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David Klein had no illusions about the cost of studying for an MBA at the University of Pennslyvania’s Wharton School. To cover his first year tuition, fees and living expenses, the co-founder and chief executive of CommonBond needed $85,000 in loans.
The surprise arrived when Mr Klein, who previously led a consumer finance team at American Express, looked into the cost of borrowing. He found that interest rates on full study loans available to domestic MBA students in the US were high - the federal Graduate Plus loan has a fixed rate of 7.9 per cent - and did not account for degree quality.
“It baffled me that interest rates were so high for students at schools like Wharton,” he says, given the higher earnings potential of students on top-tier programmes.
Also starting his Wharton MBA in the summer of 2011 was Michael Taormina, a former JPMorgan executive. With a shared astonishment at the cost of their loans and a desire to address the issue, Mr Klein describes their meeting as “serendipitous”. “It was clear to us both that the credit risk [of top MBA students] could be better priced.”
Having identified this gap in the market, their attention turned to sourcing lending capital through crowdfunding - raising funds from individual investors. “Credit is based on trust,” says Mr Klein, noting the loss of confidence between banks and borrowers since the financial crisis. “We asked ourselves, ‘where is the source of trust in the future economy?’ We believe this trust lies in pre-existing affinity groups.”
Business schools, he explains, are “a natural fit” given the strength of their alumni networks. “With alumni investors earning 2 to 4 per cent in the capital markets, and students paying 8 per cent [interest on their loans], there is room for both to add value.” Their start-up, CommonBond, would connect these two groups.
The two first-year MBA students committed to the project in November 2011 with fellow co-founder Jessup Shean, who was in the final year of her dual JD and MBA degree.
That month, the team were successful in their candidacy for the highly-selective Wharton Venture Initiation Program, where Penn students can develop start-ups. Mr Klein had been turned down for the VIP earlier that semester. “He took it to heart, got a team together, and reapplied,” says Emily Cieri, managing director of Wharton Entrepreneurship, which oversees the programme.
Teams gain access to campus office space, practical workshops and one-on-one mentorship from seasoned entrepreneurs. “It was a wonderful environment to incubate the idea during our studies,” says Mr Klein, who also singles out an earlier VIP start-up, Warby Parker, for their guidance.
Having decided to pilot their model at Wharton, the next step, during the summer of 2012, was fundraising. Networking was paramount, says Mr Klein, “we talked to everybody.” By launch, in November 2012, $2.5m had been invested by Wharton alumni and lent to 40 MBA students and recent graduates. A further $1m of seed funding was invested by a Wharton alumnus in return for a stake in the company.
Among the first tranche of borrowers was David Knox. After graduating in 2012, he was looking to refinance his federal Stafford loan - a limited graduate student loan - whose interest rate was 6.8 per cent. CommonBond’s rates are fixed at 6.24 per cent, lowered to 5.99 per cent when paid by automatic debit, with a 2 per cent origination fee for new, but not refinanced, loans. A repayment period of 10 years follows six months’ grace after graduation, though loans can be repaid early without penalty. Having refinanced with CommonBond, Mr Knox estimates that he will save up to $9,000 should he repay the loan over five years.
The co-founders are committed to a “social promise” to enhance accessibility to education. “We believe that the company of today must incorporate social mission into a for-profit model,” says Mr Taormina, chief financial officer.
For every degree fully funded, CommonBond finances a year’s education for a student at the African School of Excellence. For each school where loans are offered, the company will fund financial literacy courses in a local under-priveleged community. In Philadelphia, an 11-week programme for a school’s pupils and parents is underway, administered by current Wharton students. “Financial literacy is proven to be one of the most effective ways to allow people to climb the economic ladder,” says Mr Klein.
CommonBond is set to expand its model to 20 leading US business schools in 2013, joining the likes of SoFi in the burgeoning alternative MBA lending market. These top MBA programmes were chosen, according to Mr Klein, because of their students’ high earnings potential and employment prospects. “For our model to work for the long-term, we wanted to de-risk the model as much as possible in the beginning, particularly for our investors.”
Their target is to raise $100m - principally from schools’ alumni, who can ring fence their investment by school - for dispersal in MBA loans this autumn. Mr Klein is optimistic, citing the “substantial commitments” that have been made to date. For investors, the attraction lies not only in strong financial returns, he says, but in “being connected to tomorrow’s business leaders”.
Both Mr Klein and Mr Taormina have deferred their second year studies at Wharton to concentrate on the venture. “We were able to build up enough momentum to justify our commitment,” says Mr Klein. While they have been able to draw a “modest” salary to date, he highlights an irony that it largely goes towards paying off their own student loans.
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