The History of Charter School Capital
Janet Johnson (JJ): Good morning. Here we are with another CHARTER EDtalk. Thank you for joining us. This is a very special one. We’re going to be talking to our CEO, Stuart Ellis, about the history of Charter School Capital. The folks who are curious might want to understand the impetus behind where you were when you started it, and how you came up with this idea. It is a very unusual market for someone who’s entrepreneurial to jump into.
Stuart Ellis: Thanks, Janet. First off, I didn’t come up with it. I guess you should back up to why we started the company in the first place, and what we’re really trying to do. Like most things in life – however you figure it’s going to go – it never actually goes quite that way. Usually, it comes out better than you would imagine, but always totally different than you would ever plan.
It’s now 12 years ago, or something like that. I was traveling very heavily for advisory work I was doing for most of the major banks in the US and in Europe. I was on the road more than 250 days a year and thought it’d be really nice to see my family once in a while. I was looking for a way to create a role, job, business for myself that could support new lifestyle objectives as I approached 40—and do things that would also have a significant positive social impact. So, I created criteria for the business I wanted to either build or buy … or something.
The Challenge Charter Schools Faced
I started getting ideas from colleagues and close friends. One of the ideas that came amongst the dozen that I was looking at, was regarding charter schools and their need for money, funding, capital, particularly for growth—which most charter schools as I understood at the time couldn’t really get.
I didn’t even know what a charter school was at the time or understand what the issue was. The idea that was presented by one of my co-founders was that charter schools were coming to him to get donations, but he couldn’t generate enough donations for them. But he was in that space, and they had a need to get financing for growth.
The schools had a lot of waiting lists and they couldn’t fund any of it because of the way the state funding process worked in California, initially. He had thrown that out to me, and at the time, I didn’t even know what a charter school was, so I looked into it.
After talking to a few leaders in this space, I realized that there was this opportunity to serve students and families significantly better with an education that was more customized—where the individual child meets them where they are as opposed to the other way around. School districts have funds and government agencies are trying to do the best they can with teachers who are doing the best they can, but with a structure that is really constrained.
Charter schools had this opportunity to do things that were innovative in the context of how much money they got, but they couldn’t get the normal investment capital that any small organization, non-profit or for-profit, needs to grow and expand. They had families and students that wanted to attend, but they couldn’t get everybody in. They would grow by 20 kids a year. They could have one teacher, but they might have two or 300 in a list. We started looking into it, and actually, initially, I didn’t really get what the opportunity was.
Making Financing Affordable for Charter Schools
The idea proposed was that we could charge less than what the banks were charging, and I was looking back saying “How do we do that? Our capital will cost even more,” because there will be the charter school risk plus the risk of our company. It’ll cost us even more and we’ll never get funding to the schools cheaper.
I went out and I was looking at other opportunities, and I kept coming back to it because I couldn’t actually understand what or how a charter school was structured. As I learned about it and realized it was all government money (state, local, federal money), I realized that the flow of funds to the schools was coming from a really low-risk source, even though people in the industry – or in the capital/financial markets – view charter schools as very high-risk organizations because they were break-even institutions, non-profit running with little or no margin of any kind, run by educators and concerned parents. It’s just not the kind of thing that institutions wanted to finance or lend money to.
Solving the Problem
If we could find a way to allow investors, capital markets, financial institutions fund the state risk (the state payment obligations which were really low-risk, usually AA credits or better) instead of taking charter school risk, money could flow into the charter school space really readily at very low cost, relative to what the schools could get.
Most schools couldn’t even get it, it turned out. We knew that if we could find a way to have funds just flow into the individual schools, we could fund the waiting list, fund the growth and let them really serve the mission so much better than they already were, which is to educate more kids with higher quality education and keep spreading that.
We got into it. Nobody had ever done anything like this, and as we went into it, we talked to probably a dozen different law firms that all said somewhere between it’s impossible, that doesn’t work, it’s illegal, all of which it turned out were wrong. Eventually, we found a law firm, the biggest education bond council in California, an organization called Orrick, Herrington & Sutcliffe, that helped us create this tool.
They actually believed in it, and they believed in me, in our team, in what we created, and the idea we had. They started working on it. In fact, they did really on their own nickel for a while as we built it together. It took two years for us to actually come up with the solution that allowed funds to flow, and that ended up being this receivables purchase model which we developed, which although an idea tried in many other industries, had never occurred here at all.
What they realized and we realized was that if we could do this, we could get all this money flowing into individual charter schools to allow them to serve more and more students, and more and more kids, and fund more and more teachers. These institutions could really survive and thrive doing what they could do better than what the other public-school options were doing.
Breaking new ground
It took two years before we funded our first school in December of 2007, but it unlocked this potential to have funds and financing flow. I mentioned that I didn’t have the original idea or even come up completely with this solution. The motivation for it was that guy who founded the ninth charter school in California, I think it was the ninth, Randy Gaschler, who had seven or nine schools by the time we were talking. He sat with us early and he said “Stuart, don’t solve the problem for the 5% of charter schools that actually have access to capital, that are flexible, that are already big, and scaled, and all that. Don’t solve it for them. Actually, solve the problem for the other 95% that don’t have money.”
What our model did was it allowed us to separate counter-party risks for investors, so they wouldn’t be looking at each individual charter school—which they would never fund, either because the credit risk or because they were so small. It’s too much work. But, to fund a pool where the core investors didn’t really even need to worry about the individual charter schools. By virtue of our structure in this receivables purchase model, we were able to do things that had never been done with government receivables before, had never applied in the education space.
These were models that had worked in other industries but before us, couldn’t be applied here. We had seven different legal disciplines come together to develop it initially. We were able to address Randy’s issue which is solve it for the other 95%.
Surviving the 2007 Recession
As we did that, we had no idea that when we launched, that the credit markets were going to crash around the world. In 2007, for those of you who’ve seen the movie The Big Short, really in late summer, early fall, all the financial institutions of the country were on the rocks, and we had already raised our initial money. Then, the bank that we were funding with actually closed its doors. It was a major bank. Barclays Capital closed the division that was funding us.
We literally went from having 100 million dollars to having nothing overnight and having to start all over with a two-million-dollar angel investor and we pieced things together. I think we got that money from a guy I met on an airplane. A stranger gave me a phone number that I called. It was really just this completely upside-down time.
Everything went wrong, but here we were with this model around growth where we could acquire the state payment obligations and fund (initially California Charter Schools) right at a time when all the capital markets around the world were crashing, and there was no credit flowing, and nobody was funding anything. Certainly, they were not funding charter schools, which they weren’t really funding before either, but now all the money was pulled out, and we were sitting there and we didn’t have any money either—at the beginning.
Rapid Growth for Charter School Capital Means Schools Finally Get the Support They Need
By the end of 2008, less than a year later, we got a New York finance organization (or hedge fund) to actually give us some money and some initial capital. Then it was 40 million, and then it grew.
Literally, in our first two years, we were the only ones who were willing to fund charters. We were attracting all this capital while deferrals began in California. We ended up funding some 200 charter schools. 30 or 40% – including the 5% that Randy talked about – like Green Dot and other major institutions, charter institutions, leading organizations. They couldn’t get money to even make normal payroll payments.
Our tool which was created fundamentally to support growth is a tool that we’ve now rolled out across the country – which now costs one-third of what we were being charged when we started – despite the fact that nobody believed in anything we were doing.
First, California Charter Schools
According to Caprice Young, who was then CEO of the California Charter Schools Association, and others in the industry, it ended up that we had funded over 100 million dollars by our third year in 2010. I think that year we funded 130 schools primarily in California, who literally would’ve closed their doors when the state started deferring money to public schools. It really launched what we were doing and introduced us to the industry in a very different way, completely backward from what we anticipated. The tool we developed for something else, ended up solving this other problem also. Mostly what we’ve done is fund growth organizations.
Then Minnesota Charter Schools
In 2009, after we had launched in California, the state of Minnesota – where charter law was originally created more than 25 years ago now – started expanding what they called a holdback.
