Crowdfunded Human Capital Equity An Emerging Multi-Trillion Dollar Asset Class

By Bill Matson, CrowdFundBeat Sr. contributor MBA, CFA, CPA (Retired), CFP

Among the past few decades’ most consistent trends has been the securitizing of a growing variety of assets. Extrapolation of this trend suggests that human capital equity – the present value of individuals’ future earnings – may soon become an important investable asset class, following in the footsteps of home mortgage debt. This is especially likely to occur in the U.S. because of increasing congressional attention to the distress of student loan debtors and recently liberalized regulation of crowdfunded equity offerings, as well as the unique array of benefits that human capital equity investments may provide – to investors and investees, as well as to the financial services firms who package and market them.


Following In the Footsteps of Home Mortgages

Today’s vibrant market in mortgage-backed securities (MBS) would have been virtually impossible to envision prior to the Great Depression, when U.S. government interventions to address that era’s unprecedented numbers of foreclosures resulted in the securitizing of home loans on a grand scale.

Much as the development of MBS was useful in alleviating the nation’s foreclosure crisis in the 1930’s, the monetizing and securitizing of human capital equity appears poised to provide significant relief for millions of Americans with uncomfortable student loan burdens. The present value of an individual’s future earnings can easily amount to millions of dollars, even for those with little or nothing in terms of tangible net worth. So it should come as no surprise that America’s human capital is a multi-hundred trillion dollar asset, accounting for roughly 75% of the nation’s economic wealth.

Nor should it surprise anyone that many Americans are interested in monetizing their own human capital. Unsecured credit card debt, for instance, can be thought of as a loan backed by a small percentage of the borrower’s human capital. Even when faced with onerous interest rates, many individuals not only maintain large debit balances on their credit cards, but would also be willing to increase these borrowings if given the opportunity.

In contrast with student loan debtors, credit card borrowers accept their financial burdens in relative silence, largely due to the stigma associated with excessive credit card debt. Consequently, it is far more socially acceptable for student loan debtors, who borrowed money for the eminently laudable purpose of furthering their educations, to vocalize the travails associated with their resultant financial obligations.

Moreover, unlike credit card debt, student loan debt is not typically cancellable through bankruptcy. This strikes many Americans as unfair, particularly those who don’t believe that a misguided educational choice in one’s 20’s should result in garnishments of Social Security checks 50 years later.

These circumstances have led to widespread public sympathy for those whose expensive educations have failed to bear financial fruit, and Washington has taken notice. In April 2014, Florida Senator Marco Rubio and Representative Tom Petri of Wisconsin introduced a bill (Rubio-Petri) entitled the Investing in Student Success Act that is designed to make student loan debt more manageable through the use of Income Share Agreements (ISAs).

Such agreements have existed for years, most notably in the world of boxing, where it is the norm for fighters to be backed by wealthy patrons in exchange for a percentage of future purses. In addition, crowdfunding platforms like Pave and Lumni have begun serving as intermediaries between ISAs’ investors and investees, while Fantex is attempting to IPO tradable interests in the future earnings of professional athletes.

Questions have been raised, however, regarding what conditions ISAs must meet in order to avoid being ruled unenforceable contracts of indenture. If Rubio-Petri becomes law, resolution of these questions will do much to legitimize ISAs in the eyes of investors.

ISA proponents contend that human capital contracts should not be conflated with indentured servitude so long as the investees’ requirements do not include ongoing performance of specific services. In the minds of some, though, the phrase “human capital contract” evokes associations with forced labor, associations that are difficult to overcome, however great may be the potential value of ISAs to investees.

Income-contingent student loan payment arrangements are currently available, but they differ in several important respects from Rubio-Petri that are particularly unfavorable for low income individuals. As an alternative to debt that accumulates interest and continues to be payable for an indefinite period, Rubio-Petri proposes an equity-like arrangement prescribing income-contingent payments for a maximum of 30 years (albeit with payments suspended and the clock stopping during years with sub-$10,000 income). As a carrot for investors, it also allows for the possibility of deriving extremely high returns when they fund individuals who achieve great financial success – despite investees’ payment obligations being capped at 15% of their annual income.

Proposals consistent with the spirit of Rubio-Petri have been bandied about for quite a while. Milton Friedman’s 1962 book, Capitalism and Freedom, advocated “equity investment in human beings”, seeing this as a means of “strengthening competition, making incentives effective, and eliminating the causes of inequality.”

