Income share agreements (ISAs) recently have gained notoriety as an alternative to student loans. Unlike student loans, ISAs allow students to finance their higher education without taking on debt. Although no law schools currently offer ISAs, several private companies, as well as a handful of undergraduate colleges, have instituted ISA programs. As they grow in popularity, law schools may begin to offer their own. ISAs have the potential to be a powerful tool for financing your legal education and are worth understanding.
What is an ISA?
An ISA is essentially an investor buying equity in you. You promise upfront to repay the investor a percentage of your after-graduation income in return for a lump sum payment now.
This process is similar to a company making a stock offering. In a stock offering, a company offers some percentage of ownership in return for cash. Afterwards, a portion of the profits the company makes are paid back to the stock owner in the form of dividends. The company neither takes on debt nor does it have to make interest payments. If the company fails to make a profit, it has no obligation to make a payment to stock owners.
When you enter into an ISA, you’re like the company. The investor selling the ISA is like the stock owner. Instead of paying out profits in the form of dividends, you pay a percentage of your income. Instead of not paying dividends if your income drops, you simply repay nothing to the ISA provider.
This contrasts with traditional student loans that, continuing with the analogy to corporate finance, function like a bond. The company (student) issues a bond offering (takes out a loan) for the desired amount, promising to pay back the principal with interest.
An equity approach to financing education isn’t new. Economist Milton Friedman first proposed what resembles an ISA in a 1955 paper. Yale in the 1970s attempted to implement a payment plan similar to Friedman’s proposal.
Yale offered the option of “postponing” tuition, allowing students to pay 0.4% of their after-graduation income per $1,000 of deferred tuition. The program quickly failed due to a variety of problems—adverse selection and the overburdening of low earning graduates being the largest.
After Yale’s experiment, equity financing was ignored until a recent resurgence. A handful of undergraduate colleges—most notably Purdue University—now offer ISAs. Private lenders and smaller, non-accredited educational programs such as coding bootcamps have also begun to offer ISAs.
How does an ISA work?
ISAs are not yet heavily regulated due to their long hiatus from the limelight (though California has taken steps to regulate ISAs similarly to student loans). Despite the lack of regulation, ISA repayment terms generally share four major characteristics.
- Repayment percentage: A percentage of your future income that will be used to calculate your monthly payment. The percentage is usually determined by the amount you received through the ISA and what you studied in school. The more you’re expected to earn after graduation or the less money you borrow, the lower your repayment percentage.
- Term of agreement: The period of time you’ll be paying the repayment percentage. The number of years vary based on the field you studied and how much you borrowed, much like the repayment percentage. The more you’re expected to earn and the less you borrow, the shorter the term.
- Minimum income to pay: An income threshold that you must meet to be liable for making your repayments. This minimum serves two purposes: the first, protecting you from making repayments when you cannot afford them; and second, ensuring that the ISA provider receives a return on its investment. Years that you don’t make payments due to insufficient income don’t count towards your term of agreement.
- Max amount repaid: A payment cap for students who end up in high paying jobs post-graduation. ISA providers often cap the amount repaid at some multiple of tuition.
Pros and cons of ISAs
Understanding the benefits and drawbacks of ISAs requires some background knowledge on student loans. Any discussion of pros and cons of ISAs is essentially a comparison between ISAs and student loans. If you’re unfamiliar with how student loans work, check out these articles on federal and private loans before you continue.
Pros
ISAs have advantages compared to student loans for many borrowers. They’re an excellent tool for those who are debt adverse, whether that be for personal or religious reasons. You’ll never be stuck making student loans payments if your income lags.
ISAs also prevent interest from accruing before you start making payments because you won’t need to pay any interest while in school. This wouldn’t be a concern if your financial aid came via subsidized federal student loans, but graduate students (e.g., law students) only have access to unsubsidized federal and private student loans. Unsubsidized and private loans begin accruing interest immediately whereas subsidized loans wait until after your graduate.
ISAs also better align the interests of the investor, whether it be a school or a private company, with the student. The investor gets no return on her investment if your income is below the minimum pay off threshold. This is part of the reason why educational programs that need legitimization, such as code camps, heavily utilize ISAs. Offering ISAs with a high minimum income for payment signals to the student that the certificate from the code camp is useful for securing a high-paying job.
