When companies need capital to grow, they can generally go down one of two financial paths. They either borrow money at a fixed rate, or they sell equity where they owe nothing, but the investors get to participate in any future upside.
People, of course, only have access to debt. The idea of investing in the future earnings of a person has been discussed for a long time, but as of today there really is no such practical option for most people.
This situation is on the verge of changing dramatically: Equity-based financing for people is finally about to go mainstream.
In the coming years people will have a number of ways, going far beyond what we see today, to get access to capital by selling percentages of their future earnings rather than taking on debt.
Here is a brief overview of why I see these changes occurring and some thoughts about the path forward.
Debt-Based Finance for People Is Becoming More Difficult to Manage
Debt-based forms of finance work best when two conditions are satisfied. The first is that the borrower has assets that the lender can appraise and ideally seize if necessary. The second is that the market for those assets is stable enough so that the lender can accurately forecast the value of the borrower’s future assets and their ability to repay a loan.
Technology is having a dramatic impact on this equation for two reasons.
First, technology is making the world more uncertain. The days are over when lenders could easily think about the future value of things like a home or the wages associated with a career path. The value of assets can vary widely, and once-clear career paths with regular promotion cycles and standard pay increases are a thing of the past. The lack of predictability makes lending harder.
Second, technology is making outcomes more discontinuous. The frictionless nature of technology is leading to a world where the winners are winning far more dramatically than ever before, but it is also erasing much of the space for moderate success. A bimodal world of extreme winners and many losers is a much harder world to fit into a lending framework.
Despite these growing challenges to the lending market, the world is awash in debt today. And technology is lowering the friction to all sorts of borrowing activity by increasing the transparency and liquidity around long-tail assets, which were once hard to finance. So it isn’t that debt-based finance is going away—but it is increasingly running into limitations.
Equity-Based Finance Options Are Now Possible for More Things Than Ever Before
Equity-based financing has historically been more challenging to manage in most cases than debt is, for two reasons.
First, you need far more information about something to invest in it than you do to lend money against it. When you are lending, all you need to be able to forecast is the likelihood that you will be repaid. When you are investing, you need enough information to generate an opinion about the entity’s total operation and how much it might be worth in the future. That’s a much higher bar to clear.
Second, if you invest in something rather than lend money to it, you need a guarantee that it will repay you what you are owed and it won’t cook the books. There is a reason that when it comes to companies, the earliest versions of equity-based finance were centered around projects like sending a ship across an ocean or whaling—those types of projects are easiest to account for once the ship returns home with riches (or if it sinks).
The transparency created by modern technology solves both of these problems.
It is easier than ever before to access information about an entity to evaluate it. It is far harder to cook books today because investors can get access to such a rich information stream from an operating entity. And, of course, with a fully wired world and true identity, it is far harder for crooks to skip town and renege on deals than it ever was before.
In the past it was just too time-consuming and expensive to figure out the equity value of anything but the largest companies. But, as I have explored before, the frictionless nature of technology makes it possible to finance ever smaller-scale enterprises via equity arrangements.
Examining ISAs and Income Pools
So, if modern realities challenge the debt-based model of finance and make equity-based models increasingly possible, the question is whether there is actually consumer demand for financial products through which people sell investors part of their future earnings.
The answer seems clear to me. Consumer demand exists and is growing, as is typified in two trends today: income share agreements and income-pooling insurance agreements.
ISAs
ISAs are used increasingly for financing education, particularly at for-profit coding bootcamps.
These ISAs are by no means true equity investing in people. Rather than taking out loans to finance their education, students pay the schools where they received training a percentage of their income for a few years. An earnings floor, under which they do not pay, is instituted. And a ceiling is put on their total payment to their school.
Still, the trends in the ISA world inform the broader picture that is evolving around equity investing in people. This model, while still small, has grown enormously over the last few years for a few reasons.
First, a whole generation of younger people that has grown up through the 2008 recession is terrified of taking on debt. Even when they have cheap access to traditional loans, they prefer models where they will never owe money they do not have.
