The Report

How the self-IPO is a product of our times

How the self-IPO is a product of our times

Posting in Finance | From Issue 08 January 27, 2014

Now, you can sell a share of your future earnings. Here's why this could be an apt solution for two crises of our own making.

Budding entrepreneurs: have a great business idea but lack funds or have debt? Forget venture capital, that’s so Y2K. Credit cards? Nah, too financially risky. And crowdfunding campaigns can create too much pressure, too fast. 

So how can you pursue your dreams without taking on a fixed-debt repayment that, let’s face it, you may not be able to pay every month when you’re starting out? Hold a self-IPO.

Upstart and Pave, launched in 2012 and 2011 respectively, allow you to do just that -- take an investment upfront in exchange for a percentage of your future earnings. The concept is so new it can seem strange and risky. Some say it even smacks of indentured servitude. That may be why only a little over 100 people have received funding on Upstart and about half that on Pave, with the average amount raised around $20,000 on each site.

But despite the general queasiness around selling a share of your self, these sites are riding several big trends. First, there's the rise of crowd funding. Second, we have a shift from large venture capital investments toward earlier stage seed funding -- after all, what could be earlier than investing in the person even before they have their great idea? Third, there's the growth of an entrepreneurial culture that has prompted the launch of schools such as Cornell Tech and Tim Draper University of Heroes

Even more importantly, self-IPOs address at least one big problem -- record-high student loan debt ($1.2 trillion as of this writing) -- and may even quell investors’ post-crisis fear of risk. A 2013 study by the Consumer Financial Protection Bureau concluded that student loan debt, “may suppress risk-taking and innovation by discouraging the formation of new businesses by young entrepreneurs.” 

The impetus for both Upstart and Pave was the number of young people that the founders met who wanted to do something entrepreneurial but were instead pursuing “safe” jobs with high salaries. Upstart’s founder and CEO Dave Girouard says, “It struck me as unfortunate that there was something ambitious and exciting they wanted to do that they were postponing until some theoretical later point in life when they could afford to do it." 

As for investors, sites like these have another appeal: building trust. “I think there was an issue of confidence, where [investors] realized they didn’t understand what they bought, and there were a lot of firms making money off people who didn’t understand what they were doing,” says Pave cofounder Sal Lahoud of the financial crisis. 

Upstart's own pitch video asks, If you want to invest in a startup, why not invest in the people who make the great products and companies you want to invest in? That seems logical to enough people that one surprise trend on Pave is that people who already know each other -- a prospect and a mentor who wants to financially support him/her -- come to the site simply to formalize the arrangement. And many backers choose to actively mentor their borrowers, thereby helping ensure their return on investment. 

For instance, in January 2013, Trina Spear -- who graduated from Harvard Business School with $170,000 in debt in 2011 -- raised $20,000 on Upstart to launch Figs, which designs and produces comfortable, high-quality medical scrubs. Spear acknowledges that the small sum wasn’t enough to launch her startup, nor pay her debt; she says she used the money just to cover moving and living expenses. But the investment provided a stepping stone: “It wasn’t necessarily about the money I made. It was more about connecting with my backers, two of which invested in Figs, and they also connected me with other VC firms who invested a significant amount in the business.” Through Spear's Upstart connections, Figs raised $2 million.

Even when an investor and borrower don’t know each other, increased trust in social networks helps create trust. Naval Ravikant, an angel investor and cofounder of AngelList says, “People are more comfortable having their identity and their personal information online and having online friends.” That said, Ravikant believes that for investors, it’s extremely difficult to evaluate people virtually. “Online profiles aren’t enough, as any online dating site will show you,” he says. “At the end of the day, the only way to get to know a person is to spend some time with them.” 

Ravikant's recommendation would be for backers to spread risk by investing in, say, 50 people, rather than one, or to not view the investment in purely monetary terms: “You can view it as somewhat blurring the lines of charity, and empowering people and being an investment.”

As for the borrowers, he says, “I’m sure the terms are set up so you get a small amount of money early on but if you’re successful, you end up sending out a big amount of money later on. It’s not the worst thing, but don’t be resentful about it.”

Update: The original version of this story stated that over a hundred people had raised funds on both Upstart and Pave, when in fact, about 50 had received funding on Pave at press time.

Photo: Maltman23/Flickr

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Laura Shin

Features Editor

Laura Shin has been published in The New York Times, The Wall Street Journal and The Los Angeles Times, and is currently a contributor at Forbes. Previously, she worked at Newsweek, the New York Times, Wall Street Journal and LearnVest. She holds degrees from Stanford University and Columbia University's Graduate School of Journalism. Follow her on Twitter. Disclosure