Kjerstin Erickson is selling a 6% stake in her lifetime income for $600,000 through a vehicle known as the Thrust Fund:
Erickson’s Thrust Fund comes at a time of deep experimentation in early-stage financing across the technology and media industries. The transparency afforded by social networking is making it easier for investors to vet people’s reputations and hold them accountable. At the same time, the initial amount of capital needed to build, market and distribute a product or service has fallen, undermining the venture capital model and making angel investors relatively more powerful.
Think of Kjerstin as a self-managed firm. She could issue debt or equity. The Modigliani-Miller theorem explains why most people in Kjerstin’s position choose to issue debt. Her income is taxed, but interest on debt is often tax-deductible.
But a key difference between Kjerstin and a firm is that you if you acquire Kjerstin you cannot fire the manager. So your capital structure is also your managerial incentive scheme. Debt makes Kjerstin a risk-lover: she gets all the upside after paying off her debts and her downside is limited because she can just default. With equity she owns 94% of her earnings no matter what they are.
So many questions come up, here are just a few.
- Why don’t we replace student loans with student shares? Arguably the reason we stick with debt is that it is good policy to induce risk-taking. Because the large numbers means that aggregate risk is small and society benefits more from the big hits than it loses from the misses.
- Do Kjerstin’s investors get voting rights?
- Does the contract give her the freedom to issue more shares in the future? She wants this option but her investors don’t. The more shares she sells the less incentive she has to work hard.
- Kjerstin now has a huge incentive to take in-kind compensation that is hard to value. In corporate finance, this is called diverting the cash flows. How does her contract deal with that?
(Lid lift: The Morning News.)
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March 8, 2010 at 10:50 am
Thorfinn
Milton Friedman advocated student shares, and Australia has a program like that.
They make even more sense if you consider the following issue: students considering College are risk-averse and unsure of their ability. They might become a doctor and strike it rich, or they could flunk out and be left with tons of debt. This may discourage people from going to College at all, even if the returns to College are high.
Some Law Schools implement a version of this by writing off debt if a student goes into non-profits. But it’s better, as Australia does, to take a fraction of income, levied progressively.
The downside is that this scheme (as with Kjerstin) effectively levies a marginal tax rate, while debt leaves incentives to work even harder.
March 8, 2010 at 11:06 am
Donald A. Coffin
Proposals to make student loans equity-like have been floated before and have gone nowhere. The most common option has been to make the payment a percentage of post-schooling education (sometimes with some minimum deductible from that income–say, 10% of income after the first $30,000). I think Gary Becker proposed such a plan in the 1970s, but my memory is not what it once was…
March 8, 2010 at 12:02 pm
Matthew
She’s a 25 year old Africa social-worker; the 600k valuation is way too high.
Here’s the net-present-value math. Suppose 600k is the NPV at risk-free for 6% of future income. Suppose there’s no adjustment for risk (conservative). There what is her implied average yearly income?
Assume she works every year until age 60. Then her NPV yearly income must average across her life as
(60-25)*NPV_INCOME*0.06 = 600k
=> NPV_INCOME of 285k per year (after taxes and expenses).
Given her charity work choice of career, I just dont see her averaging that income over the next 35 years.
March 9, 2010 at 1:41 am
FT Alphaville » Further reading
[…] – “Do Kjerstin’s investors get voting rights?” […]
March 9, 2010 at 11:42 am
jeff
Could this be a commitment device for Kjerstin? She wants to help the poor in Africa but she knows that she will be tempted by lucrative opportunities that would divert her from her goal. By selling her future income she takes these opportunities away.
And that’s what the investors get out of it too. They are not trying to profit from their investment, but essentially donating to her worthy cause and at the same time buying a commitment that she will not stray.
March 13, 2010 at 8:10 pm
Tony Lima
As my dissertation adviser explained to me many years ago, there’s a serious impediment to going something like this in the U.S. It’s the 13th amendment to the Constitution. Outlawed slavery. Meaning even if you wanted to, you could not legally sell all your future human capital.
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