The fact that debt is out of cultural favor is part of the story, but it is far from the whole story.
ISAs also have grown in popularity because they represent a sober alignment of interests between schools and students. Students are rightly wary of making big upfront capital outlays or taking on debt based on the marketing promise that a school will prepare them for the world and help them get a good job. But the idea that the school effectively only gets paid if it delivers on its marketing promise seems like a fair trade and the basis for a rational partnership.
In this respect, a deep sobriety about the value of education underlies ISA trends, especially when it comes to for-profit nonaccredited institutions where people go to learn skills that should—in theory—lead to high-paying jobs.
Students do not trust that participating in a certain educational program guarantees their future. Instead they choose an option where they and their educational institution are financially aligned—and they don’t have to wait for traditional debt-based models to catch up.
Income Insurance Pools
A second rapidly growing ecosystem, smaller than the ISA world, has made headlines recently in the context of baseball.
Minor-league baseball players get paid very little, but if they make it to the majors, they can make a lot of money—and it isn’t clear to anyone who will make it and who will not.
So what has started happening is that minor-league players, working through one of a handful of companies, are teaming up to commit a certain percentage of their future baseball earnings to a pool as a form of income insurance.
A minority of players in these pools hit the jackpot by making it in the majors.. They contribute a percentage of their earnings to the pool, thereby subsidizing those that don’t make the cut.
It would be one thing if this was a fringe solution for a particularly strange situation limited to sports, but this model is spilling over into other arenas, like Master of Business Administration programs. MBA students are now forming pools with the same philosophy in mind. They are all starting in a similar place: Some will make it big as entrepreneurs, but not all. Everyone acknowledges that there is randomness to the outcome, so it is fully rational to team up and de-risk each other somewhat.
The growth of these various models that resemble equity-based financing for individuals points to the beginnings of a real trend.
Finally, as celebrities and influencers are starting to look more like companies, and the crazy new world of assets like crypto non-fungible tokens makes personal brands and reputations directly monetizable, people are getting more comfortable with the idea of securitizing income streams and thinking of their personal lives in the context of professional modern finance.
Investors Are More Interested in Equity-Based Investing in People, Though Challenges Remain
It is one thing for consumers to want access to equity-based financial models, but it takes two to tango. The second question is whether financiers are willing to fund these types of products.
The short answer is not quite yet, at scale. But I believe the demand to participate in these forms of financing people will grow soon—and quickly.
To date there have been three major problems, although solutions are emerging..
First, the payback models don’t exist yet because there is no meaningful historical data on how these types of products perform. Without these models, it is hard for investors to know what they are buying, and even harder for them to refinance the investments they are making in modern capital markets, which are critical to investment at scale.
The good news is that there is enough investment activity in ISAs and such that the data models are getting built.
Second, investors worry about structural problems around adverse selection. That is, the people who most want to avoid debt and instead opt for equity-based financing options are those who least expect they will be successful in the future.
People have been telling me this is the major problem with equity financing for individuals for 20-plus years, since I first started working on this idea in high school.
I don’t believe it is a major obstacle in practice, and if anything I think the selection bias may have flipped in the last several years. As the pace of change in the economy has accelerated, it is rational for people who need access to capital or who want to de-risk their lives upfront to seek investment in their equity rather than taking on debt. In some ways, as the world becomes more discontinuous and random, it is a sign of great rationality to want to be well capitalized, flexible and free versus stuck in a debt-oriented financial situation.
Third, a major objection that always comes up for investors is one of optics.
No one likes any product that can be misconstrued as indentured servitude or, even worse, slavery. Owning people just doesn’t sound great.
Even short of those extremes, many people see equity-oriented deals around people as looking like record-label deals, where an artist signs over future work in return for upfront financing (among other things). The long history of well-known musicians getting into very public and nasty fights with financiers over these types of deals later in their career makes investors skittish.
