At 3% gain per year from relatively safe investing, $125k would end up being $168k after 10 years. She'd have to earn an average after-tax salary of $168k for the next 10 years for the investment to be equivalent.
That's fairly high, especially for someone just getting their career started.
And if she's very successful as an entrepreneur, running a business doesn't mean you have to pay yourself some inane personal salary, especially not if you'd owe 10% of it to an investor, so if her company becomes wildly successful but she only collects some salary of 100-120k and equity which is perfectly livable at only 90% after taxes, she could still walk away with an enormous amount afterwards, yet the investor would have a significant loss.
I don't see how any investor would prefer this over equity, it seems like a guaranteed loss?
Yeah, this is a crazy investment given the likely return. Presumably an anomalous result due to the novelty of the stunt. In a world in which such a thing were common and had no novelty value, we would expect the amount of money raised by such a deal to be probably under $50,000.
It's only a gamble to a certain extent, for instance, even if her company fails, it's likely to happen in the next 2 or three years, that leaves another 7 or 8 years where she will require employment in order survive.
Judging by her character and drive to succeed (she emailed 1000+ angel investors, is starting her own business, etc) I could see her occupying a fairly high wage job, in the $50,000 - $80,000 range, if we take a mid point, that's about $65,000 per year for 7 - 8 years.
$65,000 * 7.5 = $497,500 / 10 = ~$50,000.
Assuming that's true, they only stand to lose half - if her idea succeeds however, they could make millions.
I would assume the investor isn't hard up of cash, so losing $75,000 would be a drop of water in the ocean, but making a few million would probably be a nice bonus.
It's extremely unlikely that they'll make millions. For them to make even a single million, she'd have to earn $10,000,000 before age 29. Even if her business idea is relatively successful, a payout-to-founder of $10,000,000 after taxes is very unlikely.
This concept is basically angel investing with some risk mitigation (if the business idea doesn't turn out, but the founder goes on to create another business or get a high-paid job as a non-founder, you get some money out of it), but with a much lower reward.
The lower reward is as follows: A typical angel investor might get, I dunno, 5% equity in a company. In the case of this deal, the "angel" gets 10% of the post-tax amount of the equity that the founder keeps and turns into money.
Which is AWFULLY rough! I mean, suppose that the founder maintains 30% of their company, and then converts all of that to cash, and gets hit with only 15% long-term cap gains, all in ten years. So the angel's effective equity share of the company is .3 * .85 * .1 = 2.55%.
This is a really just a disguised angel investment - it converts between a 100% ownership in her company and 10% of her salary for 10 years, at HER preference. It's actually a great deal for her - she's got very little skin in the game:
If her company fails, she'll just convert the investment so she doesn't have to actually pay out a cent and the investor gets 100% of zero (the value of her failed company).
Also, even if the company succeeds, she'll be working on her pre-revenue startup for a few years, and she won't have any meaningful income for a significant portion of those 10 years.
This just is how society currently works, except instead of $125,000 the young person gets four years of classroom lectures. And it's more like 10% of income for 20 years, depending on the school.
Student loans actually come on less friendly terms; with loans, the amount of money you pay doesn't depend on your post-school income, so the financial burden falls equally on everyone regardless of their ability to bear it.
Imagine, hypothetically, that the student loan system were replaced with percent-of-income contracts like the one in the OP. This would give investors an incentive to maximize the total future income of the students they invest in, minus school cost. There are some problems with that, but frankly, I much prefer those incentives to the ones created by the current student loan system, where the most profitable strategy is to get students in as much debt as possible.
That is how student financing works here in Australia: below a certain threshold income (about $37k in a country with median wages of about $50k) you pay nothing, then you pay a percentage of your income over that.
The article won't load for me. $125k? Is that the number? Am I failing at math, or does that mean someone is betting she will average at least $125k/year over the next 10 years?
Not sure how to react. Not outside the realm of possibility, but a pretty darn aggressive bet nonetheless.
$168k. After taxes. If you assume 30% taxation, she'd have to have a pre-tax salary of $240,000/yr.
