment a year.
“The Upstart arrangement sounds really scary until you consider the alternative,” said entrepreneur Nathan Sharp, 27, from Boston, Massachusetts, who raised $50,000 on the platform in 2012.
Sharp, who has begun repaying investors 2.5% of his income, used the money to offset $100,000 debt he accrued while earning his masters of business administration degree — as he was trying to grow his online shopping start-up, Nifti.
But it’s not just about the money. Sharp considers the professional mentorship he’s received from backers “the best thing about Upstart.” (Pave and Lumni backers also have the option to mentor investees.)
“I don’t feel timid at all asking them for advice or help,” Sharp said. “Number one, because they had faith in me early on, and number two, their investment depends on it.”
Why investors take the risk
Upstart CEO Dave Girouard said there must be a worthwhile opportunity for investors. To that end, Upstart uses an algorithm to predict a potential investee’s earning potential and only accepts about one-third of applicants.
“We’re structuring this to be a really smart investment, whether you have a philanthropic bone in your body or not,” Girouard said. Even with periods of unemployment, he added, “wages and income — when you invest across a portfolio of people — grow fairly reliably and steadily.”
Craig Walker, the American entrepreneur who invented Google Voice, has put up about $30,000 for seven aspiring entrepreneurs on Upstart, an investment he calls “a no-brainer.”
“I don’t know if their first ideas are going to be their final ideas, but these are top-notch kids,” said Walker, who has already received payments from several investees. “I have no doubt there’s going to be a decent rate of return.”
Like any investment, risks include possible defaults or lower-than-expected returns. Lumni co-founder and CEO Felipe Vergara declined to specify the repayment rate of the organisation’s investees. But, he said, it’s better than initially forecast, given the high employment rates in some of the countries Lumni serves.
Upstart has seen a 100% repayment rate so far, Girouard said. But should a beneficiary refuse to pay or go bankrupt, the delinquent account would be converted to a 14.99% fixed-rate loan, enabling Upstart to notify credit bureaus and work with collections agencies if needed.
CareerConcept, which handles collections in house, is able to collect payments or renegotiate terms on delinquent accounts more than 90% of the time, company chairman Garg said.
Sharp, who hopes to someday be an Upstart investor himself, wouldn’t dream of dishonouring his contract.
“I want all these people to look back and say, ‘That was a good choice. I would back Nathan again’”, he said.