Hitting the (Financial) Books

Investing in, not lending to, college students

Little Janey's starting kindergarten next year, and you're already panicking: Just to send her to a state college, the family may have to take out a second mortgage or live on canned food. What if, instead, investors were able to finance talented young people as they do untested but promising entrepreneurs? You would not have to go in hock to send Janey to State U: Willing investors would give her the money.

A New York investment group wants Congress to modify the tax code and convert college financing from a system based on debt to one based on equity. Human Capital Resources Inc. says students should have the option to get their college money from investors in "human capital equity funds," a new type of mutual fund that would pay students' college expenses and repay their investors from the incomes the students earn after they graduate. "Instead of borrowing money for college," says HCR Chairman Roy Chapman, "students could earn it."

Here's how the system might work: Say Janey would require $50,000 for four years in college. She could apply to Human Capital Resources for money. If HCR decided to invest in Janey (based on her interests, grades, test scores, participation in extracurricular activities, or whatever criteria the company deemed important), it would agree to finance her four-year tenure. (Since the tax code would treat this "investment" as income, she would also get enough additional money to pay her taxes.)

She would then enter a contract with HCR. Her academic performance as a freshman would let her "earn" her sophomore tuition, and so forth, until she graduates. If she can't keep up, HCR could terminate the contract, and reduce her repayment obligation accordingly. If she fulfills her academic commitments, however, upon graduation she'll begin paying a percentage of her income to the fund that owned her contract for the first 15 years she's in the work force. (A model developed by HCR would have students repay 0.22 percent for each $1,000 received, and a student receiving $50,000 would pay 11 percent of her income.)

Equity funds would finance the contracts. Much as mutual fund managers try to minimize their investors' risks by funding many companies in diverse industries, equity fund managers would bundle contracts, thus spreading the risk for investors in newly graduated workers. Not every student, after all, will earn big bucks at graduation; some, for instance, will no doubt choose full-time parenthood over earning salaries. Chapman says a fund wouldn't need much start-up capital: He estimates a fund as small as $25 million to $50 million (with as few as 500 contracts) would offer enough diversity to attract investors.

The equity fund would be a good deal for parents and students. Families could avoid going into debt to finance their children's education. If Janey earned $30,000 at graduation and saw her income grow at about 5 percent a year, over the 15-year span she would pay about 50 percent less to her equity fund than she would to lenders in a typical student-loan package. Taxpayers wouldn't be on the hook if she defaulted. And if she didn't stay employed the entire time, or worked sporadically, her investors would still get some money as long as she worked.

Chapman and his partner, Gerard Wendelken, have drafted a bill that would incorporate the tax changes to let equity funds form. They're meeting with members of Congress, looking for sponsors. "Instead of investing in [educational] access," says Chapman, "we ought to support success."