By Bill Matson, CrowdFundBeat Sr. contributor MBA, CFA, CPA (Retired), CFP, FLMI.
If you or your company could share in a promising entrepreneur’s future income in exchange for doing a favor that costs you little or nothing, would you take that deal?
Conversely, if you were that promising (albeit impecunious) entrepreneur, might you be willing to trade away a small fraction of your personal income for the next ten years in exchange for a major favor – a referral to a prospect who becomes your biggest customer, for instance?
How about if you didn’t have to pay out a dime in years when your income fails to reach $100,000?
Or how about if only your annual income in excess of $1,000,000 were subject to sharing?
Favors that cost the favor giver little or nothing can be tremendously valuable to the recipient, but even the most valuable of them often go unreciprocated and otherwise unrewarded. The market for favors might, therefore, be characterized as inefficient.
There is a similarly inefficient market for the value of individuals’ future earnings (often referred to as “human capital”). It accounts for roughly 75% of America’s economic wealth – $700 trillion as of 2006, according to International Monetary Fund economists (di Giovanni and Matsumoto). Yet only a tiny percentage of most Americans’ human capital may currently be accessed, typically through credit card debt and other unsecured loans with appallingly high interest rates.
Not only could a vibrant marketplace for favors motivate large numbers of people to be proactive in seeking out ways to help each other, but it could also provide an economical means for individuals to benefit today from the value of their future earnings. The social and economic implications of this could be enormous.
It’s not hard to envision a situation in which it costs Person A just a ten minute phone call to do a favor worth $10,000 or more to Person B – referring an important customer, for example. Nor is it hard to envision both Persons A and B being better off for an intermediary making this scenario possible, even if its fee is a substantial percentage of what B ultimately pays for A’s referral.
There are a variety of ways in which A could fail to be repaid for this referral if the payment is contingent upon B’s future income. That income could be less than expected. B might choose not to properly credit A for the referral. Or the courts might find B’s payment obligation to be unenforceable if B chose to ignore it (if ruled a contract of indenture). Nevertheless, the minimal cost to A of doing B a favor can allow A to profit, on average, from these transactions even if a large percentage of them result in no repayment whatsoever.
Favor Exchange Mechanics
Now consider how such an agreement might be structured to incorporate crowdswapping.
An entrepreneur, for example, could agree to a ten year agreement obligating her to pay a centralized favor exchange (CFE) up to 10% of her annual taxable income over a $100,000 threshold. Consistent with income share agreement guidelines proposed by Senator Marco Rubio and Congressman Tom Petri (in the Investing in Student Success Act), the threshold amount would be adjusted annually for inflation. The entrepreneur’s payments to the exchange (less the CFE fee) would then be distributed to those who do favors that support her business ventures (or career as an employee if her business fails).
Our entrepreneur would maintain a Wish List of suggested favors linked to the exchange’s web site. The list would focus on requests for sharing of what Hayek would term “private information” (i.e. the “knowledge of the particular circumstances of time and place” that is unique to each individual) and personal relationships – including customer referrals, job leads, personal introductions, and mentorship. Within broad guidelines, she would be free to put whatever she wanted on her Wish Lists, and to offer whatever income percentages, threshold amounts, and contract durations she might desire.
She and other CFE members seeking favors (“Protégés”) would credit favor givers (“Patrons”) with what we’ll call “Karma Points.” Up to a total of 1000 Karma Points per month, for example, might be available for these awards.
The allocation of Karma Points would be completely at her discretion, but there would be strong motivation to award them in proportion to value received. Were a Patron to do her a valuable favor and not be properly compensated with Karma Points, she would be unlikely to receive that Patron’s help in the future.
Though awards of Karma Points would be made at Protégés’ discretion, imposition of a monthly limit on these awards would be essential. In the case of a ten year agreement with 1000 Karma Points per month available for allocation, Patrons could take comfort in knowing that the number of Karma Points outstanding at any given time could never exceed a pre-defined limit. Thus, there would be no chance of a printing press-driven, Weimar Republic-like hyperinflationary scenario diluting their value.
In years when her income exceeds the threshold amount, the payments she makes to the CFE would be distributed (net of the CFE fee) to her Patrons in proportion to the cumulative number of Karma Points she has awarded each of them over time.
If there’s a month when the Patrons aren’t helping, the Protégé may decide to award them less than 1000 points – or none at all. This would reduce the Protégé’s future obligation to pay the CFE. Note that she is obligated to pay “up to” 10% of her above-threshold taxable income. If no Patron ever did her a favor she believed worthy of Karma Points, she would never have to pay anything to the CFE.
Reputation and Verification
A CFE would require a solid reputation system rooted in user transparency in order to overcome trust issues. Patrons and Protégés alike would need to be confident that their counterparties not only are who they say they are, but also that backgrounds and qualifications being claimed are accurate. User profiles on the exchange site would, ideally, serve as an information hub, linking interested parties to supplementary profile data on social media sites such as LinkedIn and Facebook, as well as to YouTube, personal web sites, and entrepreneurs’ presentations.
