Oregon State Bar Bulletin — FEBRUARY/MARCH 2011
Parting Thoughts
Equity vs. Debt
By Jeffrey Standen


Recently I enjoyed a pleasant dinner with three law students. One of the topics of discussion was the significant financial debt with which these students will soon enter the work force. Even with the government subsidy, the debt load can be staggering. Worse, the repayments will begin at a time in the young lawyer’s career when earnings will be at their lowest. This debt undoubtedly influences career and life decisions, forcing these young people to seek the highest wage possible, postpone childbearing, and avoid pursuits that might interfere with their earnings. Debt matters.

Then just days later I had occasion to meet with the son of a friend who is about to try his fortune as a professional golfer. Like the law students, this young man plans to spend three or four expensive years learning his trade, in his case taking his game on the road to play in various minor-level pro tournaments in the hope of playing his way up to the lucrative PGA Tour. Would this young golfer, like our young lawyers, turn to debt (albeit without the nice government subsidy) to fund his vocational training? In small part, yes, he will borrow a little money. But the amount of money he’ll need to fund three years of full-time golf exceeds the funds the students need to complete law school, amounting to over $150,000. With no government handout available and with no bank willing to lend on such an endeavor, where will this talented young golfer get that kind of money?

The answer: he plans to sell himself. Or more specifically, he’ll sell shares of his future earnings in exchange for cash up front. His investors will give him several thousand dollars each in exchange for a small percentage of his future winnings over a specific period of time. He’s just a business person raising venture funding, only this investment is directed into human capital, not into some business plan. This method of financing, by the way, is common among fledgling golfers.

What perplexes me is why don’t law students raise capital the same way? Why don’t they, like novice golf professionals, turn to the venture capital markets to fund their training? Part of the reason has to be easy availability of subsidized debt, which renders venture capital comparatively less economical. The provision of subsidized debt drives students into debt, with all of its attendant lifestyle limitations. Yet subsidized debt fills only part of the market. There is plenty of room left for venture capital.

Why is equity better than debt? Golf’s historic practice of investors sponsoring a young player puts everyone on the same team. The golfer and his investors all desire the same success. With the debt financing that is common in higher education, the student incurs debt and demands a product from his supplier, the educational institution, which will suffice to pay that debt back. A relationship that should be nurturing and supportive turns antagonistic.

Finally, and not to put too fine a point on it, but why don’t law schools make this market? Law schools could just give away their education in exchange for an equity position in their graduate’s future. A law student could in effect pay for her tuition by selling a small percentage of future wages. Do the math: a law student could be obliged to pay something like 7-10 percent of his income, whatever that income happens to be, to his investors for the next 15 to 20 years. Assuming industry-average salaries and low default rates, the present value of that sum roughly equals today’s debt obligation. Schools would have a financial incentive to admit students they believed could be successful and then do everything within their powers to ensure that success. As for the graduates, without debt they would be free to pursue lower-paying jobs in the public sector, to seek part-time work to facilitate family choices, or to go for the gold in private practice. Debt would not dictate careers. Law schools would be fully invested in their students’ success, accepting lower returns from some graduates while reaping outsized rewards from the most financially successful. Like (limited) student loan repayments, these repayments could even be treated as tax deductions.

If I had about $30 million in capitalization (I’m a little short), I would buy equity in as many law students as I could. Although I’d have to worry about adverse selection (and might vary the repayment obligation accordingly), as a whole law students would be a great bet. Heavily motivated, super-diligent, bright young people who, unlike many college graduates, are about to complete credentialing requirements for what continues to be a comparatively high-salaried occupation? Perfect.

 

ABOUT THE AUTHOR
The author is a professor at the Willamette University College of Law in Salem.

© 2011 Jeffrey Standen


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