ISA investing is different from early stage or venture investing, in that, there is more data usually available on school outcomes in ISA investing. Moreover, ISA investing does not follow the “home run” model of most types of angel or VC investing, relying instead on a more normal distribution of outcomes. Investment in ISAs can follow returns typical of higher yield structured debt/PE funds to lower yield impact funds, depending on investor interest.
Q: What are the key risks that you look at in an ISA investment?
Program and employment risk:
Program risk relates directly to employment outcomes. In our experience, there are three important components of this – employment and income outcomes, time to placement, and dropout rates.
Mean placement rates and dropout rates can significantly affect ISA returns. Time to placement is also important. Longer placement horizons can reduce returns to investment and can affect students adversely. In our experience, time to placement is somewhat correlated with outcomes.
As important, if not more, is the variance of incomes of graduated student. Since ISA returns are capped, any variance beyond a certain point is downside risk. Properly assessing the level and composition of the variance is important. Investors in this space are generally comfortable with schools with multiple years of outcomes data.
Program risk is also reflected in how the school manages its career program and any corporate relationships it may have. Typically, we have seen that the better programs have at least one, if not more dedicated career and support persons to help students prepare for, seek, and find employment opportunities. A broader team overview can be useful, particularly for investments in newer programs with limited track records. In this case, we would want to understand the team’s background, experience, prior success in the higher education space, the student acquisition and placement strategy, and expansion plans.
The admissions process and how schools, particularly recently established schools and boot camps, screen students is an important part of the process. It can particularly affect drop rates of students, which can really hurt ISA returns. We prefer ISA program designs that mitigate this risk – for example, by staging the payment of tuition to schools based on completion.
Capital deployment risk
Ideally, investors want capital in an ISA fund is deployed in short order. If not deployed speedily, it can end up tying capital and lowering returns to investors. In our conversations with ISA investors and having funded ISAs to students, the key aspects that we have seen come up in ISA offerings for deployment are as follows:
Marketing approach – The sales and marketing approach and how schools provide information on ISAs to students needs to be clarified and at least somewhat tied up during the investment process. Is the school appropriately letting students know about the ISA option? Are they using the right materials and properly reporting the financing parameters to school? There is also a regulatory component, for instance, is the school providing the ‘Application Solicitation Disclosure’ to students?
For the programs we fund, we provide an offering explanation document along with a clear FAQ and contact details students can reach out if they have questions. Our experience is that once students learn about the financing terms clearly, they are fine with it, and would rather move on to discuss how valuable the program can be for them in getting skills and jobs.
The marketing channel and clarity are important – is the student getting to know about the ISA program through the website only or is someone at the school letting them know of the option in person? How are they reporting the ISA option compared to other financing or discounting options they may have (more on this below)?
Another important aspect is how schools are marketing their overall program. If schools are targeting individuals with relatively low need for financing, then deployment is going to suffer. This conversation needs to happen early on in the ISA investment diligence process.
Screening process – The admissions screening process is very relevant and impacts returns in two ways. Very lenient admissions criteria will increase drop rates. While we can control for this through ISA program structure, it is imperfect. That said, any rigorous program is going to have drop outs, simply because people find they are not ready for the program, or their other commitments get in the way. Our underwriting strategies provide another mitigating tool – we utilize some psychometric criteria as well as some other assessments to estimate completion likelihood.
However, very strict screening by the school, particularly on aspects like ability to pay, is going to severely lower the deployment rate, and hurt returns. We would want to have an understanding of what the school’s qualification criteria are, and what percent of their top of the funnel students they are converting. A very high qualification proportion is going to lower the quality of their screen, and make the investment riskier.
Keeping an eye on the screening process is not just a diligence time need, it is actually a longer term process. The worst thing that can happen is that a school changes its screening process after the ISA program is in place. It can destroy the assumptions based on which the ISA pricing and diligence is based. We prefer to use an active underwriting criteria beyond the school’s screen to mitigate this risk. In fact, active data collection and reporting is very important through the fund investment process.
Alternative financing and discounts – Some investors we have talked to have expressed concerns about how the presence of loan and tuition discounts can affect ISA financing options. They have expressed concerns of credit quality adverse selection, where students with better credit will select loan options. Similarly discounts offered to students for cash payments can make ISAs less attractive for students. These are valid concerns and need to be fleshed out up front.
Having talked to a few schools, the terms and provider of alternative loan options matter. Usually, third party loan providers have strict underwriting criteria, and their acceptance rates can be really low. However, it may be high enough to lead to significant adverse selection. Flexibility and loan risk aversion are two important reasons students may prefer ISAs to loans as well.
Having clear data on what fraction of students are getting financed with loans or discounts, and what proportion of discounts might be replaced with ISA financing is an important part of the early diligence in ISA investment.