Cons
ISAs aren’t a panacea for financing education. They’re not the right fit for everyone and student loans, especially federal ones, are often better. Federal financial aid loan programs offer income-based repayment that essentially turn them into ISAs, though their repayment terms are much longer than ISAs. ISAs still have the advantage of being interest-free while in school, making them an attractive alternative to unsubsidized student loans that do accrue interest during your schooling. However, subsidized federal student loans don’t accrue interest while you’re in school, making them almost always superior to ISAs. Because of this, ISAs in their current state are only viable for students ineligible for subsidized federal aid or for those who need to borrow more than the subsidized maximum.
ISAs also carry the risk of you paying significantly more than you would have if you borrowed using student loans instead. Even with a maximum amount repaid clause in the ISA, the amount repaid by high earning grads often exceeds the amount that would have been repaid on a student loan.
The viability of ISAs for students expecting low salaries and the unattractiveness of ISAs for students expecting large ones creates the risk of adverse selection. Students who plan on taking low-earning jobs will gravitate towards ISAs while their higher earning counterparts will instead opt for traditional loans. This would, and has, forced lenders offering ISAs to raise repayment percentage and term length for all students to accommodate for the skew towards lower earners.
ISAs for law school
This brings us to the big question: would ISAs be a viable financing option for law students if law schools began to offer them? The answer, as with all financial advice, is it depends on the student.
Law students aren’t eligible for subsidized federal loans, making the deferment that comes with an ISA attractive. If you borrow $150,000 at a 6 percent interest rate for law school via student loans that start accruing interest immediately, you’ll have $20,000 of interest to pay back on top of the $150,000 principal when you graduate. That $20,000 of extra student loan debt wouldn’t exist with an ISA.
Law schools that offer ISAs also have a large financial incentive to help you find a high paying job. Due to ISAs having minimum income requirements, if you don’t find gainful employment the school has no way of getting a return on its investment. If you instead had student loans, you’d still be obligated to make payments regardless of your financial situation.
The minimum income requirement of ISAs also would allow you to work a lower-paying job that interests you without worrying about huge student loan payments. Your ISA payment will never be more than you can afford, regardless of income. This benefit isn’t unique to ISAs though. Schools already offer LRAP (Loan Repayment Assistance Program) plans and the federal government offers the PSLF (Public Service Loan Forgiveness) program.
ISAs from an investor’s perspective
While ISAs would likely be a good fit for many students, it’s less clear that they’d be profitable for investors. Starting pay for lawyers is famous for its bimodal distribution. For the class of 2020, roughly 50 percent of starting lawyers made between $50,000 – $70,000 while 25 percent made $190,000. Relatively few lawyers earned a salary in-between. ISA providers would likely have difficulty anticipating the starting salary of lawyers. Everyone gets the same JD, regardless of whether they plan to be a public defender making $50,000 or a Biglaw attorney making $200,000-plus.
This difficulty would likely lead to two practices from investors. One possibility is that they’d raise repayment rates and terms for everyone to offset the risk of students opting for lower pay jobs. This would likely lead those attending T14 and other Biglaw target schools to opt for loans while students at lower ranked schools would opt for ISAs. This disparity creates the possibility of making ISAs unprofitable for investors and thereby limiting ISA providers to non-profits or schools that can subsidize the losses.
Alternatively, investors might choose to include a minimum amount to repay in the ISA contract, not just a term length of repayment. This would allow rates to remain lower, likely enticing more students with Biglaw aspirations to take on ISAs. However, this would also increase the burden on those who don’t pursue Biglaw. A minimum repayment reasonable for a Biglaw associate would be untenable for many lawyers working in the public sector. Setting a minimum rate has failed in the past. A minimum repayment amount was a large contributor to the failure of the ISA program offered by Yale that was mentioned earlier in this article.
Joseph Parise is a junior at the University of Buffalo. Joseph grew up in New York and is majoring in Philosophy and Economics. He is currently taking a gap year to study for the LSAT exam and to serve in the US Air Force Reserves.