This is assuming the investor could have obtained 3% per year in relatively safe investments. To break even (which is actually a loss, due to inflation), it would still be somewhere in the $160-170k ballpark.
51% seems intuitively appealing, but salary isn't like voting stock--it doesn't give control. My guess is there's no clean answer to this one, but you'd have to factor in both earnings percentage and duration. It's not that big a deal if I agree to give you 99% of my earnings for the next 10 minutes.
If anything, this is a decent-sized loan, with a very safe, variable repayment amount that is defined to always be a small amount of her income, and the collateral is a company that may or may not succeed. More than that, the investor only even takes the company if she's dishonest. There's almost no downside for her here.
If you want to be concerned for someone, I'd be concerned about the investor.
He doesn't say 'this is slavery'. So, which of the points listed would have to fail for you to consider this concerning? If she was only getting $10,000? If the variable repayment was 50% or 90% of her salary, or a fixed small or large amount per year? If the investor got the company if the 10% over 10 years did not meet some minimum amount? Never?
The point is to take legal scenarios like this and see how far they can be pushed. What if her parents were the ones auctioning her potential earnings off and using the money to pay of a mortgage. What if the following year they did it again for another 10%? Things get really sketchy when you draw up these kinds of contracts that revolve solely around an individual.
Okay, so you're suggesting this seems to set a dangerous legal precedent with slippery slope potential? I still say it's just a loan. To your argument here, can her parents legally take out loans in her name? I don't actually know the law there, but I don't think a lawyer would have a hard time answering that.
To your earlier question about 51% or 100% of her salary, if an investor loans me $500,000 at 0% interest to pay back in 10 years, and I only make $50,000/yr, that would suck, but I'm not becoming a slave to that investor. I can't afford to pay that back, so I'm going to default on my loan. There's a huge difference between that and literally being owned by someone.
I would prefer deals like this, than my current deal: huge sudent debts that I must pay monthly, no assets, bachelor degree don't helped me at all, and thus leave me with little choice... I MUST have certain jobs (ie: jobs that allow me to pay my food and the debt... and where I live those are few).
At 100% it's a brilliant scam because you can collect the EV of your income, then not do any work. Or do open-source work and build your career, or price yourself extremely low as a consultant and build a network, then improve your rate once the window is open.
There are some weird nonlinearities to this problem. For example, if 1% of a typical top-25 college STEM major's (lifetime) income is worth $50,000, then my estimation is that 10 percent is actually worth $1-2 million (20 to 40 times more). Why? Because, with that money and the cushion, he'll be able to take more risks and have a better career. But then at 50-100%, you get a Laffer-curve effect. So the value of N-percent of someone's income is:
(a) faster-than-linearly increasing for a while (career benefits) until it peaks and plummets (Laffer effect).
(b) not necessarily well-defined, because the infusion of capital has career-building effects that mean it might be better to give more money (for equivalent percentage).
Funny because I was doing the math on this exact question the other week. I was thinking zero coupon bonds but conceptually they are similar. Basically computing the discount rate for a STEM degree in terms of forward earnings potential. Consider a technical degree with a starting salary of 75K going to 150K in year 10. With a linear progression that is basically about $1.0875M in salary over 10 years. 10% of that would be $108,750. Lets make the face value $100K, The question being what discount rate would you need to offer a bond at that matured in 10 years? 10 year treasuries [1] are currently at not quite 2%, junk bonds might be 6 - 7%. So at the low end we sell our bonds for $85K, pay them off in 10 years at $100K for an approximate 2% annual yield. But at 7% you have to sell them at $50K for an annual yield of 7%. So depending on how risky investors in this persons bonds considered them, would affect the discount rate for them. Then you could bundle these bonds into tranches and sell off the high end as treasury equivalent and the low end as a more speculative investment :-)
If she didn't care about her reputation, she could screw over the investor pretty badly by deferring her income. She could even sell her company (for stock of the acquirer) and then hang onto the stock until the payback period has ended. The sale transaction could be structured to avoid a current tax hit, which would also result in the investor being cut out of the loop.
Additionally, there's the possibility of shifting income to family members (and the complicated question of what happens if she gets married and has income from the investment of community property assets).
This type of auction could also raise questions of legality/constitutionality. Although it doesn't seem that bad to give up 10% for 10 years, it would feel different if someone sold 90% for 90 years. Starts to sound like a bit like slavery, albeit voluntary at the outset.
I think Warren Buffet once said that he'd give college graduates $100,000 now for 10% of their lifetime income. This kind of reminds me of that. And begs the question, should somebody build a platform to make transactions like this more easily possible?
We already have things that give you money now and take 10% of your lifetime income. They're called colleges. Well, except the "give you money now" part.
Colleges take a flat fee. If they worked for a percentage, then (a) they would probably try harder to increase the lifetime earnings of their students, and (b) tuition would be de facto subsidized by the students who go on to earn the most money.
Are people actually going into $250k of debt just for an undergraduate degree? I wouldn't even consider that sort of debt unless it was for medical school.
No, no one is (without some weird circumstance like their guardians are able to pay for the college, but would rather take on debt for tax/other reasons). Average debt is about an order of magnitude less, and I believe the mean is even less. Avg is pushed up by bad schools charging absurd fees.
It isn't the norm, but yes. Folks have generally settled on that number as the benchmark college debt because it is very dramatic, but still not so far off in fantasy that you could call it false.
What is the actual average debt on graduation? ~$27,000
> What is the actual average debt on graduation? ~$27,000
That does not seem bad at all, though I suppose I am coming from the perspective of being employed immediately out of school in your field, which obviously is not the case for everyone.
Does anybody know what the average time to pay off that sort of loan is? I'm assuming that any undergraduate, regardless of degree, could expect to have that same average debt, but maybe that isn't true either.
It's not just HN, everyone seems to be in love with that number. Reddit, old media, etc. Previously I thought I was some sort of extreme/lucky outlier for getting out with a little less than $25k.
Amusingly, if the graduate's average yearly income over the career is $62500 (about right for a median college graduate) and the length of career is 40 years, then it comes out to exactly 10%.
My original reaction was surprise since ten percent after tax seemed like a lot but after thinking about it this really is that bad of a deal for the entrepreneur, ten percent is a tithe.
More impressive (and useful) would be an auction of time. Percent of salary can always be gamed.
I'm considering offering 5 years of a one-Saturday-per-month (12-hour day) consulting commitment for somewhere around ~400-800k. Taken as an hourly rate, it seems very high, but:
(a) I'll code, make introductions, advise, or whatever else is needed.
(b) smart people can add high value in small amounts of time ("fresh pair of eyes" effect). I'm sure there's someone out there who could extract that much value from me.
(c) if I became wildly successful, the person would be able to "pimp" my consulting services out to a client at a higher rate and pocket the difference, and
(d) with the 5-year commitment there's a huge call option involved that's probably worth more than the underlying.
It's different, because it takes advantage of the nonlinear value of time. It's specifically designed not to preclude other employment, hence the Saturdays.
A highly competent person's marginal value per hour starts very high, then drops around the 100-hour per year mark, then goes up slightly again from 500 to 2200 hours. Most people are paid based on the bottom of that U-shaped curve.
For example, pretty much any company would benefit from hiring someone like me at $1000/hour for a few hours at a time, because I'm very good at spotting problems and coming up with plausible solutions... but very few companies could justify a full-time retainer at that hourly rate.
So that's the economic theory behind it. I feel like career modularity is going to be more important in the 21st century anyway. The evil of the current arrangement isn't working for other people or "being employed"; it's the lack of diversification and the fact that people are coerced into a one-size-fits-all model that has ceased to add value, especially at the upper end.
That's fairly high, especially for someone just getting their career started.
And if she's very successful as an entrepreneur, running a business doesn't mean you have to pay yourself some inane personal salary, especially not if you'd owe 10% of it to an investor, so if her company becomes wildly successful but she only collects some salary of 100-120k and equity which is perfectly livable at only 90% after taxes, she could still walk away with an enormous amount afterwards, yet the investor would have a significant loss.
I don't see how any investor would prefer this over equity, it seems like a guaranteed loss?