We use the term market risk to refer to geographic competition and talent need. Education is highly localized, particularly for boot camp students. However, the advent of online education has made that distinction less relevant. Having taught online courses myself, I can say that students can end up learning content almost as well as in class programs. You give up the option value of connecting with class mates on a regular basis and the tangibility of face to face teaching, but gain flexibility to access skills at your pace and, in some cases, while you are working.
That said, local competition can actually be a two edged sword. Competition can suck away potential students a school can enroll, but the presence of many high quality local schools in a location is actually spurred by the presence of employers who are willing to hire from these programs. California is certainly a key market, and the programs emerging here have a built-in advantage of the technology ecosystem that can absorb this talent.
Market assessment of the talent need in a space is always going to be an integral part of the ISA diligence process. Since the demand for technology talent is so severe, we are seeing a rapid emergence of alternative education structures in technology in geographic areas where the demand is the greatest.
Q: How do you view economic cycle risk and its impact on ISAs?
Many investors have asked us this question. The answer for ISAs, however, is actually more nuanced than saying ‘people will not get good jobs in a recession.’
A recessionary economy will hurt the ability of people to find and keep their jobs. A good risk mitigation strategy is to focus on high quality programs in geographic areas with significant talent needs, high attrition, and low supply. The technology, data analytics, and cyber security areas fit these criteria. Certain programs support students who are already employed, but may still need ISA funding. These students can be somewhat more recession proof.
ISA program design is a lever to pull at to mitigate economic cycle risk. For instance, the deferral period, that is the period during which a student can defer payments while they are seeking a job paying wages higher than the salary cap. The deferral period, which is 24 months for our ISA agreements, provides a buffer period while the student is seeking employment, before eating into the payment term period.
The flip side of a recession for ISA investment is that deployment speed will increase in a recession. Two interesting effects can lead to this. First, there is the well-documented effect that people who leave or are forced to leave employment during recessions seek cover to get into higher education and use this time to increase skills. Second, as more students join higher education and budgets of governments decline during recessionary periods, schools are more pressed for the need for alternative financial aid options.
Ultimately, recessionary economies are not good for any kind of pro-cyclical investment. So, it comes down to whether education investors have conviction that the program they invest in can achieve their financial and impact goals through the duration of the investment period.
Q: How important is regulatory risk in considering an ISA investment?
Regulatory risk in this space fall into two categories:
School operations: The diligence process has to confirm whether the school has appropriate licensing and documentation to legally operate the program. This is relatively straightforward to verify.
ISA regulations: This issue is a bit more complicated. Most of ISA regulation does not exist yet. Congress has a few bills in committee to effectively define ISAs, but that process will take some time. We have done a lot of work to ensure that we are compliant with any relevant federal or state level regulations relevant to ISA financing, including lending regulations such Reg Z and TILA. Ultimately, we believe that this model is a significant part of the solution to the student debt crisis, and will be viewed by regulators as such.
Our active career support model actually ends up reducing such risks, as we don’t only providing financing, but value improvements for the students we fund. Such an integrated approach is likely to get a more sympathetic view from regulators.
Q: What about school accreditation as a risk factor?
Some investors express a preference for accredited vs. unaccredited programs. While this is a reasonable distinction, the quality of a program is unlikely to be dependent on accreditation. Accreditation standards are based on rigid criteria, which in many cases may not reflect employment outcomes.
An ISA investor, on the other hand, is likely to care about risk, return, and employment impact. Having gone through a higher education accreditation process myself, I can say that while it is useful, it can have low correlation, particularly with more innovation models of education. One example is the project based model of Holberton School, which we are big fans of. They have an impressive placement and salary record, which reflects the effectiveness of their program
Q: Are there any of those major categories of risk or red flags that concern you to a level that you might decide to pass on a school?
Outcomes, data, and program details (education track, career approach, screening methods, etc.) are key to putting together ISA programs, in our opinion. If the school is not willing to clearly lay out their outcomes, provide complete data, and allow us to directly talk to students, then we have no interest in participating.
If the business model and marketing is misleading, significantly inflating placement outcomes or making false statements, then we will not be interested.
Major deficits in the school’s team on the career, enrollment screening, or marketing side will make us hesitant, especially when the team does not recognize the deficit and plan to hire for it. If we feel that the school is misleading us on traction, placement, and other relevant metrics, we will would not want to work with that school. If the school views the ISA program as a short term fix to their financials, but have no clear path to a longer term expansion goal, then we will not work with the school.
Q: How do you work with the school to monitor and track the progress on risk mitigation?
At MentorWorks, we consider ourselves as partners with schools to help improve student outcomes, and in turn, school performance. We work with them and develop a good dashboard of all the key performance indicators and monitor it regularly. If you have the right measures on your dashboard, and you keep your measurement set up to date as the program evolves, it is just a matter of looking at the numbers that are out of whack relative to the initial assumptions and asking “why?” and “what are we missing here?”