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.

  1. 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.
  2. Do Kjerstin’s investors get voting rights?
  3. 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.
  4. 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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