Information provided or verified by trusted third parties would be particularly helpful, and users would have significant incentives to make such information available. Especially in the case of Protégés, the more detailed and verifiable users’ disclosures are, the more plentiful and desirable will be the opportunities that come their way. Allowing Protégés to charge for access to their information (such as credit scores, standardized test scores, transcripts, .edu email addresses, pay stubs, and work performance reviews) would provide additional impetus for openness and transparency.
In order to verify Protégé incomes – and thereby increase the likelihood of Patrons being paid what they are due – it would be advisable for Protégés to authorize the IRS to send copies of their tax returns to third party verifiers, such as CPAs. In general, the confidentiality of this information can be maintained if the verifiers are ethically obliged to reveal only the absolute minimum needed to facilitate proper billing.
Crowdcasting for Corporate Protégés
Businesses or other organizations acting as Protégés may offer a specific amount of money to a favor exchange in return for its assistance in solving a specific problem. This approach is especially useful for projects that can benefit from the collaboration of multiple contributors. Each contributor (i.e. Patron) would be eligible to receive Karma Points and thereby earn a portion of the specified payment when a project is complete.
Crowdcasting in this manner may provide a more equitable matching of reward to value contributed than the “winner take all” awards associated with competitions such as the Netflix Prize. It would also encourage contributors to build upon each other’s efforts, rather than duplicate each other’s work in secrecy.
Observations, Visions, and Upcoming Developments
Anyone on the planet with the ability to enter into a binding contract could theoretically participate in a CFE.
Long, dry books could no doubt be written about the tax planning and wealth transfer possibilities inherent in the swapping of non-cash favors for stakes in future earnings that may never materialize. For instance, the values of intangible assets being swapped (i.e. favors and stakes in future income) will often be difficult, if not impossible, to assess with confidence at the time of the swap. Consequently, swappers seeking to minimize their tax bills may enjoy a great deal of latitude in arriving at favorable valuations of these assets.
The ability to create Karma Points is very much like the power of a sovereign state to print money. Though the buying power of Karma Points may vary vastly from Protégé to Protégé and fluctuate sharply, this is analogous to the varying buying power and volatility of state-issued currencies. The value of Karma Points, as well as traditional currencies, will largely reflect the underlying financial health and prospects of their issuers.
Karma Points are similar to Bitcoins in that the number of Karma Points that each CFE member may issue is pre-defined, as is the supply of Bitcoins that may ultimately exist. Unlike Bitcoins, though, Karma Points yield payments to their owners when specified conditions are met, in addition to having specified expiration dates.
Using mobile apps, CFE members could declare themselves open to being “discovered” by other members in their vicinity, wherever they may be. They could also make their presence known only to other members with specified characteristics (e.g. Stanford alumni with Computer Science degrees), as well as block specified individuals or groups of individuals. These capabilities could greatly increase the frequency of mutually profitable connections being made through serendipitous encounters.
Participation in a CFE may afford entrepreneurs, as well as investors, an alternative to the restrictions, expense, inconveniences, and invasions of privacy associated with public offerings conducted in compliance with the JOBS Act. (You’ll still need a good attorney to point out the lines that shouldn’t be crossed, though.)
The ability to offer income-contingent payment plans can be a game changing sales tool. Many business owners may find CFEs useful in the administration of these arrangements. To sell slow-moving inventory, car dealers, for instance, might charge cash to cover costs and take their profits in Karma Points. Or accept Karma Points to reduce or eliminate a cash down payment requirement.
Peer-to-peer lenders could benefit by allowing borrowers who fall behind on their loans to make some or all of their delinquent payments with Karma Points. This could become an especially attractive proposition for financial firms if legislation pending in Congress as of January 2015 allows income share agreement obligations to survive bankruptcy.
In that event that CFEs are one day allowed to broker Karma Point transactions without burdensome regulation (or equally burdensome regulatory uncertainties), this would be a major step toward realizing the vision outlined by Miguel Palacios Lleras in his 2004 book, Investing in Human Capital, of “a global market where the value of Human Capital can be traded, in different forms, either directly or through derivative securities.” A free and liquid market for Karma Points could certainly make their use feasible in a broad array of commercial applications.
CFEs may also be useful to geographically dispersed Patrons sharing common interests in specific charitable causes. The CFE model would afford them opportunities to discover and connect with each other, as well as to organize support for Protégés whose businesses implement cause-related marketing programs addressing these Patrons’ interests. For example, Patrons who are active in PTA affairs might be inclined to back a Protégé
whose business donates a significant percentage of its sales to support K-12 education.
Aside from the financial benefits and commercial advantages generated through favor exchanging, it will also spawn treasured personal relationships. Though the prospect of financial reward may provide the premise for initiating these relationships, strong personal bonds and friendships will inevitably develop when Protégés and Patrons are motivated to focus on helping each other.
Bill Matson is the CEO of INTERKEX, the International Karma Exchange division of BrainFutures.com, Inc., a centralized favor exchange scheduled to launch in early 2015. He is the co-author of Data Driven Investing and may be reached at BillMatson@interkex.com.
….More To Read: