Wednesday, November 7, 2012

Is Upstart the right way to get college student start-ups funded?

In 2010, the movie “The Social Network” was released, which has had a tremendously positive effect on the computer science department at Yale; and from what I have heard, a similar effect has been observed across the country. My understanding (I have not seen this movie myself) is that the movie’s plot revolves around Mark Zuckerberg and his role in the formation of Facebook. In the time since the movie was released, the number of computer science majors at Yale has nearly quadrupled, and these majors  are increasingly looking at start-ups (either founding their own or joining existing ones) as options for when they graduate (instead of going to Wall Street and working as quants, which has historically been the popular career path for Yale CS majors).

In my opinion, this is unquestionably a good thing. Yale has some of the brightest minds of the next generation, and I feel a lot more confident about the future of our country when I see these great minds being applied to creating new entities and jobs and building something real, instead of being wasted in the zero-sum gain arms race of who can create the automatic trading algorithm that is epsilon better than anybody else’s.

One consequence of this start-up craze is that I get bombarded with requests from students who want to meet with me to discuss their start-up idea. This partly because I teach the “Intro to Programming” course at Yale which has had consistently between 120 and 150 students (many of whom are budding entrepreneurs) enrolled since the release of “The Social Network”, partly because the success of Hadapt is certainly no secret around Yale, and partly because I live on Yale’s campus and part of my job in this capacity is to serve as an adviser and mentor to undergraduates.

When I meet with these students I hear all kinds of ideas. Some of them are good, and some of them are bad. Some of them make me think about an area in a different way, and some of them are carbon copies of something that already exists. Some I could get excited about and some I couldn’t. But just about all of them have one thing in common: the students involved vastly overestimate their probability of success. I suppose this should not surprise me --- after all, these are Yale students that have been successful in just about everything they have ever done in their life. So it follows that they would expect their start-up to be successful. But even when I talk to students at other universities who have start-up ideas --- students who have not necessarily been so successful in their lives --- even they are totally convinced that their startup idea is unlikely to fail. It seems that there is a basic psychological flaw in the human mind --- we so desperately want our dreams to come true that we ignore statistical data about the probability of success and trick ourselves into believing that we are the statistical anomaly and will succeed where others have failed.

Many of these students find out the hard reality regarding their start-up idea when they attempt raise funding. They find out that investors are extremely conscious of the probability of success of a group of students with no experience, no reputation, and a limited network. Most of these start-ups fail to raise funding from professional investors. Some students give up at this point. Other students continue along with limited funding from friends and family in an attempt to create more meat around the bones of their idea and reduce risk for the professional investors. Most will eventually fail, while a rare few will succeed.

The outcome of all this is that despite all of these students eager to be entrepreneurs and start companies, very few student ideas receive funding, and most of these ideas never see the light of day. Whether or not this is a good thing is certainly up for debate, but my feeling is that it is a shame that so few student start-ups get funding.

Therefore, when I first heard of Upstart (I think it was in August), I was quite interested in the idea --- it proposed a way to get student start-ups funded. I signed up to receive e-mail updates, but did not hear from them for several months. However, on Monday of this week I received an update from them that they were open for business. I looked through the profiles of the students who were looking for funding and I saw that no fewer than 4 out of the (approximately) 20 profiles that were available online were from Yale University.

However, a deeper look at the Upstart Website reveals a problematic clause that is attached with the funding of the student start-up ideas. This is not a traditional crowdfunding model where investors receive equity in the start-up in exchange for their investment dollars. Instead, the investors get a percentage of the student’s income for a 10-year period in exchange for the investment. This way, in the likely event that the student’s start-up idea does not work out, the investor is able to receive a nice return on investment by taking a cut from the student’s hard earned salary when the student enters the workforce.

This does not seem right to me. On one side you have students who have an inaccurate view of the probability of success of their start-up, and on the other side you have investors who are looking to profit off of the boundless optimism and dreams of these students. These students, with no experience in the real world, no understanding of what skills are necessary to build a company, and a perception of entrepreneurship built more from Hollywood than the cold realities of business, are more than happy to mortgage a percentage of 10 years of future earnings for a chance to receive some short-term money about which they have no idea how to properly evaluate the costs vs. benefits.

