Is human capital investing finally going to be a thing?

income share agreement and cumulus funding

As online finance companies continue to develop new types of loans, one firm is growing an innovative form of finance. Chicago-based Cumulus Funding offers something called an income share agreement, or ISA. In contrast to plain-vanilla unsecured loans, in an ISA, a borrower pledges a percentage of his or her income. As a borrower’s income rises, payments therefore rise, as well. Cumulus loans range from between $1500 to $10,000 for a period of 2-6 years. Starting interest rates are based on credit scoring and funding can happen as quickly as a day or two.

While ISAs are a relatively new financial product at scale, Milton Friedman first wrote about them in a 1955 academic paper entitled The Role of Government in Education. Jeb Bush, once considered a front-runner in the 2016 Presidential campaign, positioned ISAs prominently in his economic plan to overhaul the US educational system — one that’s burdened its graduates with $1.2 trillion in debt.

From Bush’s plan:

“Finally, instead of the current burdensome federal loan system, we will give all high school graduates access to a $50,000 line of credit through their Educative Savings Account (ESA) to pay for college and career training. For every $10,000 spent, students would repay 1 percent of their income for 25 years. This ensures affordable repayment, removes risk of default and protects students during periods of unemployment, while the ESA structure gives students flexibility and the incentive to be cost-conscious. In addition, low-income students would have access to an improved need-based Pell Grant through their ESA.”

Outside of lots of discussions and a few experiments over the years, the massive federal student loan industry never really adopted the ISA structure. That’s beginning to change, though. Purdue University has plans in the works to launch its own form of income share agreements in the fall of 2016. Called Back a Boiler, Purdue’s new lending program will be the largest of its kind to date. Student who opt for Purdue’s ISA would receive $10-$15,000 to use on tuition, board, books, and expenses in return for a share of their post-graduate earnings.

“The motivation to explore an ISA was to determine if an alternative could exist to the private loans and Parent PLUS loans that some Purdue students need to take out to help pay for their education over what they are able to get from government loans or scholarships,” explained Brian Edelman, Purdue Research Foundation CFO and treasurer. “The intent is that this type of educational funding resource would be a supplement to a government loan or scholarships.”

The Purdue pilot is planned to be a small roll-out, seeded with about $3m.

Cumulus, which recently announced $30m in funding, says it has issued ISAs of this type to 500 customers since it launched in 2012. Cumulus isn’t the first online finance firm to market ISAs. Upstart, which was founded by Googlers in 2012 with its own ISA product, no longer offers income share products and instead is focused on efficiently providing capital to younger professionals who don’t have a lot of credit history. Pave, which launched around the same time and also markets to millennials, transitioned toward a more traditional lending product after beginning with an income share agreement. The companies have raised over $50m and $300m, respectively.
“We found that the market wasn’t quite ready for income share agreements,” explained Upstart’s CEO and founder, Dave Girouard.  “While there was definitely a lot of early-adopter interest, the complexity and regulatory ambiguity suggested to us that it would likely take a decade or more to become a mainstream product. Given the robustness of our ISA data science in predicting future earnings, we decided to repurpose the analytics to price personal loans, especially for consumers with short credit history.

Photo credit: dewfall via Visualhunt / CC BY-SA