Human capital contracts make you an investment vehicle, but is that really such a good idea?
Investing can be tricky if you aren’t well-versed in finance. Sometimes you might do really well and in other cases, you might lose it all because you didn’t pick the right stock. But you know, there is one kind of investment that always pays off: an investment in yourself. This is precisely why people spend a lot of money on their education even if they have to take out big loans.
However, loans can sometimes become a heavy burden on a student. According to a report by the JPMorgan Chase Institute, 7% of students were unable to pay back their loans as of 2020. A potential solution to this problem is to enter into human capital contracts (HCCs), which involve pledging a portion of your future income to those who invest in your education. Let’s break down the concept of HCCs, the pros and cons of signing such contracts and whether they can disrupt traditional forms of investment.
What are HCCs?
Human capital contracts (HCCs), also known as income share agreements (ICAs), were introduced by American economist Milton Friedman in 1945. The idea is that knowledge and skills are treated as assets, and investing in them can lead to high returns in terms of future earning potential. Under this form of investment, the value of an individual is determined by factors such as their academic performance, the academic institution they choose to study in and the field of study they are pursuing.
Pros of HCCs
Reducing bad debt
HCCs have the potential to reduce bad debt and save students from bankruptcy by offering a repayment structure that is directly proportional to a student’s earnings post-graduation. This provides a safer and more flexible option than traditional student loans, which require repayment of the original amount along with interest
Giving an objective value to education
Since HCCs determine an investment’s value based on the field of study and academic institution, they can help students better understand the economic value and the long-term implications of the degrees they wish to pursue. Moreover, the relationship between investors and students could create a beneficial mentorship dynamic.
Cons of HCCs
Shifting the burden onto investors
While students are no longer burdened with bad debt under these contracts, investors bear the financial risk because these investments aren’t liquid and cannot be easily converted into cash like other investment vehicles. Moreover, students may be unable to live up to the expectations of the investor. They may be unable to complete their degrees or achieve the expected grades. Some students might be less inclined to push themselves as hard as they would have with a traditional student loan to pay off.
On the other side of the coin, HCCs can result in high returns for investors if a student performs exceptionally well in their field and lands a high-paying job. This could result in the student having to pay more than the amount the investor spent on said student’s education. This might be disadvantageous for students who now have to pay more than they would have had they taken a loan instead.
HCCs don’t cover everything
While HCC contracts only pay for a student’s tuition fees, they do not cover expenses such as room and board, books and supplies, which can add up to a significant amount for the average student. According to the American non-profit organization College Board, a four-year degree at a public university with the student living on campus costs US$44,150, of which US$16,590 are spent on things besides tuition.
So, are HCCs viable?
In the past, HCCs have been experimented with several times. The first HCC popped up in 2001 and went by the name MyRichUncle.com. Then, in 2012, two more startups, Upstart and Pave began offering HCC contracts. Unfortunately, none of these initiatives were successful in making HCCs a mainstay in the education sector. While MyRichUncle was shut down, the other two businesses pivoted and began offering different services.
However, in 2022, there was a return in this form of investment with the discussion surrounding the Liberman siblings—Daniil, David, Anna and Maria Liberman. The four entrepreneurs from Moscow in Russia were behind the startup Kernel AR which worked with Snapchat on 3D Bitmojis. They also helped the company gain users by analyzing the issues with its Android app’s performance.
The siblings are planning to list themselves on the stock market this year, having already sold 3% of their future for US$4 million, with one million dollars going to each sibling. Whether their venture will turn out to be successful still remains uncertain, but hopefully, it will lead to more ideation in the field of human capital investment so that students and working professionals alike can reach their full potential.
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