Mar 12, 2019

10 min read

A guide to Income Share Agreements (ISAs)

How they work, the history behind them, the current landscape, and where they’re headed.

As student debt approaches the $2 trillion mark, borrowers are looking for better ways to pay for school. Loans are often inaccessible and can be predatory. 90% of private loans require a cosigner and almost all loans require a credit score.

By 2023, 40% of borrowers are expected to default on their student loans. According to TICAS, some interest rates for private loans ran as a high as 14.24% in September 2018. And unless borrowers refinance to income-based repayment, their payments aren’t tied to their income, which means whether they’re making $100K, $50K, or $0K, their payments are the same.

The solution? Income share agreements, or ISAs.

What’s an ISA?

Income Share Agreements (ISAs) are a debt-free alternative to loans. Instead of going into debt, a student receives interest-free funding directly from a benefactor or fund. In exchange, the student agrees to share a percentage of future income with the lender.

The five parts

An Income Share Agreement consists of five main parts:

Principal: The initial amount borrowed.
Income Share: A percentage of pre-tax income, due monthly. Think of the Income Share like “equity.”
Payback Period: The maximum number of months for which a borrower owes income.
Payback Cap: The maximum amount a borrower can pay back, expressed as a ratio of the principal. For example, a payback cap of 1.5x means a borrower can pay back up to 150% of what they borrowed.
Minimum income threshold: The pre-tax income amount at which monthly payments drop to $0.

How it works

A borrower begins payments once employed, and continues making payments until their Payback Period expires, or they reach the Payback Cap. Payments are equal to their Income Share times pre-tax income.

Here’s an example:

A student borrows $10,000.
Their terms are set such that their income share is 2% for up to 100 months with a 1.5x payback cap.
After graduating, the student receives a job making $60,000 per year. At this salary, their monthly payments are equal to $100 per month.
The student will make their payments for 100 months, or until they pay back $15,000 (1.5 x $10,000). It’s possible they may pay back less than they borrowed. In this example, they’ll pay back exactly $10,000.

The history of ISAs

Milton Friedman

In 1955, Milton Friedman proposed the idea of an equity investment in an individual, allowing investors to buy “shares” in future earnings.

[Investors] could “buy” a share in an individual’s earning prospects: to advance him the funds needed to finance his training on condition that he agree to pay the lender a specified fraction of his future earnings. In this way, a lender would get back more than his initial investment from relatively successful individuals, which would compensate for the failure to recoup his original investment from the unsuccessful.

Yale University

In the 1970s, Yale University ran an experiment based off Friedman’s idea. Instead of individual contracts with fixed payback periods or payback caps, Yale created the program so that each participant continued making payments until the fund as a whole was returned.

Yale’s program was the truest form of a progressive ISA fund, where higher-earning graduates compensated for lower-earning graduates, but there was a catch. Because they had more money, “the highest earners had the chance to prepay and opt out, leaving the rest of the group to shoulder the burden, despite their lower salaries” (Levin 2018). Understandably, this left many of the borrowers upset, feeling like they’d been cheated out of what was pitched as a more affordable option.

Despite the program being dubbed a “failure,” some graduates like Blair Levin called it a success. It allowed them to pursue what they wanted. In Levin’s case, he pursued lower-paying public interest positions — roles he likely wouldn’t have considered if burdened by fixed principal and interest payments from traditional loans.

The Yale experiment was the first of its kind, and it wouldn’t be until much later when another major university would give ISAs another chance.

ISAs Today

Purdue University

In 2016, Purdue University launched Back a Boiler, a dedicated $2 million fund offering upperclassmen at the university to fund their education with ISAs. Since then, they’ve raised another $10.2 million for “Fund II,” and issued 759 contracts totaling $9.5 million in funding disbursed to over 120 unique majors.

Rather than competing against federal loans, which often have low (and unsustainable) interest rates, Purdue’s Back a Boiler fund markets itself as an alternative to private student loans and Parent PLUS Loans. Funding is available to sophomores, juniors, and seniors in any major.

With the launch of the Back a Boiler program, Purdue University became the first major research university in the U.S. to offer Income Share Agreements to their students.

Lambda School

While Lambda School wasn’t the first coding bootcamp to offer ISAs — that award goes to App Academy, founded in 2012 — Lambda has become one of the leaders in the space thanks to its founder, Austen Allred, and the team taking to Twitter to share their brand’s success stories.

Founded in 2016, Lambda School is a nine-month online program that’s free until you get a job. Instead of paying tuition, students can attend Lambda School for free, then pay 17% of their income for the first two years they’re employed (as long as making more than $50,000). Total payment is capped at $30,000, and students have the option of paying $20,000 upfront.

Unlike higher-education institutions, whose main value proposition in offering ISAs is increased affordability and accessibility to education, bootcamps are leveraging ISAs to communicate aligned incentives to students. In a crowded market with no shortage of skepticism around program performance, aligned incentives offer students something similar to a money-back guarantee.

Startups in the space

Align

Chicago-based Align, originally launched as Cumulus Funding (founded 2011), offers borrowers Income Share Agreements to pay for anything, whether it’s debt consolidation, medical bills, or wedding expenses.

In their first five years of operations, Align issued ISAs to over 500 customers.

Lumni

Founded in Chile in 2002, Lumni is the largest (and oldest) company in the space. They’ve issued ISAs to over 10,000 students, and been recognized for their “excellence in social impact” by the World Economic Forum, Bloomberg, the Clinton Global Initiative, and more.