Though Rubio-Petri is ostensibly intended for the purpose of providing relief to student loan debtors, there is reason to believe that its impact could be much more far-reaching. Miguel Palacios Lleras’s 2004 book, Investing in Human Capital, envisioned: “A global market where the value of Human Capital can be traded, in different forms, either directly or through derivative securities.” Given that the total 2006 dollar value of U.S. human capital was estimated to be in excess of $700 trillion by International Monetary Fund economists (di Giovanni and Matsumoto), it is clear that the global market suggested by Lleras could be enormous, even if only a tiny percentage of it ever becomes securitized and tradable.

ISA vs. Stock Ownership

The JOBS Act and its loosening of restrictions on the public solicitation of accredited investors are likely to accelerate the pace of crowdfunded investment in human capital equity. In the near term, the vast majority of equity capital raised via crowdfunding is likely to be directed toward businesses rather than individuals. Ultimately, however, many investors may well find ISAs with the entrepreneurs themselves to be a viable, if not preferable, alternative to owning stock in specific ventures.

Due diligence considerations Whereas properly determining the investment merit of a private company seeking crowdfunding is typically difficult to cost-justify, it is far easier to assess individual entrepreneurs’ odds of achieving financial success. Think of investing in a startup as akin to a Lloyd’s syndicate underwriting insurance for a unique situation – and investing in entrepreneurs’ income potential as more similar to the underwriting activities of a life insurer.

Since situations entailing novel risks (including startups) don’t usually afford much useful historical data from which to calculate the odds of catastrophe or success, proper vetting demands that new data be generated and analyzed, often at great cost. Insuring or investing in the lives of people, on the other hand, avoids much of the need for additional data collection and analysis, especially if the sums at risk are relatively small.

The odds of making profitable investments in startup companies may be vastly improved through market research and a variety of other due diligence and analytical activities that tend to be time-consuming and expensive. Spending thousands of dollars to vet a single venture is certainly justifiable for venture capital professionals making six- and seven- figure bets, but it is totally out of the question for someone investing $10,000 at a time.

To a great extent, the due diligence on individual entrepreneurs has already been taken care of by others through standardized tests, university admissions committees, professors, past employers, and credit rating agencies. Though any given bet on a single entrepreneur’s financial success may still be quite likely to result in a significant loss, the returns on diversified portfolios of bets upon high-achieving individuals of solid character can be relatively predictable. Again, this is analogous to the underwriting activities of life insurers, who can’t say exactly which of their customers will die this year but can say with uncanny precision how many of them will.

Avoiding the perils of minority ownership Minority investors in profitable privately held businesses often have difficulty deriving cash flow from their investments. It’s not unusual for the bulk of a successful business’s profits to be paid out as CEO compensation. Whereas stockholders typically require dividend declarations or a public market to generate cash flow, investors in ISAs could be paid when entrepreneurs’ tax returns indicate adjustable gross income (AGI) in excess of a designated threshold. (A reputable CPA firm, for example, can be given access to these tax returns through powers of attorney in order to monitor ISA deals on behalf of investors.)

Though there are no foolproof ways to avoid being cheated by a dishonest entrepreneur, the ISA model lowers this risk. Tying investees’ payment obligations to the AGI figures they report to the IRS makes the U.S. government, in effect, an ally in enforcing contract terms. In addition, owning shares in entrepreneurs’ AGI, rather than in their companies, ensures that ISA investors’ interests will not be diluted when entrepreneurs issue additional stock to themselves.

Note also that venture capital firms prefer not to fund businesses with fragmented ownership, due to potential difficulties with gadflies, cranks, and disclosures of sensitive information. Consequently, investing in the founder on a personal level rather than buying the company’s stock enhances its chances of securing additional funding on favorable terms in the future.

Monetizing investor mentorship Were Rubio-Petri or similar legislation to be passed, ISAs could afford investors the opportunity to enhance their returns by helping investees build their careers over the course of several decades. Traditional angel investments only incentivize investors to mentor company founders for as long as the company survives – and only to the extent that it makes the company more profitable. ISAs, on the other hand, can incentivize investors not only to help investees develop their businesses, but also to wield whatever influence they might have in securing desirable positions for investees with established companies.

Investors who have attained great success in their own careers or possess extensive personal networks of influential associates could undoubtedly negotiate favorable pricing of their ISAs, further increasing their returns. Senior executives of multi-billion dollar businesses, for instance, would be particularly well-positioned to accelerate the careers of those whom they fund, as well as to generate revenue-producing opportunities for investees’ businesses.

A potentially valuable tangential benefit of mentorship for business owners and corporate venture capitalists would be the opportunity to build relationships with extraordinary individuals whom they may want to employ at some point. Rather than relying on a few hours (at most) of interviewing in order to assess a candidate’s suitability, mentoring ISA investees can give them months, if not years, to get to know investees’ strengths and weaknesses, as well as to establish personal chemistry.