This in my mind is where it is very important for equity-based financing models for people to be well designed. In an ideal world, investing in people should work just like investing in seed companies. The investors get no board seats, they are owed nothing and they get no control over what a person does—ever. Further, healthy products in this space have to be constructed in a way that limits how much of a person’s income can ever be sold and puts an earnings floor under which investors can never collect.
Finally, and substantially, people worry about the enforceability of contracts whereby people grant percentages of their future income in return for upfront financing. Decades ago, Yale Law School experimented with an early ISA concept where their students were supposed to pay back a percentage of earnings rather than paying tuition. Most of the students just never paid. Modern ISAs have still not been fully proven legal—and longer-term financial arrangements present an even bigger problem. There simply is no precedent for these types of arrangements in traditional law.
There isn’t much of a way around this other than finding opportunities over time to test these new financing frameworks in the courts. From my viewpoint, a structure that is clearly good for everyone, and that adults enter into with full knowledge and for a fair value exchange, should stand up legally. But only time will tell.
Beyond these commonly cited issues, there are so many reasons for investors to like new forms of equity investing in people.
In a very uncertain world, it is far better to bet on people and their continued ingenuity and resilience than it is to bet on a single company.
Further, one can make a strong argument that the path to the greatest returns will lie in putting people in a position that frees them to pursue their best options over their lifetime rather than remain stuck in suboptimal positions to service fixed debt and traditional commitments.
And let’s be honest: With the world awash in money and with very low interest rates, financiers are very open to exploring new investment opportunities—perhaps more so than ever before in human history.
The Near Future
In a big-picture sense, we all already have an equity-based financial arrangement in the form of the income taxes we pay to the government. We agree to hand over an enormous percentage of our earnings in return for everything from the rule of law, to a military force, to social services.
As Joe Lonsdale and I explored years ago, ideas like a universal basic income, which are gaining popularity, also share a lot with the idea of equity investing for people. Taking tax receipts based on income and using that to give people upfront cash effectively functions as an enormous social insurance plan, not unlike what baseball players are doing today with their pools in the private market.
The point is that it isn’t so strange to trade an income share for upfront capital to fuel growth in your projects or just de-risk your life enough so that you feel confident going after big opportunities.
These models for personal finance are not going to wait for a big societal shift. My sense is that a lot will happen soon. ISAs and income pools are going to continue on a path of rapid growth. It wouldn’t be surprising to me if in the coming decade a double-digit percentage of young professionals start participating in some form of income sharing, such as paying back a school or participating in an income insurance pool.
As I have noted before, I think and expect this model will rapidly shift to the influencer and creator world, where people are building huge personal brands but don’t have access to traditional financial products. In some ways this is an obvious connection. Traditional banks and the financial system are ill equipped to deal with influencers’ financial needs. And the idea that they can build big businesses just off their cash flows is just nonsense.
Even entrepreneurs, some of the folks most intimately familiar with the realities of risk, reward and security, are examining the idea of financing their own lives by selling personal equity, and I expect this idea will go from fringe to mainstream quickly in their community.
The most important thing in the coming years, however, is making sure that as these new types of financial products for people come online, they do so in a fair and healthy way.
To my mind, that means as we start directly investing in creators and entrepreneurs, we set up guardrails so these products create positive outcomes for everyone involved. That means making sure investors never own more than a small minority share of income from any person and never have any control over what the person does with their time or money. It means making sure contracts limit the downside for people. You never want investors getting paid a percentage of earnings when a person isn’t earning enough to live on. It means a person should always have a right of first refusal on whether any shares in their income change hands.
Finally, and also perhaps counterintuitively, it means making sure that when you invest in people you do so it with a very long-term horizon in mind rather than just a few years. Longer time frames allow investors to take a lower percentage of income. They also enable what looks more like a venture capital style of investing, where a few superwinners can subsidize the cost of financing for everyone else, lowering the effective cost of capital for people.
This model is going to come into being, and it can be great for the world. The key is to make sure that in its nascent state we build it on as strong and healthy a foundation as possible.
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