ISA Investment 101: How Does Active ISA Investment Compare to Angel/VC Investment?
There are some parallels between active ISA investing and angel investing. The fund and support approach that MentorWorks promotes is consistent with the angel or VC investing framework. That is, you fund a well-run startup and then you provide expert advice and guidance as well as connections to help the startup do well. The investor then shares in the part of the upside generated from this support.
MentorWorks’ career augmented ISA program works along the same dimension. We fund students with promise and help them to do well through career advice and networking with employers. The ISA investor then shares in the upside this support generates.
However, there are some very clear economic differences between angel investing and ISA investing. Beyond the obvious fact that you are investing in a very different asset class, the ISA investment is more liquid, in the sense, the investor starts seeing returns on a continuous basis as the student makes ISA payments back to the fund. Continuous support to students can increase this return significantly. On the other hand, angel investment provides return typically at the time of exit. This can be highly uncertain and can take a long time, in the horizon of 5 to 10 years.
Another key difference is in terms of diligence. The diligence process is to clearly assess the outcomes that will be provided by the school for its students. Naturally, outcomes of prior student cohorts at a school provide a pretty good starting point for such diligence. On the other hand, angel diligence needs a lot more “faith” and subjective decision points - Can the business replicate its small scale success on a larger scale? Does the IP create value? Is the market large enough? Can the team create effective strategy and execute?
In some ways, we care about a lot of these questions in ISA investing as well. Except, a lot of this information is embedded in prior outcomes information. The diligence does not stop there, because we need to know the growth trajectory and plans of the school, and how well they can deploy ISA capital. On average, though, these facts reflect higher predictability of ISA investment returns.
Many angel deals are done through convertible notes ostensibly because valuation can be difficult. In other cases, investment groups have specific valuation ranges that they invest in and select companies that are consistent with valuations. These valuations and convertible note caps are, however, relatively subjective and built upon some kind of pro-forma financial projections, which themselves are built upon assumptions.
ISA pricing is also based on assumptions about the program and student outcomes. However, these assumptions are based on information that already exists about student outcomes of recently graduated cohorts. This provides a lot more practical grounding for assumptions to be made. To be sure, there may be cases where schools do not have a documented history of prior cohorts, and in such cases, we are closer to assumptions made in the angel case.
Given that the ISA asset class is still in its early stages, PE and angel investors require higher rates of returns than loans. ISAs have lower liquidity and outcome risk (so long as data on prior student cohorts is available), but elevated regulatory risk. Thus, targeted returns can be attractive for many investors seeking returns.
To be sure, there are limitations of ISAs. The upside is capped on ISAs, unlike the returns for angel investments. However, given the lower liquidity and outcome risk compared to angel investment, the lower return seems reasonable (which we understand is a relative term!).
Scalability of the active model is another question that comes up. How can you provide active support to thousands of students whereas such support is much easier when talking about the 30 or 40 investments made by an angel or VC. Our approach to this is to utilize school alumni and graduated students as mentors in our network, as well as bringing in employers and providing them unrestricted access to talent in our programs. A key effect of our approach unlike loans is that ISA payments are no longer a zero sum game. The students benefit from increases in income from our active program, and part of that is shared with ISA investors.
Technology plays a key role in our active approach. Students, mentors, and employers use our technology platform to connect with each other, creating a social ecosystem that students can leverage. Many of our schools have utilized this technology to provide alumni based mentor networking program that allows them to connect alumni with students as well as provide students with active network to access.
Room in your portfolio?
When considering an investment in an angel asset class, a key consideration an investor needs to make is how much of their investment portfolio do they want to invest in this asset class. Same holds true for ISAs. In a sense, ISA create a more complete market for investment, and provide a diversification opportunity that was not available before. This investment class is more liquid than angel investments, and (at least currently), can provide expected returns likely on the lower end of angel investment returns.
There is also the impact aspect. Investors having an affinity toward education, economic mobility, and education to career transition can receive non-monetary value from this model. The MW active model, in particular, can appeal to impact oriented as well as financial investors.