ISAs and Power Laws

There are a number of professions where incomes are distributed according to a power law. The most successful people in the professions corner a very large share of the income that people in the profession make, and unless you reach that very high level of success, you might even struggle to make a living wage.

Professions of this nature include the arts (movies, music, drama, standup comedy, painting, sculpture, etc.), sports, writing and entrepreneurship. The thing with such professions is that it needs some degree of “socialism” – if people are left to their own devices, then the 99% confidence payoffs will mean that few people will enter the profession, and when fewer people enter the profession, the overall quality of the profession goes down.

So what is required in this case is some sort of a safety net – people who are reasonably competent at the profession get paid a sort of regular basic income (could either be one-time, periodic or output-based) by “investors” in exchange for a cut of the upside. And this, for a talented but struggling beginner, is usually a good deal – they are assured a basic income to pursue what they love and think they are good at, and anything they have to pay in return is only probabilistic – contingent upon a heavy degree of success.

And in order for this kind of safety net to work, it is important that the investment be of the nature of “equity” rather than “debt” – the extreme power law nature of these professions is that only a small proportion of the people who get the safety net will be able to pay back, and those that are able to pay back will be able to pay disproportionately large amounts.

Entrepreneurship and film acting have sort of done well in terms of providing these safety net. Entrepreneurs get venture capital investment, which allows them to fund their business and take (nominal) salaries, while working on the thing they hope to make it big in. The venture capitalists make money even when a small proportion of their investments don’t fail.

The model in acting is a little different- studios hire actors on long term contracts at negotiated salaries. These salaries give actors the safety net to continue in the profession. And in case the actors become popular, the studios cash out essentially by “encashing the option” of using the actor at the pre-negotiated rate for the duration of the contract.

There are other examples of these safety nets as well – artist studios pay their artists a basic wage, in exchange for a cut on the sale of their paintings. However, the model is not as popular as it seems.

For sportspersons, for example, apart from things like the Ranji Trophy increasing match fees in a big way in the late noughties, this kind of a safety net has been absent. The studio model in acting hasn’t held on. Writers get advances but that doesn’t represent much of a “living wage”.

The good news is that this is changing. Investment in athletes in exchange for a cut of future earnings is gaining traction. And now we have this deal ($):

Taxes will cut into his new 14-year agreement with the Padres, of course. But Tatis also must pay off a previous obligation, a deal he made during the 2017-18 offseason, when he was turning 19 years old and preparing for his first full season at Double A.

It was then that Tatis entered into a contract with Big League Advance (BLA), a company that offers select minor leaguers upfront payments in exchange for a percentage of their future earnings in Major League Baseball. Neither Tatis nor BLA has revealed the exact percentage he owes the company.

The company’s president and CEO, former major-league pitcher Michael Schwimer, told The Athletic in April 2018 that BLA uses a proprietary algorithm to value every player in the minors. Players who receive offers can accept a base-level payout in return for 1 percent of their earnings, with the chance to receive greater incremental payouts and pay back a maximum of 10 percent. If a player never reaches the majors, he keeps the cash advance, with no obligation to pay it back.

This is an awesome thing. For a struggling potential sportsperson, a minor investment (in exchange for equity) can provide a huge boost in their chances of making it – hiring coaches, for example, or eating better food, or living more comfortably.

While the media attention will go to the small proportion of investments that do pay off (like how tech media gives disproportionate coverage, and quite rightly so, to startups that do well), arrangements like this mean that more people will play the sport, and the overall standard in the sport will improve.

We need to see if such arrangements start making a mark in the rest of the arts and writing as well.

Oh, and much has been made of income sharing agreements for professional colleges and “tuition centres”. I’m not sure that is the right model there – the thing is that if you are studying to be a software engineer, your payoffs don’t follow a power law. Yes, if you are successful, you make a few orders of magnitude more money than the less successful ones, but even an average software engineer can expect to make a fairly decent income.

From that perspective, selling equity in your future earnings to get paid to study engineering is not a great idea, and can lead to adverse selection on the part of the candidates (the better ones will prefer to get funding through debt, which their average salaries can help pay off). In that sense I prefer what the likes of MountBlue are doing, where the “training fees” get paid off by simply working for the company for a certain period of time.