Top performers can be many times more valuable to an organization than average performers. Therefore, the ability to identify who they are, get to know them, and develop an advantage in vying for their services can provide a game-changing competitive edge.

Diversification benefits Given that entrepreneurs tend to benefit from creative destruction of the status quo and the disruption of business as usual, investors are likely to experience a low degree of correlation between ISA returns and the returns of stock in large cap, publicly traded companies with dominant market shares. Thus, there is reason to believe that ISAs could be useful in enhancing the risk-adjusted returns of conservatively managed equity portfolios. Loosening of restrictions upon non-accredited investors’ ability to participate in crowdfunded equity deals could allow even retail investors of modest means to enjoy this benefit.

Facilitating serendipity The returns on ISA investment vehicles would stand to benefit as they attract growing numbers of investors, since each new investor would be in a position to add value through support of investees’ businesses and careers. The more investors that such vehicles attract, the greater will be the potential for investors’ serendipitous interactions with investees.

A window to future opportunity Investors may choose to take advantage of the “window” provided by ISAs into the prospects of businesses founded by investees, potentially opting to make side deals involving investments of cash or sweat equity in these companies. Corporate investors, in particular, might conceivably have either employees who can be called upon to assist investees’ companies in areas of staffing weakness or idle assets that these companies could put to productive use (office space and equipment, for instance).

Psychological and societal benefits Aside from financial reward, ISA investors may derive satisfaction from developing personal relationships with investees and helping them achieve success. The ISA model provides a basis for these relationships to last for at least as long as the agreed-upon contract term. Consequently, they are more likely to blossom into lifelong collaborations and friendships than are the typical dealings between angel investors and the entrepreneurs they fund.

The potential for societal benefit from ISA investments is likely to be significant, inasmuch as they will often entail the channeling of funds to promising entrepreneurs who might otherwise be financially pressured to scale down, delay or abandon their plans to create new businesses – especially those with significant student loan debt.

The Politics of ISAs

There is no doubt in my mind as to the inevitability of congressional action clarifying the legal status of ISAs. Their potential benefits are so overwhelming that even a body as colossally myopic and vexatious as the U.S. Congress can’t overlook them indefinitely.

As this is written (August 2014), though, Rubio-Petri is dead in the water. Upstart, a promising venture headed by former Google executives, got out of the ISA business when it became apparent to its CEO that Congress wasn’t going to address the murkiness surrounding ISA enforceability anytime soon.

It would be presumptuous of me to say unequivocally that Rubio-Petri is a flawless piece of legislation. Given the potential of ISAs to diminish the U.S. student loan crisis, while stimulating entrepreneurial activity and new job creation, however, I believe the concept embodied in this bill deserves far more congressional attention and discussion than it has received.

In my opinion, the Republicans who fail to keep this discussion alive are just as culpable
in consigning Rubio-Petri to legislative limbo as are the Democrats who dismiss it without offering suggestions for compromise. If, for instance, anyone feels that $10,000 is an inappropriately low income for purposes of triggering a repayment obligation, why can’t they suggest $50,000, $100,000, or more?

How about setting a $1,000,000 income as the minimum repayment trigger? Then see how that works and lower the trigger figure as appropriate for future ISA deals.

I can understand a legislator’s hesitance to encourage high school dropouts earning $20,000 a year to bargain away $1500 of that income for 30 years (as Rubio-Petri would allow). At some point, though, I believe worthy social objectives almost everyone can agree upon – competitiveness in international markets, technological advance, job creation, and the like – ought to trump the objective of protecting our citizenry from making self-destructive financial deals.

My own inspiration for exploring the subject of ISAs was a client who became extremely enthusiastic last year about investing through Upstart, due to the mentorship opportunities this involved. He told me that he would be even more enthusiastic, however, if Upstart offered ISAs with terms longer than 10 years that would be akin to deep out-of-the-money options with no cap on investor returns.

In terms of income and wealth, he was not a one-percenter. He was a point-one-percenter. He wasn’t interested in exploiting the straits of those on the bottom – or even the middle rungs – of the financial ladder. Rather, he wanted to invest his mentorship and cash in impecunious individuals with the potential to build successful businesses. And he was willing to wait for his return until they too would be earning seven-figure incomes.

Does that sound like indentured servitude to you?


Bill Matson is the CEO of a stealth crowdfunding startup that will be specializing in human capital equity investing. He is the co-author of Data Driven Investing and may be reached at

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