What if instead of charging tuition a private investor took an equity stake in students? If the student does well, the investor gets a strong return. If the student just gets along, the investor gets a modest gain. If the student flails and fails, the investor gets burned.
It's an idea that has been kicking around for quite some time, at least since Milton Friedman floated it back in 1955.
An investor, Friedman wrote, would give the up-front 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."
But today, Education Equity, a for-profit company, is testing the concept with a working prototype, already funding real students.
Education Equity's mission statement, its website states, is "to increase human capital and support positive social mobility by identifying, funding and guiding students in their pursuit of cost-effective higher education."
George Anders at Forbes reports on a recent conversation he had with Education Equity founder Andrew Davis. Anders offers a few strategic insights garnered from his talk with Davis.
Davis aims to be very careful about which career tracks he invests in, Anders said, steering away from high-end careers in favor of steady performers such as school administration and engineering, where the financial value added of the added degree is more clear.
He also is looking to provide networking and career support reaching beyond awarding the degree, in keeping with his financial stake in long-term results.
"It’s still early days," Anders notes, "but Davis hopes that Education Equity can help with professional networking, so that graduates can alert one another to good career opportunities that they might not find if everyone operated solo. "I’m very motivated to see everyone succeed in this program," Davis told Anders.4 comments on this story
A wide variety of structures are possible under Income Share Agreements. Back at Forbes, for example, Anders cites one Education Equity customer who is pursuing a graduate degree in education administration. If he becomes a school principal, EE expect him to earn around $120,000 a year. If he does not, he'll pay back far less as a regular schoolteacher. But if he hits the big time for some reason, the deal caps out at $200,000 a year, reducing the upside risk for the student.
The concept is laid out in detail in a recent white paper published by the American Enterprise Institute. The authors offer a number of arguments in favor of Income Share Agreements, emphasizing that the dynamic obligation responds to income levels and thus is less likely to heavily burden a student whose educational gamble does not pay off.
Borrowing for risky investments, the authors note, is usually shunned in favor of giving high equity stakes to investors, who then assume a greater share of risk in exchange for sizable payoff when the investment pays off. This frees the entrepreneur from carrying the entire risk burden, and gives the investor an incentive to make sure probable rewards justify the risks.