Young people who can show they’ll earn a decent living in the future should be able to access some of that wealth now. So says Upstart, a new type of lender based in Silicon Valley. It matches wealthy folks willing to front money to college students and recent grads. Generally within one year of accepting the money, recipients have to start repaying backers. The twist: Rather than return the specific amount, they agree to pay a chunk of their annual income, as reported on their tax returns, for 10 years.
Upstart, which accepts applicants from 30 states in which it has lending licenses or where no licensure is required, has big ambitions: “We’re trying to create a fundamentally new category of finance that theoretically is applicable to any person in the world,” says Jeff Keltner, who co-founded the venture with former colleagues from Google (GOOG). The website launched in August and started accepting profiles in September. (Upstart isn’t the only business pushing this model, as the Verge pointed out earlier this week.)
The money might enable participants, dubbed “upstarts” by Upstart, to enroll in coding boot camp, pay off college loans, or start businesses. “The thing that’s new is you’re investing in an individual and their personal potential,” says Keltner. With today’s crushing levels of student loan debt, “we see so many students coming out saying: ‘I can’t turn down this job, because I have this $700 a month loan payment … trying my own thing is just crazy.’”
Backed by $5.25 million from investors that include Kleiner Perkins Caufield & Byers, First Round Capital, and Mark Cuban, Upstart doesn’t intend to squeeze struggling people. Payments are waived as long as the recipient earns less than $30,000 in a year. (However, Upstart will extend the term of payments one year at a time per low year, for a maximum contract of 15 years.) Payments to backers are capped at five times their original investment.
Kathleen Day, a spokesman at consumer advocacy group Center for Responsible Lending, hasn’t studied Upstart’s service. But she says my description of it “raises red flags because it sounds like it would be very hard for the person borrowing the money to have a reasonable idea of what they’re going to have to pay” in the future. Upstart’s money, she notes, may keep recent grads from being tied to a job for a stint, but it doesn’t erase their previous debts. “There’s a whole range of people [earning more than] $30,000 for whom paying a portion of their salary for the next 10 years would be a severe financial hardship.”
To predict applicants’ future income, Upstart funnels personal information on the application—such as credit history, SAT scores, major, and schools attended—into a statistical model that compares the applicant to others. The money’s intended use is displayed on the applicant’s profile but isn’t factored into the income calculation. If an art history major from a state school pledges 1 percent of income, he or she might get roughly $5,000 from a backer, while a former Blackstone Group (BX) associate who attended Harvard Business School would get closer to $20,000, Keltner explains.
Trina Spear, who fits the latter profile, used the money she got through Upstart to join medical apparel company FIGS Scrubs as co-founder earlier this month. The risk profile is better than angel investing in a startup, says Keltner. For example, he says, if Spear’s company fails, “she’ll get a job. And she’ll probably get a pretty good paying job and [her Upstart backer] will get a portion of that income.”
The target annualized return for backers is 8 percent. That’s just a target and will only happen in the “highly unlikely” event that the upstart’s income matches Upstart’s statistical model exactly and the borrower pays the income share due, Keltner explains. If Upstart is wrong, backers will earn less—or more. Backers, he notes, “could lose their investment entirely if the upstart makes less than $30,000 for 15 years after funding, but we think this is fairly unlikely for the upstart cohort we have.” Upstarts can pledge no more than 7 percent of their future income.
While only about 10 of its 40-plus upstarts are in repayment phase, none have defaulted, according to Keltner, who says investors might find it attractive to think: “‘I can invest in here and make 8 percent and have it completely unrelated to what happens to my portfolio invested in real estate or equities.’” Upstart makes money by taking 3 percent of what an upstart raises and a 0.5 percent annual fee on funds invested.
So far, more than 100 backers have invested a total of over $500,000, which Keltner says isn’t nearly enough volume. That’s why the 10-person venture is exploring ways for investors to bet on a pool of people, rather than just one person. The goal is change the perception of the model from a “peer-to-peer novelty” to a broader “new asset class [that] you can analyze in a more traditional way,” Keltner explains.
Upstart has held no discussions of this nature with schools, he says, but “it would make total sense for every endowment fund to be willing to invest in any student who graduates from [their school]. For example, an investor could someday say, ‘I’m a Stanford guy—here’s $50,000, put it in Stanford kids’ … or any other category—say, women engineers” from different schools.
