Some entrepreneurs and educators have seen Income Share Agreements, or ISAs, as a new way to improve diversity and access to higher education. The idea is students pay nothing up front for college but pledge to pay a percentage of their wages for a set time after they graduate and get a job. One startup leader who tried the approach says it didn’t quite go to plan, as he shared in a Twitter thread making waves this week. See a version here, published with the author’s permission.
I launched an Income Share Agreement (ISA) company in 2019. Our company survived, but our use of ISAs did not. Overall, I think the ISA experiment has failed and is not the revolution we hoped would transform training and education.
In this article, I hope to share what I learned.
ISAs tend to have significant adverse selection problems, stemming from two sources. First, the lack of skin in the game leads to very poor participant behavior. Participants haven’t put anything down so it’s easier to not complete the program.
Also, participants judge educational success in many ways that don’t trivially reduce to “make more money.” Generally, ISAs narrowly align the organization with this one specific outcome. This new misalignment tends to cause problems for both the participant and the program.
Second, credit scores were the most predictive variable of good participant behavior for us. But people with high credit scores tend to have better, cheaper options than ISAs. Also, using credit scores for ISAs is largely missing the point.
Furthermore, consumers were consistently confused by ISAs and had a vague sense they were exploitative. I think ISAs are less complicated than debt, but consumers don’t have experience with them. Educating the market on a new financial instrument is a big, expensive job.
The lack of legal infrastructure around ISAs leads to difficult collections-related issues. You can’t ding somebody’s credit score, and there aren’t easy legal paths for collecting. Are you really prepared to go to small claims court? We weren’t.
On the regulatory side, there is currently a gap between the level of regulation for consumer debt & ISAs. It is easier to offer ISAs today. But there’s no reason to believe regulators will (or should) treat ISAs any differently than consumer debt.
Largely due to the regulatory risk, there are not mature capital markets for ISA programs to tap. The large capital markets for credit & securitized debt packages drive costs down.
But the small number of players interested in ISA assets results in very high capital costs.
Getting access to capital markets is very important to grow because ISA programs have an awful cash conversion cycle. You outlay a bunch of cash upfront and get paid back over time. If you are cash-poor like most startups, this is hard to make work without capital markets.
To recap, the primary issues that company using ISAs face are:
- Consumers are confused by ISAs.
- And when they take the deal, they often behave poorly.
- And when they behave poorly, you don’t have great recourse.
- And there’s a looming regulatory threat.
- And the financial markets aren’t supportive.
All of these things can be fixed. But in fixing them, we might as well just use debt instruments rather than a brand new thing.
Better than an ISA is an income-dependent loan with some minimum amount that must be paid back regardless of the program outcome.
- You concede and comply with the existing regulation.
- You get access to the existing capital markets so financing costs come down.
- You can use credit reports as a way to enforce the contract so collection rates go up.
- Consumers already understand debt.
And, most importantly, the consumer gets a better deal than a classical loan.
In sum, we can build better outcome alignment in our financial tools without totally throwing out the tools we already have.
Of course, there will be >0 companies that succeed using ISAs. The model isn’t hopeless.
But providers of debt and fee-for-service education/training do not need to be worried about their future.
ISAs aren’t the revolution we thought they would be.
My company, Placement, wound up changing our business model completely, so none of this is really relevant to us today. I’m sharing my lessons here so future entrepreneurs can short-circuit their learning process.