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When Trina Spear graduated from Harvard Business School in 2011, she knew she wanted to set up her own company. She also knew that with $170,000 of debt, and monthly loan repayments of $1,500, that she could not afford to do so.
“It’s quite a burden to pay every month. I felt I needed a six-figure salary,” she recalls.
But after earning her six-figure salary at asset manager Blackstone for nearly two years, she decided to team up with a fashion-designer friend to launch Figs, which brings trendy styling to the fusty world of medical scrubs. “[Working at Blackstone] was an incredible experience but it was not what I wanted to do with my life,” she says.
To help finance the career change, she turned to funding site Upstart. Set up in 2012, it combines crowdsourcing techniques with investment opportunities to help students finance their education and pay off their loans, and to help entrepreneurs find investors. Participants pay investors an agreed percentage of their salary for a required period, usually 10 years.
Advocates of these human capital contracts, also called income share agreements, believe it is a creative and flexible form of funding. Unlike with loans, repayments are fixed as a percentage of income, so if recipients lose their jobs, or want time off for personal reasons, they can do so without worrying about repaying a debt.
Others see it as a 21st-century version of indentured servitude, a system dating from the 1600s in which employers in the US paid the cost of the sea crossing for would-be immigrants in return for a fixed number of years of labour.
Unsurprisingly, Ms Spear is a real fan. “I think it is revolutionary. It gives people freedom,” she enthuses.
She is not alone in her enthusiasm, and some of the companies offering human capital contracts have impressive credentials and backers. While Upstart was established by former Google employees, rival Pave was set up in 2012 in New York by two Britons, who met when they both worked at Goldman Sachs in London. Pave lists Laura Tyson, former dean of both the Haas school at Berkeley and London Business School, among its advisers, as well as professors from Oxford and Yale and a clutch of MBA-trained business people and investors.
Pave was set up in New York because the problem of student debt was far greater in the US than in the UK, says founder Oren Bass, though there is growing demand in the UK for this style of financing. Upstart is also looking to expand to Europe – the UK and Germany in particular. Mr Bass believes that MBAs are a particularly attractive investment. “It [an MBA] is a very clever credential that investors can feel comfortable with.”
The economic credentials for this sort of funding have been proved. In 2002 Miguel Palacios, an assistant professor at the Owen Graduate School of Management at Vanderbilt University, co-founded Lumni, principally to help young people from low-income families in Latin America to go to university. “Loans are a bad tool for financing education,” says Prof Palacios, who has a specialist interest in asset pricing. “This is particularly true for students from families with low resources. It has a big impact if you have someone who cannot go to university because it is too risky.”
The popularity of the scheme is apparent from the numbers. In 2002 Lumni had four students, today it has more than 5,000.
Pave and Upstart both have roots in the changes that followed the banking crisis of 2008 and the subsequent mistrust in the traditional banking system. David Girouard, one of the founders of Upstart, believes Pave and his company have also tapped into a societal shift, in which many of today’s students – the millennials – want to start their own company. “They want to build something, it’s the lifestyle they are interested in. It’s absolutely a millennial view of the world.”
There has been a change in the strategy and motivation of investors too, Mr Bass says. “Individuals want to do more with their money than just get a financial return.”
This shift has been particularly beneficial to social entrepreneur Lawrence Cann, a Columbia MBA (2013) who raised $40,000 through Pave to help pay off his debts. His organisation, Street Soccer USA, uses sport to help homeless men and women get their lives back on track, but it is a project that would have been unattractive to investors who had the sole concern of making money.
“Our project is worthwhile and something they [our backers] want to connect with,” says Mr Cann. “[For me] there is no downside to this kind of funding. If I am successful, I will pay a little more,” he says, explaining that repayments are linked to income.
Sean Jackson, an Oklahoma State MBA graduate of 2004, had already paid off his student debt when he decided to set up an adventure travel business. He is raising money using Pave to expand the company. For him one of the biggest attractions is that he can woo investors who have a particular interest in his business.
This can in turn lead to further investment, as Ms Spears discovered. She raised $20,000 with Upstart finance her move to California to start Figs. Now some of those who invested in Ms Spear have also gone on to invest in her company, as well as opening the door to other venture capitalists. She recently raised $2m for the company. “I could comfortably say that Upstart investors [and their contacts] have raised $300,000 of that.”
For many, the idea of having to self-market to investors is disturbing, but it is something that Ms Spears enjoys. “You’re telling your story, you’re telling people who you are as a person,” she says. “It is people who are drivers of value in a company.”
And as Mr Girouard concludes: “There is no such thing as a free lunch.”
How the funding sites work
● Websites such as Pave and Upstart vet prospective candidates and verify their credentials before conducting financial viability tests. These use proprietary regression modelling techniques to predict earnings and potential return for investors.
● Approved candidates promote themselves on the respective websites. Pave is particularly selective and has accepted only 5 per cent of applicants.
● Prospective investors select the candidates in whom they would like to invest. This can be done anonymously.
● Investors can also invest in groups. This month Pave will launch affinity groups enabling investors to support different classes of individuals, for example, women entrepreneurs or graduates from Columbia University. The New York Rising Stars affinity group is for those who want to invest in entrepreneurs in the city.
At Lumni there are three ways of funding: companies can finance their employees; universities can support admitted students; and individuals can invest in common funds.
● Investors and candidates agree the investment, the percentage of salary to be repaid and the repayment period. Repayments are usually over a 10-year period and are for about 3 per cent of income. Most candidates have multiple investors.
● The companies supporting the human capital contracts offer a range of additional services. At Upstart two contracts are drawn up, one between Upstart and the investor and the second between Upstart and the student or entrepreneur. Upstart manages the collection and distribution of repayments. The company is also exploring ways of enabling hedge funds to invest.
This article has been editied since first publication.