An Income Share Agreement (ISA*) is a personal financing instrument where repayments are determined as a percentage of someone’s income for a specified period, an equity-type alternative to personal debt for individuals. It’s something of a hot topic, having been adopted by some high profile coding bootcamps, and a lot of the interested folks came together on Wednesday for the Life Capital Conference, hosted by Slow Ventures, Village Global, The Information, and Cooley.
It was a packed agenda in a packed auditorium. It is still a nascent industry, so the discussions were mostly forward looking, and were variously practical (how do we make this work right now) and expansive (what is the possible future for this thing). It highlighted some of the progress already being made, as well as some of the challenges.
Equity for individuals?
While “equity for individuals” is a catchy tagline, it doesn’t necessarily describe how ISAs are actually working at the moment.
From a practical standpoint, ISAs today predominantly provide funding for education in return for a fixed percentage of personal income (revenue) for a set period of time, where the income is above a certain annualised threshold, and where the total amount repayable is taxed. This is different to equity investment. I will leave aside the troublesome ownership implications of “equity” when applied to an individual.
Benefits of ISAs
The benefits of ISAs were well understood and articulated throughout the panel conversations. One of the core premises is incentive alignment: everyone involved wants the ISA recipients to do well. A significant benefit for the individual is risk reduction: if things don’t work out, they have to pay less back (or nothing at all). There are also opportunities for improved accessibility, affordability and outcome transparency not offered by conventional borrowing.
Happy even if it goes well
As a student attending a coding bootcamp, downside protection is a significant advantage, when compared to a conventional loan. Aanand Radia of University Ventures described an ISA as “a loan with an insurance wrapper”, which resonated, but Barry Cynamon’s “insurance where you pay the premiums afterwards” captured the behavioural challenge of ISAs, where if you have a good outcome (i.e. you earn a good salary), you have to pay more, after the fact. One of the core challenges with ISAs is this cross-subsidising across a cohort of students, where the more successful students pay more (often a lot!)
Ensuring people are happy “even if it goes well [and they have to pay a lot more]” is one of the key communication challenges facing ISA providers. In this case the successful students are paying for the downside protection they didn’t end up using, but it was pointed out by Ashu Desai of Make School that this was not an easy thing to put a value on. Multiple panelists highlighted the importance of students being well-informed and “bought in” to the collective nature of ISAs because of this dynamic, understanding that the ISAs work as a kind of income tax (Sam Lessin, who hosted the event, even noted that as taxpayers, we are already participating in an Income Share Agreement by another name).
This has lead to the natural concern that ISAs will suffer adverse selection, where students with a lower chance of success are more likely to take an ISA. Purdue University’s Mary Claire Cartwright indicated that their research showed that there was no adverse selection, having compared their ISA students and those taking regular student loans. I understand that this would be reassuring, but I find it quite surprising that this would be the case: companies that take equity financing are different (and often more risky, with more volatile outcomes) than companies taking debt financing. As an individual with predictable outcomes, a loan is probably a better option, while for someone with a bit more volatility, an ISA is a much more attractive option. If this is not being reflected by those taking ISAs at Purdue, it says something about human psychology, or a lack of appropriate information. Perhaps both.
ISAs are a significant enabler for accessibility, as they can be offered to people who otherwise might not be able to access finance (and might therefore be excluded if the ISA is for an educational course). This is an undeniably powerful benefit, particularly in the case of coding schools and the tech industry, which has an acknowledged problem with diversity and access.
Though a word of caution – while some credit checks used for conventional loans are exclusive (based on historic income and credit worthiness), affordability decisions on the basis of significant existing debt are still likely relevant for individuals taking on an ISA.
The incentive-aligning power of ISAs was much discussed throughout the day. It is definitely very powerful for vocational schools’ payday to be aligned to the paydays of their students. However I worry that it might drive a one-dimensional money-focused approach to student success. With a conventional loan, the lender’s concern is that the borrower has a certain threshold of income where repayment is affordable. Anything beyond that is just upside for the borrower. While for an ISA, higher and higher salaries are even more rewarding for the ISA provider. I wonder whether that might motivate schools with ISAs to focus purely on placing into positions with higher salaries, rather than thinking about other things that contribute to happiness and fulfilment in a job (particularly given research that indicates that incremental income above a certain threshold doesn’t contribute any more to happiness).
