Another Take on Human Capital Contracts

Fellow Rhymes with Education contributor Andrew Bennett’s decision to ignore title capitalization conventions in his most recent post notwithstanding, he (re-)asks a very interesting question: “Why are the things we study so often so unrelated to the things we end up doing for a living?”

I don’t have the answer, but the folks at Upstart, a SF-based startup which just announced its public launch this week and boasts Dallas Mavericks owner and maverick financier Mark Cuban as just one of its many impressive funders, think that not only have they stumbled on one contributing factor but also purport to have a product which may be able to free future collegians from the dilemma of whether to follow their dreams or take the “safe route.” Their product, which is none other than a standard human capital contract (HCC), will allow those select few collegians who have the right combination of ambition, drive, and focus to escape the soul-sucking campus recruiting cycle, or the even more soul-sucking process of telling your parents you couldn’t find a job and have to move back in with them for a few weeks months years. (Note: Upstart.com is completely separate and different than Upstartbayarea.org.)

The basics of Upstart are these (and they should sound familiar to anyone who has read my earlier posts on HCCs, because they’re nearly identical) :

1. 

2. 

3. 

What separates Upstart from other HCC vendors I’ve read and/or written about before (e.g. Lumni, 13th Avenue Funding) is its choice of target market. As a financial product, human capital contracts are relatively simple and, for all the reasons I’ve listed before, actually better than analogous debt products when it comes to financing education. From a cultural perspective, however, converting to HCCs as a remedy for out-of-control student debt is actually a pretty tough pill to swallow. In nearly all of the conversations I’ve had with people about human capital contracts, the mention of having students sell a portion of their future income, and the corresponding truth that someone else owns that portion of their future income, consistently elicits the following knee-jerk reaction: “That sounds like indentured servitude.”

In the follow-up to his blog post on New York Times’ Fixes last summer, David Bornstein picks up on this objection and writes:

It’s not clear to me why someone who agrees to sell a portion of his future earnings for a given period of time is being enslaved. The essence of servitude is a loss of freedom. What happens today for many college students who take on student debt is that they get locked into high payments that limit their career options. I’ve met many students who say they would love to spend a number of years after they graduate working for a social-purpose organization, or serving in a program like Teach For America, or trying to start a business — but many of them end up going the corporate route because of their loans. That sounds more like servitude to me.

With human capital contracts, students would have wider options. They would know that, regardless of their career choices, their payments would not be unmanageable. For example, doctors who financed their education this way could feel more comfortable going into lower-paying, urgently needed specialties like geriatrics or serving in low-income communities, where they might earn less; young professionals in many fields could trade off some income for the chance to do work that is more meaningful and potentially more fulfilling.

Well said, David.

However, rationally arguing for why people shouldn’t be creeped out by other people owning a share of their income does not mean that we can then dismiss their being creeped out. As my girlfriend and I prove and re-prove time and again, fighting rationality with emotion (and vice-versa) rarely ends well. Best to let things cool off for a while until you can both speak the same language. (Who knew there would be free relationship advice thrown in here?) Anyway, I would imagine that being uncomfortable with people owning a share of other people’s income has its genesis in our country’s complicated and troubled racial history. And just to be clear: I’m talking about slavery.

When one adopts a more culturally holistic perspective, one can understand why the water might feel uncomfortably warm when a company creates a product that “aims to facilitate buying and selling the shares of low-income students’ future income in order to provide financing for their higher education.” Of course that characterization is quite oversimplified, but it’s not technically inaccurate. In fact, as it pertains to the company I hope one day to start or work for, it’s technically accurate, which is to say, it’s dead on.

As I was saying, Upstart chose a different target market and consequently side-stepped the mine field that is America’s racial history and present. (Yes, I did jump from talking about low-income students to talking about students of color. Unfortunately, race and class are still far too inextricably linked when it comes to educational outcomes.) Upstart, on the other hand, focuses on students who see a more entrepreneurial future for themselves. As Founder Dave Girouard wrote in his company’s inaugural blog post:

We have a surplus of bright young people who want to carve their own way – to take a risk, start something new, and make a difference. They have all the energy and passion you’d expect from people in their twenties. In most cases, they’re yet to be weighed down by the obligations that curtail risk-taking later in life – spouses, kids, mortgages, health, etc. And while not generally creditworthy in the traditional sense, there are clear and measurable signals reflecting their accomplishments and hinting at their potential. Yet we collectively tell them to take the job.