Lumni works with investors, corporations, and educational institutions to fund diversified pools of students. While they operate primarily in South America, Lumni can also fund students in the US and Mexico.

Vemo Education

Vemo Education was founded in 2015, and is based in the DC-metro area. Vemo works with universities, colleges, and coding bootcamps to launch and manage Income Share Agreement programs.

Vemo services 30+ institutions, including Purdue’s Back-a-Boiler Fund, and the recently-announced University of Utah fund.

Avenify

Founded in 2018, Avenify is the only peer-to-peer lending platform for ISAs on the market. With Avenify, retail investors and alumni can invest in students, and students can borrow up to $15,000 to pay for school.

Avenify is launching to upperclassmen students studying at accredited institutions starting in Fall 2019.

The legal landscape

While there are no formal rulings on ISAs (yet), there have been numerous pieces of legislation proposed at both the state and federal level to set standards for how ISAs are issued and regulated.

Investing in Student Success Act (H.R.3432, S.268)

The Investing in Student Success Act has been proposed in both the US House and Senate.

Under the Investing in Student Success Act, ISAs would not be considered debt instruments. Instead, they would be classified as qualified education loans, making them non-dischargeable in bankruptcy. In addition, the bill amends the Investment Company Act of 1940 to exclude classifying a company whose primary purpose is issuing ISAs as an “Investment Company.”

The bill also includes various consumer protections, like a standard structure consisting of payback caps and payback periods, and includes a limit on the amount of income an individual can agree to share.

Since ISAs aren’t (and wouldn’t be) regulated by the Consumer Financial Protection Bureau, the bill includes required disclosure information that must be presented to borrowers:

That the agreement is not a debt instrument, and that the amount the individual will be required to pay under the agreement — May be more or less than the amount provided to the individual pursuant to the agreement; and Will vary in proportion to the individual’s future income;
That the obligations of the individual under the agreement are not dischargeable under bankruptcy law, except in a case that would impose an undue hardship on the debtor and the debtor’s dependents;
Whether the obligations of the individual under the agreement may be extinguished by accelerating payments, and, if so, under what terms;
The duration of the individual’s obligations under the agreement (absent such accelerating payments), including any circumstances under which the duration of the agreement would be extended;
The percentage of income the individual is committing to pay under the agreement and the minimum amount of annual income that, pursuant to subsection (b)(1), triggers the individual’s obligation under the agreement to make payments for such year;
The definition of income to be used for purposes of calculating the individual’s obligation under the agreement; and
A comparison of — The amounts an individual would be required to pay under the income-share agreement at a range of annual income levels, which income levels shall correspond to the levels the individual might reasonably be expected to make given the intended use of the funds provided under the agreement, as determined in accordance with guidance issued by the Secretary of the Treasury; to The amounts required to be paid under a comparable loan that bears interest at a fixed annual rate of 10 percent.

California Assembly Bill 154

This year, Assemblyman Randy Voepel proposed Assembly Bill 154, which would allow students at the University of California and California State Universities to borrow for school using Income Share Agreements in lieu of student loans.

If passed, the bill would require each system to select a campus to run a pilot program and submit reports to the state in 2023 and 2026. The programs would be open to second-, third-, and fourth-year students.

Just like the Investing in Student Success Act proposed in the US House and Senate, Assembly Bill 154 would exclude ISAs from classification as “debt instruments,” and require protections such as payback caps, payback periods, and consumer disclosures.

Criticisms & concerns

Adverse selection in ISAs

Argument: Because ISAs are potentially more risky than a student loan and don’t require the same qualifications as a loan, those looking to borrow with an ISA are likely to be a more risky investment.

Rebuttal: In September 2018, a research study from Purdue University was published that looked into adverse selection in ISAs. After analyzing data from students participating in Purdue’s Back-a-Boiler fund, the study concluded there was no adverse selection by student ability among borrowers.

The cost of education is the problem, not debt

Argument: The value of a college degree is decreasing and isn’t worth the investment or time. We should be incentivizing colleges to lower their costs to more accurately reflect the value, instead of building solutions around it.

Rebuttal: According to a 2016 study by The College Board, median earnings for full-time workers with a Bachelor’s degree earn almost 67% more than those with a high school diploma. ISAs exist to increase accessibility to education, and empower a new generation of learners and workers.

ISAs are just indentured servitude

Argument: Requiring a share of income in exchange for working sounds like indentured servitude.

Rebuttal: Unlike indentured servitude, borrowers are not required to work. And, unlike private loans or indentured servitude, ISAs are a promise to share future income, not an obligation to repay a debt.

ISAs are unregulated

Argument: ISAs are unregulated, and don’t provide the same consumer protections student loans do.

Rebuttal: All companies and institutions currently offering ISAs operate according to best practices set forth in proposed legislation, including required consumer disclosures and borrower protections.

Lack of transparency into how much may be paid back

Argument: Because ISAs are 100% income-based, students don’t have a clear understanding of how much they’ll end up paying back when they borrow.

Rebuttal: ISAs include payback caps and maximum payback periods to ensure a borrower never pays for more than they should, or for longer than they should. The payback caps and payback periods are communicated clearly upfront and included in the required disclosures and contracts. Because payments scale with income, borrowers have peace of mind knowing their payments will always be affordable.