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Trina Spear, 29, graduated in 2011 with an MBA from an elite school and a hefty $170,000 in student loans. The debt was the reason she took a job in private equity rather than start her own company. "For someone coming out of Harvard Business School, people think you have every opportunity in the world to do everything you want in life," she said. "[But] you really feel like you’re handcuffed and you have to go to the big corporate job."
Trina raised money from investors in exchange for equity in herself
Two weeks ago, Spear moved to Los Angeles to join FIGS Scrubs, a startup she co-founded that’s attempting to freshen up the medical apparel industry. She was able to quit her big corporate job at Blackstone Group thanks to 13 strangers who invested $20,000 in her future in exchange for one percent of her pre-tax income over the next ten years. The money will cover her $1,500 monthly interest payment and hold her over as she raises $1 million in venture capital for her startup.
It’s called a human capital contract, in which an individual raises money from investors in exchange for equity in herself. The idea is a bit unsettling. It sounds like either a modern version of indentured servitude, or the early version of some dystopian future in which every person is valued in dollars. In the science fiction novel The Unincorporated Man, every human is incorporated and most don’t own a majority of themselves. Their shareholders are their parents, the government, schools, corporations, and investors who bought their equity on the secondary market.
But there is a difference between buying and selling people — which would be slavery — and investing in their careers. Human capital contracts have been proposed by esteemed economists including Milton Friedman, who advocated them as an alternative to taking on student loans. Yale University even experimented with them before the federal government started guaranteeing loans. The concept has been compared to artistic patronage, as when wealthy merchants funded artists in Renaissance Italy in exchange for prestige, artistic influence, and a collection of works that could climb in value. Today, it's common for tournament poker players to raise money from backers in exchange for a cut of the winnings.
"People find it creepy because people in general don’t want to believe that there is a market value associated with them," Spear said. "Take this to another level, and everyone would have a value to them. And they do, we just don’t talk about it. You’re worth this much given your future projections about what you’re going to make in life. It’s just math. It’s just facts."
"You’re worth this much given your future projections about what you’re going to make in life. It’s just math."
Spear raised money through Upstart, a company founded by former Googlers that launched in April. She actually had the idea of launching a similar venture herself, and was checking out Upstart as a potential competitor when she realized it just might be the solution to free her from the pressure to stay in a high-paying job. Using its proprietary "pricing engine," Upstart approved Spear for a $20,000 investment for every one percent of future income she was willing to give up.
Upstart allows promising college graduates and entrepreneurs to upload pictures and information about themselves, including their resume, academic performance, credit score, and fun facts (Spear has a photographic memory, for example). This "upstart" profile is similar to a Kickstarter campaign because it has a trigger mechanism that aborts the investment if the full amount isn’t pledged within a certain timeframe.
Upstart vets the candidates, calculating how much they can raise and at what income share — the terms of the deal — according to how much money they’re expected to earn. If approved, the applicant sits back and waits for the checks to come in.
Upstarts do not have to make payments in years they're not making money
Upstart estimates that backers will earn an eight percent return if the recipient meets or exceeds expectations, making the terms for a recipient comparable to a loan at eight percent interest. It is possible to just get a cheaper loan from a bank, but human capital contracts can be more flexible and attractive in other ways. "Equity will always be more expensive than debt," said Spear, who was a top-ranked analyst and associate at Citigroup before she went to business school.
But unlike loans, upstarts do not have to make payments in years they're not making money. Their obligation also evaporates at the end of the loan period. In addition, upstarts have the opportunity to tap into powerful and knowledgeable mentors.
Spear chose to give up just one percent of equity. Upstarts can offer up to seven percent of their income, the logic being that a higher stake would pervert everyone's incentives. The total payback is capped at five times the initial funding — or $100,000 for a $20,000 loan — so the upstart doesn't have to pay out millions if he or she manages to build the next Instagram.
On the other side, backers sign up by answering a few questions about income and checking a box that affirms they meet the criteria to be considered an accredited investor by the Securities and Exchange Commission. Upstart later verifies that information against third-party databases, since non-accredited investors are prohibited from participating by law. Backers can choose to remain anonymous, be named, or be a mentor to the upstart. The company is building a messaging system to make contacting backer mentors seamless and unintrusive.
When Spear talks about her arrangement with her backers, she slips back into Wall Street-speak. "You could think about it like a discounted cash model," she said, referring to a method of evaluating a security’s intrinsic value as she talked about investors that "put money into me." Using Upstart’s numbers, she estimates her net present value is $2 million. "I think I'm worth more than that," she said.
Upstart has already funded 40 people for a total of $500,000 invested
Upstart has already funded 40 people via more than 100 backers, for a total of $500,000 invested. It already has some contracts in repayment. But Upstart isn’t the only company eyeing human capital contracts.
There’s Pave, a similar endeavor that launched in New York in December and focuses a bit more on creative entrepreneurs, whom it calls "prospects." Pave funded eight people in its pilot launch, and is now raising money for another nine. Lumni provides human capital contracts for low-income students in Columbia, Mexico, Chile, and the US. Chicago-based Cumulus Funding proposes to do the same for American workers, although its scheme sounds more like a dressed-up payday loan.
"If someone has a portfolio of equities, bonds, private equity, real estate, timber, infrastructure, venture capital, why shouldn't people be a part of that portfolio?" Spear said.
Jeff Keltner, head of business development for Upstart, pointed to the upsides for the people selling equity in themselves. Deal terms vary by platform, but Upstart only requires repayment in years that its upstarts make $30,000 or more, verified by tax returns. At the end of the ten years, the deal is up — and unlike student loans, Upstart contracts can be forgiven in bankruptcy. "These young people are so thankful for being given the opportunity to pursue something different," Keltner said.
The boom in human capital contracts is natural given the popularity of crowdfunding, said Ryan Randall, a Virginia-based investor who invested in Upstart, Spear, and Spear’s company.
"It’s still very early, as far as being able to track this emerging asset class. Every time you're investing with something with that type of uncertainty, probably there are very large risks," Randall told The Verge. He noted, however, that investing in a person over ten years is safer in many ways than investing in a startup. "The failure rate for a company is much higher than for a talented individual."
There is no obvious legal obstacle if people want to sell stock in themselves. Platforms like Upstart must limit themselves to accredited investors, but even that is changing as the SEC implements new rules passed as part of the JOBS Act last year. However, the regulatory requirements are somewhat unclear. For example, the SEC has no precedent policy for dealing with companies like Upstart.
The SEC has no precedent for dealing with companies like Upstart
Keltner said Upstart has been talking to the SEC, FINRA, and other regulators, in order to figure out whether the contracts are considered investments or commercial loans. He’s leaning toward loans. Pave has also been in touch with regulators, but came to the opposite conclusion. "Hopefully one day there will be new laws to enshrine this and make it a very scalable and widely available alternative," Lahoud said.
Of course, there’s still the matter of the heartless-sounding terminology. "Human capital contract" is the technical term for the security, but it conjures images of traders selling tranches of human capital derivatives; a byzantine secondary market where contracts are resold without the human capital’s permission; and diabolical hedge fund managers shorting assets with names and faces, hoping that they fail.
"Some people like the idea of investing in individuals the same way people pick stocks, and think they can pick winners," Keltner said. But Upstart also eschews the term "human capital contract," preferring to call it "investing in people."
"In general, we haven't gotten a lot of negative feedback," he said. "We've got a model the regulators are generally happy with. Both sides are willing to sign up. [We've] proven the model is there." His biggest challenge is figuring out how to expand quickly enough, he said.