Could we imagine a future where talented grads are given a modest window of economic freedom, combined with the help and support to do what they were really meant to do?

With no explicit social agenda other than to expand opportunity broadly, Upstart may just be the company that introduces HCC-like instruments to the masses. In doing so, the risk of HCC’s “experimentation phase” will be borne by those who are best able to bear it: the risk-takers among us. And when it comes down to it, that’s the essence of financial capitalism.

Upstart is beginning this fall with recruitment efforts at 5 universities: Arizona State, Dartmouth College, Rhode Island School of Design, University of Michigan and University of Washington. A quick review of Upstart’s founding team reveals notable diversity (except with respect to age, but nobody’s perfect!) for what is essential a financial/technology start up (traditionally white and male sectors). Most notable, in my opinion, is the inclusion of Damon Whitsitt as a principal. While nearly all companies’ first priority is sales, Upstart has made the impressive realization that its product is people first, and its platform second. Damon’s background is not in sales and marketing, but rather in staffing (albeit most recently nearly six years in sales and marketing divisions at Google.)

As Upstart gains traction in the marketplace, I expect they will quickly start running into SoFi. I’ve written about SoFi earlier here. Needless to say, the financing options available to students are going to get more complicated before (if ever) they get simpler.

But wait! There’s more! Upstart isn’t the only one trying to get in on the action of helping America’s 20-somethings get a jump start on changing the world. Check out Thrust Fund.  With much the same idea and target profile as Upstart, Thrust Fund, which currently lists only two entrepreneurs seeking funding. Though it should be said that if Jon’s and Saul’s profiles are any indication, Thrust seems to be going for quality over quantity.

Anyway, as always, I’m excited to see if Upstart and Thrust can make strides towards popularizing HCC-like instruments.

The College Graduate as Collateral

You know you’ve staked out a small niche for yourself when emails start pouring into your inbox with a link friends and family think you’ll find interesting before you’ve even gotten out of bed in the morning. (I suppose the same scenario could also be used as evidence that I’m sleeping too late in the day, but never mind that…)

Anyway, this is exactly what happened when Luigi Zingales’s Op-Ed, entitled The College Graduate as Collateral, was printed in the New York Times last Wednesday. Professor Zingales’s piece is the latest high-profile mention of human capital contract-like instruments (such mentions seems to occur about twice a year). Although he never mentions HCCs by name, it’s clear from phrases such as “Investors could finance students’ education with equity rather than debt. In exchange for their capital, the investors would receive a fraction of a student’s future income,” that Professor Zingales has been reading my blog is walking the same intellectual path as those pioneering HCCs.

It’s always a challenge for me to write about events such as these when accomplished and well-respected intellectuals write so clearly and succinctly about topics the navigation of which feel to me like being chest-deep in a muddy bog (the soccer ball in the picture is not a part of my metaphor, but as an aside, did you know Swamp Soccer was a real thing?).

Having said that, I think Zingales goes too far in his vision of how equity can be used to finance an individual’s pursuit of her own education. The trouble with debt as an instrument for financing education is it leaves the individual holding the entire “risk” bag. Equity, on the other hand, would allow the individual to transfer the risk of pursuing higher education (e.g. uncertain income after graduation) to an investor who is best able to bear that risk. Human capital contracts as I conceive of them deal mainly with the individual benefits of education. However, as many scholars including Professor Palacios (author of the book on human capital contracts) have pointed out, education is not solely a private good. There are public benefits (i.e. benefit recognized by parties other than those directly involved in the transaction) of education as well, which forms the basis for public involvement in education in the first place. Zingales, however, seems to advocate for the privatization of the higher education industry using equity-based instruments.

FAIR (Funding with Affordable Income-Based Repayments) Proposal in UK

Carlo Salerno at ESM sums it up best:

Here’s the link.

