The U.S. government’s monopoly on student loans may be one reason why startups innovating in the space haven’t seen a higher level of investment.

An estimated 45 million Americans hold educational debt, and many of them struggle to repay it in the face of high interest rates and opaque lending processes. Student loan debt has swelled to a whopping $1.5 trillion — eclipsing credit card debt and auto loans combined — in the face of rising college tuition. In the last 50 years, tuition has increased at four times the rate of inflation. 

The result is generations of workers whose career options and life decisions are being shaped by their indebtedness. The crisis has reached such magnitude that the New Yorker recently wrote, “Wide-scale student debt forgiveness no longer seems radical.”

Over two dozen startups have cropped up to address aspects of the crisis, but investors have been slow to direct funds to them. The ideas range from debt repayment strategies to alternative loans for nontraditional education. The startups include Sofi, which has a $4.3 billion valuation and refinances student loans; Goodly and FutureFuel, which make it easier for companies to offer student loan repayment as an employee benefit; and Chipper, an app that helps borrowers formulate strategies for paying off student loans.

Investments have fluctuated over time. While private market investors poured over $1.1 billion in capital into startups tackling student debt in 2015, last year’s figure was less than $162 million, according to Pitchbook data. In 2019, the firms have raised an estimated $700 million. Fourteen deals have occurred in the space this year, more than last year’s total of 13, and the entrepreneurs involved say they see plenty of room for growth.

“Ed tech has been a tough space for a long time. Investors and entrepreneurs face a lot of resistance from regulators, schools and parents,” Sayshu Medicherla, principal at Third Prime Capital, an early-stage venture firm in New York City, told Karma. “There is a lot of regulatory focus, and investors get spooked by that.”

Even with the regulatory focus, significant players have invested in the arena, including Goldman Sachs. The investment banking company participated in a $9.8 million investment round for Climb Credit in June, which Third Prime led with New Markets Venture Partners. Climb Credit offers loans to people in certificate programs and online courses not traditionally eligible for student loans. In April, Goldman Sachs also invested $100 million in MPOWER, a startup that helps provide loans to international and undocumented students ineligible for traditional funds.

Yet investment levels are nowhere near those seen by fintechs operating in other spaces, including mortgage and insurance.

Slow evolution

Many of the startups in the student lending space are focused on refinancing loans or creating transparency to help borrowers make smarter decisions about how to repay them. Steven Muszynski, founder and CEO of Splash Financial, which partners with banks and credit unions to offer student loan refinancing, said the institutions traditionally involved in student lending haven’t paid much attention to developing the asset class.

“This space has been slower to evolve. Alternative lenders and fintech players are coming into the space, and most of the companies are really aiming to help,” Muszynski told Karma. “I think we’re all out to serve a mission.”

The company raised $4.3 million in a Series A round led by CUNA Mutual Group and Northwestern Mutual Future Ventures in June. “We have tremendous growth, and our investors definitely recognize the opportunity,” Muszynski said.

Like Splash, nearly all of the deals happening in the space are venture-backed. The reason why private equity has been more hesitant to step into the market may have to do with the presence of the federal government in student lending. 

The U.S. Department of Education is not just the major lender and manager of student loans — accounting for 92% percent of outstanding student loans  — but it also has a strong regulatory hand in overseeing the companies operating in the space.

Still, Muszynski said that investors should note student loans have a higher debt return than the more mature and active mortgage market, where many fintech companies have set their sights. There may be less activity in edtech, but he believes the opportunity — both from a returns and from a social impact perspective — is significant. 

“We believe student loans are holding people back from accomplishing what they want to do,” he said. “By helping them get out of debt faster, we’re impacting the world by freeing them up.”

Limited Scope

One of the startups Third Prime backs is Piecewise, which makes student debt easier for borrowers to understand and pay off. One of the challenges for startups and their investors is that they can only alleviate certain pieces of the student debt problem, Medicherla says. “There’s a lot of scope for companies to come in after the fact, but the real problem is just the cost of education.”

He sees a big opportunity in alternatives to the four-year degree, with startups such as Climb Credit. 

“The cost of a four-year education is going up and there is a real labor shortage of highly skilled laborers. Our view is that there is a real structural tail wind here,” he said. “The future of work is changing, and one of the areas with a glaring need for funding is non-traditional education.”

Jason Palmer, general partner at New Markets Venture Partners, a venture capital firm focused on the education sector, says that the opportunities in student lending for nontraditional programs should not be underestimated. 

“Because the federal government now handles 90%, all the innovation has gone to the fringes of the higher education or post secondary market,” Palmer told Karma. “It’s doubled in the last two years and some market watchers think it’s growing at 30% to 50% annually, and we don’t see any slowdown in that.”

Investment is starting to grow, but the market remains small relative to other opportunities in fintech, Palmer noted.

“If you’re purely a financial investor, there are other markets that are bigger and more liquid, such as the housing market and the auto loan market,” Palmer said. “Student loans is a big amount, but if you [take out what’s held] by the government, it makes it much smaller.”

U.K. Innovations

It’s not just the U.S. that is seeing investment and innovation around student loans. 

In the U.K., Future Finance was founded to fill a funding gap for students who have capped out on government loans and still need more to cover tuition and expenses. The startup that launched five years ago has provided £100 million in loans to over 15,000 students, and completed a Series D funding round in July worth €23 million.

“With student costs continuing to rise year-on-year, we expect the number of companies and platforms with a focus on students and recent graduates to continue to grow,” CEO Olga Dolchenko told Karma, noting that fintech in general has seen rapid growth in the U.K. 

According to a recent report by the British government, there are 1,600 fintech companies operating there, a number that is set to double by 2030.

“This is a thriving sector, albeit one that is still underserved by specialist lenders. The private student loan market therefore holds huge potential,” Dolchenko said.