We do definitely understand the power of the outcome-based nature of ISAs. In the work we are doing at Vested we are excited by the possibility of an outcome-based loan, providing downside mitigation without requiring significantly more from the highest performers.
Headline risk and regulation
One of the prevalent concerns amongst participants was the risk of one or several bad actors taking advantage of students with usurious ISAs, and the associated headline (and existential?) risk for the industry. This likely drove the excitement over potential ISA regulation, a strange occurrence at a tech conference (as Austen noted on Twitter). Local and national legislators were represented on panels, in Adam Boman of California State and former congressman Luke Messer, who both indicated positive progress on that front. As a Brit, I am familiar with the quasi-ISA used for university financing by the government, and I definitely see the potential for state-enabled post-secondary ISA-funded education. I wonder whether legislature in the States will make moves in that direction, or remain focused on privately funded ISAs.
Sam Lessin was one voice in favour of a considered approach towards regulation, thinking carefully about any legislation that is too prescriptive based on ISAs as they currently exist, for example mandating caps or minimums or terms. “Let’s not make short-term trades that might handicap us in the long-term”.
Bundling and unbundling
The ascent of Lambda School has done much for the profile of ISAs. Austen Allred’s discussion with Will Quist highlighted the interesting way in which the Lambda School model is both an example of bundling and unbundling. Austen acknowledged that traditional universities layer in things that Lambda does not (the housing, the extra-curriculars), while Lambda School just focuses on the “I want a job” part of the university experience. The best choice for the student depends “which bundle is the student choosing”. In this sense, Lambda School is an example of unbundling education, but at the same time, Austen described their vertically integrated “underwrite, teach, place” model as key to their success – bundling up three pretty distinct competencies.
Must be the money
Given the (relatively) embryonic stage of the ISA market, it is not surprising that source of investor capital was a common topic, with schools from Holberton to Lambda talking about funding ISAs with their own equity. Tonio DeSorrento of Vemo described the outside capital evolution that almost all ISA businesses would go through, from philanthropy to novelty to impact to hedge funds to municipal money, based on the evolution of rate of return and track record. University Ventures are currently the largest provider of ISA financing in the world, but as they themselves noted, for the success of the industry that couldn’t remain the case.
Future for ISAs
A lot of participants were clear that ISAs were not a replacement for student loans, and both would likely co-exist in the future. There was a prediction that in 5-10 years, ISAs would be the same size as private loans, in dollar terms. Richard Lee of Leif predicted $500M in ISAs originated in five years time. Austen suggested that, however guaranteed their outcomes became, they would never switch to debt (“Debt is fundamentally opposed to the lambda model”), and will instead just work to drive the cap down.
At least offering an ISA was expected to become table stakes, in terms of offering affordable post-secondary education. “300 universities will offer ISAs in five years time” per Andrew Platt of Vemo. “If your vocational school doesn’t have an ISA, you are dead in five years” per Austen. We are certainly currently seeing a chain reaction in coding schools that is a move in that direction.
It will be interesting to see if that continues to other vocational skills – sadly Austen and Will’s discussion didn’t have time to fully cover Lambda’s ambitions beyond bootcamps, which are substantial. Austen did note that the model would likely look similar but slightly different in nursing, for example.
There was general agreement that growth of ISAs in the future could contribute to much improved outcome data for educational institutions, to enable applicants to make better informed decisions about their education.
The focus of the day was very much on educational financing, though the “Imagining the future” session took a more expansive view, with Dani Grant, Sam Lessin and Erik Torenberg. Were current models “too practical” – why have a cap on repayment? Why can’t individual teachers be motivated and remunerated in this way? What if individuals in a cohort or community (Stanford grads, say) cross-invested in one another to normalise our outcomes? This is apparently something which apparently already happens in high-stakes poker games. Dani Grant of USV wondered wether we would we be kinder to each other, if we were cross-invested. But there was general acknowledgement that we maybe were not ready for the “out there” version quite yet.
So what, for the future of ISAs? Tonio DeSorrento was optimistic, anticipating “a Cambrian explosion of ISA businesses”, though he wryly noted that the Cambrian explosion took 25M years. Those in the room seemed hopeful it might all happen a bit sooner than that.
* British readers will be confused by this acronym, which in the UK refers to tax-free Individual Savings Accounts