Basically, there’s a proposal floating around various offices in Britain for a human capital contract-like arrangement. It’s called the Funding with Affordable Income-Based Repayments (FAIR) plan. A quick summary:

Under the plan, a student would sign a contract with a special purpose company, acting for a university or group of universities, to repay a fixed percentage of their earnings over a set number of years. Banks would package the graduate contracts and sell them on to investors, particularly pension funds.

Read more: http://www.insidehighered.com/news/2012/05/03/plan-floated-britain-investors-pay-tuition-and-students-repay-based-income#ixzz1uBzNK07d
Inside Higher Ed

More to come…

P.S. I’m with Carlo on “disruption” too…

The Uncertain Future of American Colleges: A Roundup of Articles from Around the Internet

(By Jeff)

A quick run-down of a few recent posts from around the internet raise some interesting questions.

1. Frank Bruni’s Sunday NYT column entitled The Imperiled Promise of College. Without getting into specifics, Bruni laments the rising cost, declining benefit, and social stratification of American colleges and universities. It’s a well-told tale, but worth of repetition to be sure. Towards the end of his monologue, Bruni raises the idea of using incentives to nudge students towards “fields of studies that will serve them and society best.”

I don’t always try and bring it back to human capital contracts, but when they’re relevant, why not? One of the possible benefits of widely using HCCs is an alignment of incentives so the students who are interested in studying subjects which tend to lead to more lucrative careers (though certainly not a perfect indicator, one way to measure a profession’s utility to society is by its relative compensation) not only do so but also do so at the colleges and universities which are able to provide the best valuefor the dollar. For instance, if two students earn degrees in computer science, one from MIT (total tuition: $160,000) and one from University of Maryland, Baltimore County (total in-state tuition: $80,000; total out-of-state tuition: $120,000), and get jobs paying $80,000 and $70,000, respectively, right out of school, investors will see the latter student as earning a better ROI and will prefer to invest in her over the Harvard graduate. In effect, this will signal to Harvard that they must either lower their tuition (at least for computer science majors) or their CS graduates must earn higher salaries if they are to be competitive in a HCC finance market. (Side bar: If you aren’t familiar with Freeman Hrabowski, the President of UMBC, check out these profiles at 60 minutes and Time.)

People Capital is another peer-to-peer lender like SoFi that offers a way for students to secure loans outside of the traditional lending market. People Capital’s innovation is to use personal information such as school, major, GPA, SAT scores and length-of-time to graduation, rather than a student’s credit score like commercial lenders, to measure risk and determine interest rates.

(Side bar #2: Business Week has, to my knowledge, the most comprehensive measurement of college ROI data to date. Click here for analysis, data table, and methodology. I hope to write a future post on this topic as well, so do check back if you’re interested.)

Naturally, this leads to the question of whether colleges and universities should charge differential tuition rates based on a students course of study. Complications abound, but that doesn’t mean it’s not a valid question. I predict we’ll start hearing much more about this in the coming years as the higher education industry gets increasing amounts of push back about rising tuition and decreasing benefits.

2. For another high-profile inquisition into the benefits of college, see Richard Vedder’s Why College Isn’t for Everyone in Business Week. My first reaction: I worry about the implications of Vedder’s not-for-everyone mindset on education reform efforts that are predicated on a belief that everyone should be able to go to college (a belief that I share), especially in light of the absence of any widely available alternatives to a college degree that allow for even the hint of possibility for upwards social mobility. My second reaction: My first reaction still stands, but Vedder’s commentary on the necessity of understanding the limitation of statistical averages in telling a story is incredibly important.

Third, not everyone is average. A non-swimmer trying to cross a stream that on average is three feet deep might drown because part of the stream is seven feet in depth. The same kind of thing sometimes happens to college graduates too entranced by statistics on averages. Earnings vary considerably between the graduates of different schools, and within schools, earnings differ a great deal between majors. Accounting, computer science, and engineering majors, for example, almost always make more than those majoring in education, social work, or ethnic studies.

The phenomenon he’s referencing here is that although lifetime incomes averages of college graduates are vastly greater than lifetime income averages of non-college graduates, the variability in lifetime incomes is significant and too-often ignored. In fact, it is this variability in individual lifetime incomes that make equity instruments (such as human capital contracts) far more appropriate than debt instruments (such as loans) for financing education.