In the traditional model, where the  investor receives equity in exchange for the investment, at least the investor is in the same boat as the student --- their interests are aligned and focused on making the start-up a success. With the Upstart model, you have almost the exact opposite. Since the salary of a founder is typically below-market in exchange for the equity the founder receives, the expected rate of return for the investor is actually higher if the student were to give up on the start-up and get a normal job. This is especially true when the investment rate of return for the investor is capped (as it is in Upstart), so that even if the start-up were to take off and the student were to become very wealthy from it, the return to the investor is not markedly different from what it would have been if the company had failed and the student later received a salary at market value. To exacerbate the situation, the investor-investee relationship in Upstart is supposed to be somewhat also a mentor-mentee relationship, which is particularly dangerous when interests are misaligned.

I think Upstart should be commended for trying to get more funding to college students with ideas for starting companies. And although I don’t know many people involved, the people I do know are good people and I highly doubt they are trying to do anything evil. (Jonathan Eng was a TA for my Introduction to Programming class for me 4 years ago, and he was a good and honest TA). However, I do not believe the people involved in Upstart realize how hard it is for students to accurately evaluate the costs and benefits of receiving funding in this way. Therefore I am highly concerned about this model as a way forward for student entrepreneurship.


  1. Interesting. Following this line of reasoning, if you're a student raising money for a startup, you should actually make your idea sound UNLIKELY to succeed on your Upstart profile. This way Upstart investors will expect you to fail quickly and move on to an industry job, increasing expected returns and thus, presumably, the amount they are willing to invest in you.

  2. good thing is that there is someone out there willing to listen to students' ideas and giving them a platform to raise money. We should also realize the fact that everyone has to survive and if Upstart gives funds without any restriction then how do they survive? Even Upstart is a company and they have to pay to its employees; I think its for students to discuss their financial needs with Upstart and reduce the 10yr deal to 5/6

  3. Daniel, I applaud your standing up for students exploited by vehicles like this, that is why I started hack-reduce as a 501-3c charity. At hack reduce young people can innovate without a financial gun to their head. Frankly, it's the same reason I joined Atlas, to seed and develop people and ideas. I am really proud to to be in business with someone of your intellect, and character.


  4. I'm Dave Girouard - founder of Upstart. I'd like to address some of your concerns, as I clearly didn't found the company to exploit anybody.

    First, upstart funding is not typically competing with or comparable to angel/seed funding of a company. In the end, I suspect a small single-digit fraction of upstarts will actually be trying to fund tech startups that are likely to sell equity at all. Even in those cases, Upstart is not an alternative to those types of funding - they are personal $$ that allows somebody the freedom to take on a riskier path. Early signs are the dollars are used to retire student debt or just provide living expenses for somebody - not typical uses of VC or angel funding.

    Income-based lending is far from exploitive - it actually shares risk between borrower and lender, which is a feature, not a bug. For upstarts, the only other source of $$ typically available (other than asset-based loans) is credit cards. Is there any source of personal capital that doesn't come with the risk that you spend it all up front, and retain the repayment obligation over time? (BTW, donations are wonderful - I"m all for them).

    I'd be happy to debate the merits of Upstart funding versus student loans - a much longer story. But in short, we have the advantage of "affordability by definition" - and the ability to have higher variability in personal income without going into default. Lack of affordability of student loans drives defaut rates up by 50% (not surprising).

    I appreciate that income-based lending is new, but it's disappointing to see you jump to such dire conclusions so quickly. Better access to capital on fair terms is inherently a good thing. It doesn't mean bad things can't happen, and that the borrower isn't taking on a serious obligation, but we're working hard to make Upstart a valuable and useful choice for people who want to pursue non-traditional careers.

  5. Hi Dave,

    First of all, I hope I was clear in the last paragraph of my post that I certainly wasn't accusing you of starting a company to exploit anybody. My post is simply critical of the Upstart model, not the people behind Upstart.

    You are quoted in several articles, including in Wired ( saying that you started Upstart because "I’d see that someone would have an idea for a startup or a research project that they were really excited about, but they were going to accept a job with a large company instead". Furthermore in your comment to my post above, you say directly that you are giving people "the freedom to take on a riskier path".

