An angel when a parent's wallet isn't around

Without venture backing and unwilling to ask her family for help, she used money from her day job as a music composer and singer to pay people to create the app, a process she found frustrating.

Then, last summer, after introducing the app in early 2012, she realized she needed to rewrite all the code herself. The only problem was she didn't know how to do it or have the money to learn.

That was when she stumbled upon a new site called Upstart that pairs investors and people who finished college or graduate school after 2008. The Upstarts, as they are called, are looking for relatively small amounts of money, about $25,000 on average, to finance their idea or even pay off debt.

Kumar Friesen, whose father is an inventor, wanted to raise $70,000 through Upstart to learn to write code, pay legal bills from an offer she ultimately turned down and push through her patent application.

Last week, I wrote about how parents should think about lending to their children. But for many young adults, parents are not a source of financing. This is where a site like Upstart comes in.

The investors, or backers as they are called, receive a percentage of the young person's income for 10 years, regardless of whether the idea they backed is successful. If the person is paid less than $30,000 a year, the period extends for a year to a maximum of 15 years. If the person tries to avoid repaying the investment - as opposed to earning too little money - that investment converts into a loan with a staggering annual interest rate of 15 percent.

Dave Girouard, founder and chief executive of Upstart, said that to ensure borrowers do not regret the deal, the amount a person could borrow is limited to 7 percent of future earnings and the payback is capped at five times the loan amount. That limits the upside on the few people who succeed financially.

"People might be paying more than they would on their fixed-rate loan," Girouard said. But, he added, the people who have gotten financing so far were comfortable with the possibility of paying back a higher amount than on a loan because it would mean their idea had succeeded.

What I wanted to know was: What did investors want to get out of this and how did they select young people who would agree to give them a percentage of their income for a decade?

Backers on Upstart have to be accredited investors, which means having an annual income greater than $200,000 or a net worth above $1 million. They can invest any amount they want, though their offer has to be accepted. They can also sign on to be a mentor.

For connecting borrowers and lenders, Upstart takes 3 percent of the money young people raise, and 0.5 percent annually of the amount a backer has invested. Girouard said the company is close to signing an agreement with a student loan processor to act as a backup if Upstart goes out of business and can no longer collect payments owed investors.

David Croson, a professor of entrepreneurship at the Cox School of Business at Southern Methodist University, said he had invested between $100 and $10,000 in about two-dozen young entrepreneurs over the last month through Upstart. He did so after talking to his wife, also a business professor, about how hard it was for young entrepreneurs to get started.

"We were discussing the problem of people who had been relieved of all of their money by educational institutions," he said. "That doesn't matter much for people going into traditional professions, but it does for an entrepreneur who has a negative $100,000 net worth."

He said he does not have high expectations for a return - about in line with his bond portfolio - but he was hoping there would be the additional upside of one or two people succeeding wildly. "It's almost like being on the board of directors of these companies," he said. "All it takes is for one of these people to succeed for it to work out."

(Girouard said he projected about an 8 percent annual return after fees.)

Still, as someone who has studied entrepreneurship, Croson said there were flaws in the model. For one, the young people who have the time to go through the vetting process are not the ones who are working around the clock on their idea.

Croson's research has also looked into the optimal time to quit your job to start a company, and he said that most of the people on the site were probably quitting too soon. But he was heartened that Upstart takes a percentage of a person's income for a decade, which made it more appealing than some peer-to-peer lending sites.

"It's not something that allows people to default and walk away," he said. "They can't say I failed once and let me start again. Most of the people I picked are people who are going to have second and third ideas."

Susan Tenney, a former software engineer turned nurse practitioner and baker in San Francisco, said she backed 20 people with $500 each, simply because she wanted to help young people. She liked the prospect of receiving a good return for doing it but considered it fairly high-risk.

"I am interested in talking to people who were interested in being socially responsible entrepreneurs," she said. "I invested a modest amount so that if I lost it completely, which I recognize could happen, it would not be a severe financial blow."

Her one complaint was how long a financing round was open - generally 60 days. If the young person did not accept the offer or raise enough to close on the financing, there was an opportunity cost to committing money that could have gone to someone else.

As for what the borrowers are using the money for, there is a range from the practical to the speculative.

Josh Eddy, who graduates this spring from UCLA with degrees from the business and law schools, said he went on Upstart for money so he could study for the bar exam before starting his job at a law firm in the fall. He had tried to go the traditional route of taking out a so-called bar loan but was turned down because he already owed about $250,000 in student loan debt and had no parents to co-sign the loan.

"I'm somebody who came from an at-risk background," Eddy said. "But I graduated from high school, college, started my own business and went back to graduate school. I'm proud of that, but student lenders don't give any credence to your history beyond your credit history."

He said his funding period has not closed, but so far he has raised $13,000, which was what he needed and worked out to less than 1 percent of his income. "A lot of people look at giving away a percentage of your income, but I look at what I'll be giving away with my student debt," he said.

At the other end is someone like Cynthia Salim, who quit her job as a consultant at McKinsey & Co. to start a clothing company that would make business attire for young women with an eye toward ensuring the manufacturing process was ethical.

"We're challenging the idea that being wildly profitable and being ethical are mutually exclusive," Salim said of her company, C Suite Apparel.

As for Kumar Friesen, who was in the first class of people to receive financing, she said that the process was already paying off. She learned how to code, relaunched a new version of her Emotitones app this week and paid off her earlier debt. Even the prospect of paying 6.89 percent of her annual income for 10 years - up to $350,000 on a $70,000 investment - did not dampen her optimism.

"It's happy days if that's what I'm concerned about," she said. "Because there's no equity in the business, the only person being affected would be me."

And that's what the investment is about, on what might be possible. "We're providing access to capital to consumers that's based not on the income today or their assets today," Girouard said, "but on their future."

© 2013, The New York Times News Service