(Side bar #3: I recently came across two more interesting equity-based proposals for financing education which I will profile in more depth soon. For now, though, check out this article on CNN that focuses on a early-stage proposal for an alternative to traditional higher education finance at Clarkson University in Upstate New York. The article also briefly mentions an organization called Fix UC which advocates for an entire overhaul of the tuition system throughout the University of California system by very directly utilizing a human capital contract set-up.)

3. Planet Money produced a succinct infographic/text combo entitled What America Owes in Student Loans as a part of its ongoing What America (not sure if this is the official name or not) series. With the caveat that the Planet Money piece relies heavily on averages (see #2 for forewarning), author Lam Thuy Vo presents an interesting counter-conclusion to Vedder’s:

But it turns out that the rise in total student debt is not primarily the result of each student borrowing more money. It’s the result of more students going to college.

“The main force pushing up the total amount of outstanding student debt is growth in the number of people going to college,” said Sandy Baum, an analyst at the College Board.

Average debt per college graduate is rising — but not nearly as fast as total student debt.

Now, it may very well be that both Vo and Vedder are correct, but I wonder what it says about each of them that they choose to interpret the data the way the do?

4. I don’t make a habit of trolling the pages of the American Enterprise Institute website, but when a Google search or an article I’m reading points me in that direction, I’m not opposed to exercising my open mind. So, with that introduction, I give you Lights, Camera, Crazy!, a book review of Andrew Ferguson’s Crazy U, by Michael Rosen. The book blends, as Rosen writes, “broader cultural, political and economic insights into higher education trends with a deeply person, and surprisingly moving, account of Ferguson’s and his son’s own experience visiting, applying to, and ultimately enrolling in college.” Topics in the book range from skyrocketing tuition, college rankings (I’m getting tired of saying this, but rankings are also a planned topic for a future post), standardized testing and the blogs, brochures, websites, fellow parents and admissions officers that make up the rest of the hellish admissions process.

If there’s one thing I’ve learned over the last few years of being involved in education in various capacities, thought, it’s that no other sector of life leads to stranger bedfellows. Somewhat confusedly, I found myself nodding in agreement (though I’m going to tell myself it was only in acknowledgement) during a few passages of the review. Namely:

Much of this obscene acceleration in prices can be laid at the feet of the federal government, which, in a vicious cycle, subsidizes loans, makes direct grants, and offers loan forgiveness, all of which in turn spur higher education institutions to hike tuition further, which in turn necessitates further government aid.

“It’s the same problem that afflicts health care,” Ferguson posits. “A large portion of the people consuming the services aren’t paying for the services out of their own pocket. The costs are picked up by third parties.” One massive, 10-year study Ferguson quotes found that “each increase in Pell aid is matched nearly one for one by tuition increases” among private schools.

I don’t know that I completely agree with Rosen’s paraphrasing of Ferguson’s conclusion that much of the blame “can be laid at the feet of the federal government,” and I certainly am not on board with where Rosen seems to be heading that the federal government should stay out of education finance, but I do agree that the mechanism which he describes of increasing amounts of aid being eaten up by tuition increases leading to increasing amounts of aid and so on is alive and well. The single biggest problem is the lack (or extreme delay) of feedback signalling and the use of debt in the first place. One problem is easier to fix than the other and while I have made no secret of being a huge fan of human capital contracts and other equity instruments, I think efforts by companies like SoFi and People Capital to inject some humanity and accountability back into the process are huge steps in the right direction.

Also, the comparison of health care to education with respect to out-of-control costs and using HCCs as a possible solution reminded me of an article I stumbled across recently which proposes to use human capital contracts as a way of reining in medical school debt. This proposal is much more education than health care related, but it’s another interesting area of overlap that was worth sharing.

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Note to self: get to work on posts about People Capital, college ranking system, The Clarkson Proposal (sounds like the title of a spy thriller, right?), Fix UC, Business Week’s College ROI series.