    It is precisely this point that my post is objecting to. You are giving students the opportunity to take on risk that they cannot properly evaluate and in many cases this risk is not in their best interest to be taking. Furthermore, I do not like a model where the risk is not shared in the same way between the investor and investee (as I explained in my post).

    If you'd like to discuss this more in person, I'd be happy to elaborate more about my concerns in a less public forum.

  6. Alexander,

    In fact, each year that a user's startup flounders, that user will make less than $30K, so their contract will be extended a year. Upstart investors don't need students' startups to fail particularly quickly at all. As long as it takes less than five years and the student doesn't report $30K any of those years, they'll get to milk the student's industry salary for a full decade.

    If anything, the longer that users defer payments the better for investors, since users may gain valuable experience during that time that will boost their salaries later. Furthermore, I assume that the total 15% interest continues to accrue during this time. This way, when the user finally commands a large industry salary and starts "sharing" it with investors, the payment cap will also be higher.

    It does appear to be the case that investors should profit more by (eventually) failed startups than successful ones. If a startup is successful, it will likely provide the user some income (maybe even just over 30K, the worst case scenario for investors) for a few years before becoming lucrative. If the startup is acquired and the user gets rich, they will likely buy out their contract, stopping additional annual returns from accruing. At the very least, after the big payoff their subsequent motivation to choose jobs with high salaries is significantly reduced.

  7. "Upstart: The Startup is YOU."

    That bothered me from when I first read it, but it took me a while to put my finger on why:

    The fundamental reason to create a COMPANY when pursuing a commercial endeavor (as opposed to selling a good or service as an individual) is that incorporation LIMITS personal liability should the endeavor meet with misfortune. This is basic sound business practice, established over centuries.

    Yet Upstart depends on users explicitly accepting personal liability for the debt incurred creating their startups. I can't help interpreting that tagline as "We view you, personally, as a corporation that owes us money."

    Now, I don't see anything inherently wrong with Upstart entering into this arrangement with consenting, informed adults. Particularly since payments are capped and very reasonably scale with income. In fact, the world would undoubtedly be a better place if businesspeople everywhere developed the habit of taking personal responsibility for the consequences of their actions.

    But Upstart's rhetoric in this area seems deeply deceptive, whether intentionally or not, for two reasons:

    First, the tagline CONFLATES the company and the person. This can be psychologically appealing to a college student who feels that financiers care about their ideas. It's certainly more flattering than "You've been pre-approved for this loan." But prospective mentors should really be reminding their charges that people normally go out of their way to legally SEPARATE the person from the company!

    Second, it bothers me that "loan payments pegged to personal income" is referred to as "income sharing." The verb "to share" evokes a strong image of voluntary cooperation towards a common goal. You SHARE a workspace with colleagues. You SHARE the use of your lawnmower with your neighbor. You SHARE an intimate experience with a lover. When someone wants to STOP sharing one of these things, forcing them to continue may constitute theft or rape. Upstart doesn't appear to be out to mess up anyone's life, but they're not exactly asking users please to "share" either: they're obligating them to make payments on a loan. Words have meanings.

    So particularly given that they're offering mentoring services to their users, Upstart's marketing material is frighteningly manipulative. Perhaps not false enough to the point of brazen dishonesty, but it certainly crosses my repulsiveness line. (That said, I tend to find any marketing material distasteful that doesn't go something like "Here are the technical specifications of our product." So maybe it's just me. I'd be interested to hear others' thoughts on this, Professor Abadi's in particular.)

    (Meanwhile, this is from's own terms of use: "LIMITATION OF LIABILITY --- You agree that all access and use of the Site and its contents is at your own risk. In no event shall we be held liable for any damages, including direct or indirect, special, incidental, or consequential damages, losses or expenses arising in connection with the Site or any linked site or use thereof or inability to use by any party, or in connection with any failure of performance, error, omission, interruption, defect, delay in operation or transmission, computer virus or line or system failure, even if we or our representatives are advised of the possibility of such damages, losses or expenses.")