An Introduction to Income Share Agreements
In this post, I want to introduce the idea of income share agreements and define their basic features.
Fundamental to the idea of an income share agreement (ISAs) is that the amount of money you owe should be based on the amount of income you earn. In this way, ISAs differ from loans because they do not have a traditional interest rate. Instead, when a student receives funds as part of an ISA, they agree to repay the provider based on a percentage of their future income.
Interest in ISAs has grown immensely in the last five years. Purdue University launched the Back a Boiler program in 2016 to provide ISAs to students as an alternative to private and Parent PLUS student loans. Lambda School, a coding school launched in 2016, eschews an up-front tuition in favor of ISAs.
For the purpose of this post, I will refer to the receiver of the initial disbursement of funds as the “student,” but that is not to suggest that the only use of income share agreements is for education funding. I will refer to the provider of the initial funds, and recipient of future income share payments, as the “investor”.
Features of an income share agreement
Income share agreements typically include the following elements: the funding amount, the payback rate, the income floor, the payment cap, and the term length.
This is the amount of funds provided by the investor to the student at the creation of the ISA. The funds could be used for anything that might increase your future income: tuition payments, a living stipend or for a project. The funding amount is different than the principal in a traditional loan. In a traditional loan, the borrower must payback the lender the principal plus interest. In an ISA, there is no obligation to payback the initial funding amount.
Some ISAs will not include a funding amount. Instead, the investor provides services to the student and expects to be repaid in the future based on the students future income. At Sharpest Minds mentors are connected with “students” and help them start a career in data science. The mentors are then paid in the form of an ISA.
The payback rate is the percentage of future income the student will owe the investor. The payback rate is analogous to the interest rate in a traditional loan. In a traditional loan, the minimum payment will based on either a fixed or variable interest rate applied to the principal. In an ISA, there is no principal amount. Instead, the monthly payment is based on applying the payback rate to their monthly income. At Lambda School, the payback rate is 17%.
The term length of an ISA is the length of time the student is obligated to make income-share payments. At Purdue, all Back a Boiler ISAs include a standard 10 year term. Some ISAs include provisions that allow the student to defer some of their payments. For example, at Purdue if the student attends graduate school or leaves the labor force (no longer seeking employment), their payment term will be extended.
Unlike loans, most income share agreements include a provision that restricts the student’s obligation to make payments if their income falls below a certain level. For example, if the student attends Lambda School and earns less than $50,000 per year, they are not required to make any payments. At Purdue, the income floor is $20,000 per year. This is different than the deferment provisions discussed above. At Lambda School, if a student earned less than $50,000 for the entirety of the term length, they would have paid nothing to Lambda and have fully completed their payment obligations. However, if they left the labor market or went to graduate school they would not be obligated to make payments but would have their term extended.
Another common feature of income share agreements is a payment cap, or maximum repayment obligation. At Lambda School, the payment cap is $30,000. This means that the sum of all income share payments will not exceed $30,000 and if the student reaches the cap, they will have completed their ISA’s obligations. The purpose of this provision is to protect students who earn a much larger income than is expected.
Other common provisions
Income share agreements will also include terms that decide how the agreement will be treated in bankruptcy.
It is common for the method of income verification to be included in the contract as well. Today, students are typically required to submit a pay stub from their employer, link their primary bank account to the ISA service provider and submit their annual tax returns for reconciliation.