Link

Human Capital Contracts and College Affordability (Click on Me)

The (Space) Cowboys at 13th Avenue Funding

(By Jeff)

A couple weeks ago, as I was reading bits and pieces of this and that and generally just clicking around the internet looking for material about human capital contracts that hadn’t been written by Miguel Pallacios Lleras I stumbled across this article that mentioned a guy named Tonio DeSorrento. I sent Tonio a quick email explaining who I was and that I was interested in learning more about HCCs and he promptly responded saying that he would be happy to talk to me. So we talked. Predictably, the conversation flowed mostly one direction as I didn’t have much of substance to offer, but I listened well and took notes and sent him a thank you note promptly. Sometimes that’s all it takes.

I looked up some of the people he had told me about (there were others, he said, whose names he couldn’t share because they hadn’t yet gone public[1]) and saw that one of the groups, 13^th Avenue, was in Boston. With Tonio’s permission, I used his name to introduce myself to 13^th Avenue’s COO, Casey Jennings, and he agreed to meet me.

You’ve probably never heard of 13th Avenue and that’s unsurprising. While they’re not exactly in a silent phase—they have plans for a pilot program this fall—they aren’t out there jockeying for media attention either. (Indeed, though this group has many strengths, one look at their website makes it clear that PR is not one of them.) What they do have, however, is passion and experience. Remember the movie Space Cowboys? The one where Clint Eastwood, Tommy Lee Jones, Donald Sutherland and James Garner play four over-the-hill astronauts who go back into space on a mission to repair a decaying Soviet satellite operating archaic guidance systems that ends up being more complicated than they anticipate.

Yeah, 13^th Avenue is like that. Not to beat the metaphor to death, but Casey, CEO Robert Whelan Jr. and founding partner Ed Lowry are the astronauts. Financing higher education is the soviet satellite. Equity is the archaic guidance system. Could human capital contracts be the fix?

As soon as I sat down, Casey (whose goofy smile recalls Tommy Lee Jones’s) and I dove right into a frank discussion about wealth inequality, the achievement gap, institutionalized poverty, the importance of higher education in today’s society, the unsustainable lending practices exhibited by most student lenders, and the cyclical dynamic that connects them all.

I don’t pretend to be an expert on any of the above topics, but I like to think that I am conversant and Casey impressed me with his knowledge and perspective. A self-described finance “gear head,” Casey first took an interest in education finance at the encouragement of his political scientist brother who asked how we as a society can “de-risk” students who have done everything they can to go to college but are financially unable. His extensive finance career clearly provides the lens through which he sees these issues, but he is not limited to a strictly quantitative analysis. Casey says most of the learning that he and his team have experienced has been around the concept of community and cites Robert Putnam’s Bowling Alone as being very influential on the group’s thinking.

Whereas many upper middle class families view financing discussion and decisions as private, lower-wealth communities see the destinies of individual families as more intertwined. Decisions about financing have implications for entire neighborhoods and as such, the conversation has to be brought to a higher level. One-on-ones with a student and her family will not suffice. Over the past year, 13^th Avenue has conducted numerous town-hall style meetings with students, families and community members to get feedback and help shape their program.

Robert Whelan Jr. (who, I’m told, couples Eastwood’s good looks and salesmanship with Garner’s down-home demeanor), is the organization’s founder and front man. His own experience growing up in a blue-collar family planted the seed for the idea that would become 13th Avenue. After a very successful, nearly 30-year career in finance, Robert attended Harvard’s Advanced Leadership Initiative (scroll down to paragraph 12 for the portion about Robert) in 2009 and the seed sprouted. His dream, he realized, was to use his deep contacts and experience in finance to make “college education financially available to everyone with the qualifications and desire to go.”

Robert and Casey had met professionally years earlier and generally ran in the same circles. After Robert’s experience at ALI, Casey recalls receiving a phone call from him. “I want to start an organization to reform education finance. Got any ideas?” Robert asked. Casey’s response: “You’re buying breakfast. I’ve got a great idea.” That was mid-2009. Now, almost three years later, they’re ready to test their idea. They have 21 students signed up for a pilot program at a California community college for this fall. Each of the students has completed his or her associate degree and is transferring to a 4 year institution to earn their bachelor’s. 13^th Avenue will provide each student a maximum of $15,000 over the next 2 years to pay for tuition, books, and other costs associated with going to college. Students are encouraged to only take what they need (repayment rates will be prorated accordingly) and payments will be made directly to the university or other payee on the student’s behalf.

The third member of the 13^th Avenue team is Ed Lowry, an environmental law attorney whose cousin happens to be Casey’s wife. Ed and Casey had previously collaborated on an attempt to reform infrastructure financing in California which in Casey’s estimation “failed miserably.” In addition to being the resident legal expert, the street in Sacramento where Ed’s house is located also provided the organization’s name. Legal counsel has been a particular thorn in their side as Casey says numerous layers have refused to work with them because of the complete lack of any case law on human capital contracts leading to concerns about enforceability. (I recently found this posting by another ed policy amateur that discusses the legal side of HCCs.) Casey gleefully reports that Manatt, Phelps & Phillips is graciously providing pro bono counsel now, but says that a previous law firm that had been providing services on a pro bono basis fired themselves over the potential for legal kerfuffle of 13^th Avenue’s cause. “Pro bono” and “fired” are not terms usually seen in the same sentence.

Casey is vocal about his skepticism that human capital contracts can be implemented on a for-profit basis, although he’s not opposed to people trying. Right now, he says, his goal is to prove that they work with low-income populations at all. Then: share his tools with anyone and everyone who wants to replicate 13^th Avenue’s program in their own community. His vision is an online resource where contract templates and other resources will be available under a creative commons license. Individual social entrepreneurs will then be able to download the material and, per their terms of use agreement, report back to the community about their experience implementing human capital contracts. In this way, a wiki guidebook will emerge to help each successive entrepreneur.

For instance, one unexpected feature of the student population with whom 13^th Avenue is working in California is that many of them are undocumented and consequently unable to access any other forms of state or federal financial aid, though there is an in-state tuition exemption provided to such students under a 2001 law: AB 540. Furthermore, California state aid will be available starting in 2013 on a limited basis to high-achieving undocumented students who are on a path to citizenship under the California DREAM Act. Each year 25,000 undocumented students graduate high school in California. Clearly, 13^th Avenue’s experience navigating this particular context would be invaluable to anyone working with similar populations.

In atypical cowboy fashion, Casey ultimately hopes that government, at the state or federal level, will take up the idea of human capital contracts, but until then, it is on social entrepreneurs like him to lead the charge. We wish 13^th Avenue the best of luck.

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[1] It has subsequently become clear that SoFi was among these stealth flyers. Click here for my previous post on SoFi’s launch.

A Peek Under the Hood of Human Capital Contracts

(By Jeff)

For 3 weeks, I have written, re-written, tweaked, completely erased and written once again various versions of a post about what human capital contracts are. Each time, however, I have gotten distracted by all the exciting and interesting issues that surround human capital contracts and have failed to adequately explain the instrument itself. To avoid that problem this time, I have limited myself to 600 words. Here goes…

A human capital contract is an equity-like instrument in which a student gives up a certain percentage of their income for a certain amount of time in exchange for money to finance their education.  In practice, it looks like this:

A student contacts a human capital contract provider (e.g. 13^th Avenue, Lumni, Enzi) and after a preliminary exchange of vital information (what information to collect and how it can and should be used is an important discussion that I will not be distracted by now!), the student receives a proposal that includes the terms of the contract: amount to be pre-dispersed, percentage of income owed in return, and the duration of the contract.

In his NYT article on the topic in the Fixes blog last year, David Bornstein, founder of dowser.org, gave the following example of the deal aspiring Colombian college student Jairo Sneider made with Lumni, Inc, one of the leaders in this emerging field:

In exchange for $8,530 in financing, Sneider agreed to repay 14 percent of his salary for 118 months after he graduated. At that point, regardless of how much he has paid, his obligation terminates. Although this might sound similar to a loan, an “income contingent” repayment plan like this is far less risky for a low-income student like Sneider. If he has trouble finding a job or switches careers and earns a lower salary than expected — very distinct possibilities — his payments will drop automatically. The terms are, in fact, determined based on his expected earnings. If he ends up earning the average salary for nurses in Colombia, he will end up paying the equivalent of an interest rate of 17 percent, which is the average rate in the country for a student loan. And if he ends up doing better, he will pay more, and Lumni will share in his success.

The end of this quote illustrates the key difference between an equity instrument like a human capital contract and a debt instrument like a loan. In the case of the former, investors gain exposure to upside risk (potentially making more than they put in) by also taking on downside risk; in the latter, securing themselves against downside risk costs lenders the potential upside value.

Alright, that’s it. That’s all I’m going to say for now.

I’ve briefly discussed this idea with many of my friends and colleagues and everyone has their own questions and comments. (Is this ethical? Is this indentured servitude? What about the dynamic between investors and students? How do you protect against undue influence?) Please leave yours in the comment field below and I will do my best to respond. Don’t hold back—tell me how you really feel.

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Needed: Dividends over Exits Mindset in Education Tech (And Finance!)

(By Jeff)

As I continue to get deeper into this blogging thing, one of the most happily surprising (though upon further reflection, it should have been totally anticipated) side-effects has been my exposure to other lesser-knowns writing, brilliantly and otherwise, about education.

In the last few weeks, Kirsten Winkler (@kirstenwinkler) who blogs about education technology at bigthink.com (Disrupt Education), EDUKWEST, and most recently EdCetera, has proved her worth in my mind. Earlier this week, Winkler posted about the need to change the mindset in education technology from one where investors think about “exits” versus one where they think about receiving ongoing (and increasing) dividends on their investments. (See the full post here: We need a Dividends instead of Exits Mindset in Education.) While I am completely in awe of the increased interest in education the technology sector has shown in the short amount of time that I’ve been paying attention (3-4 years), I am completely out of my depth when I try and discuss it, so I’ll leave it to people like Winkler.

However, I think the change in mindset she is advocating for is exactly the one that is needed in education finance as well. (I know, I know, I still haven’t posted about what exactly a human capital contract is, but I promise, it’s coming!) Student loans are a product of an “exits” mindset where lenders want a pre-determined (and pre-valued) exit. The lack of exposure to upside risk forces them to raise all interest rates so that those who pay back their loans subsidize those who default. Human capital contracts are a large and intentional step towards a “dividends” mindset. 13th Avenue Funding, which will utilize a co-op-type arrangement is yet another step in that direction. (Post about 13th Avenue and my recent meeting with their COO coming soon, as well!)

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A Quick(er) Word on Capital Structure–Part II: Equity

(By Jeff)

Equity Equity finance takes the form of money received up front from investors in exchange for an ownership share in the business. (I have a strong memory of my father repeatedly telling me that Warren Buffet’s definition of an equity investment was a claim to future cash flows.) 

Just as the borrower has to compensate the lender based on the principle of the Time Value of Money, so too does the investor expect to earn a return on his money. This return is sought through either capital appreciation or dividends. 

Relative to debt, equity is a subordinated (or junior) obligation in a company’s capital structure. This means that in the event of a default, all claims by debt holders must be satisfied before restitution can be made to equity partners. Whereas debt issuers paid for this seniority by giving up their claim to upside risk, equity investors make the opposite bargain: while they may be left with nothing if the line of creditors in front of them is too long (or the company’s assets are too small), they also stand to gain the most in the event of brilliant business success on the part of the company. Miguel Palacios Lleras summarizes this difference:

Equity is used for investments with high-risk profiles where the use of loans would be excessively costly, if not impossible. The use of equity suits risky investments better because investors compensate possible loss through a significant financial upside potential, well above the original value of the investment. With debt, all investors have is downside. (Investing in Human Capital, p. 2)

Because equity investors have a stake in the financial success of the company rather than just the absence of financial catastrophe, equity investors (especially those who hold significant ownership shares) are often viewed as partners. 

One last important thing to note about equity investors is that they usually have a “voice” in management decisions that is in proportion to their total ownership share.

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Trouble Down Under

(By Jeff)

The Australian media has worked itself into a mini-frenzy recently over reports (here, here, and here) that since 1989, workers who went to college in Australia but then expatriated to work overseas have left Australian taxpayers on the hook for about A$500M (US$513M). Moreover, that shortfall is projected to surpass A$1B in the next 10 years.

I realize I’m getting a bit ahead of myself here in that I haven’t yet introduced  Australia’s HECS (Higher Education Contribution Scheme), but I promise to do so soon. In the meantime, click here for the Wikipedia page and scroll down to HECS.

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