This is basically another deferral form as a result of the recession—or what I refer to as The Great Euphemism, because recession has all the numbers that are as bad or worse than The Great Depression, but we get to call it the great recession as though it wasn’t that bad.
Minnesota started delaying payments to public schools, which was also going to kill charter schools. We were called by a leader in the charter school movement in Minnesota in September of 2009. Late that fall, we were introduced to John Cairns, the attorney who wrote the original charter law in Minnesota, who had relationships with all the schools there.
We went to some meeting (I think it was late September) where 80% of the charter schools, over 100 charter schools in the state of Minnesota were all in a room to meet with us. We were like “Hi.” They don’t know what we are, and there are people there from all sides of the movement who don’t trust us or believe anything we’re saying, and nobody will fund them, and they don’t know what’s really coming, and the holdback increased that year.
One of the leaders in that space in Minnesota, a woman named Lisa Irwin, was really aggressive about trying to get us to come to the state. Lisa’s like “I think what you’re doing in California, will solve the problem in Minnesota.” She had projected that 30% of the charter schools in Minnesota would be closed by spring – or even by the first of the year – they would run out of money. But nobody believed that.
This was a little bit like Noah saying “It’s going to rain. I’m building this big boat. You guys should all get ready for the rain.” People are like “Whatever dude.” Lisa’s like “We’re all running out of money, and we’re going to close.” She says, “If you guys don’t get here, I don’t see anybody else who could solve it.”
We were this tiny little company in Portland, Oregon, and at the time, just looking to do it in a second state. She introduced us to John Cairns and we start trying to figure out how to accomplish the same things we did in California in Minnesota. Every state is different, so we had to figure out what the laws were in Minnesota, and how these laws worked … and then we applied our model.
We funded our first school there in December of 2009. By December of 2010, less than one year after we launched, we were funding 22% of the charter schools in the state of Minnesota. We funded most of the schools throughout the entire deferral period. It was a very mature market, so not a lot of charter schools were growing rapidly so they didn’t need a lot of growth capital, but they all needed this.
I think in year one, the holdback moved from 10% of your money being delayed until the following summer, to 17% and then to 27%. By year three, I think that the state of Minnesota actually was deferring 40% of the schools in-month money to the summer.
So, for example, if your October payment was going to be $100,000 a month, by the third year in, the state was providing only $60,000, and then for the other $40,000 they’d say “We’ll gladly pay you Tuesday for teaching hamburger today,” but they actually delayed it until August, September, and even October. You get a third of the money (or something like that) nearly a full year later. Nobody could live like that, let alone non-profit organizations running at breakeven.
About Receivables Purchases
We were able to take with our model and move all that money back. When we fund for growth too, whatever your student count is, we move the payment forward, so you get it when you’re paying the expenses. You’re just moving the funds around. Unlike a loan, (by virtue of the fact that we’re acquiring the state payment obligations) the school – in addition to getting a very low discount rate on an asset sale instead of a loan – without going into details of the structure which are mind-boggling boring, fundamentally it’s like selling a desk. You’re just selling the payment instead.
If the payment actually comes late, there’s no extra cost to the school. Charter school capital is essentially eating all that timing delay, or the risk that the payment doesn’t even get made. Or if the state says, “I’m not paying schools or anything,” which they did in Chicago recently, and actually in California there were issues, and especially during the recession, a lot of that was going on. The schools eliminated all that risk. They have the cash, and we wait for the payment.
It solved problems in Minnesota, in California for deferrals, but eventually, things normalized when we got back to growth.
Where We Are Today
Today, we funded – for this little idea that Randy Gaschler had of serving the other 95% – we’ve ended up funding some of the biggest organizations when they run into a short-term crisis, or other organizations that have innovative models but can’t get the funds for it. Now they can really grow like a weed.
To date, we’ve funded over 600 charter schools across the country and we’re in 12 states and expanding. We have a national footprint and now also support charter schools with long-term facilities financing as well. We started that a little over three years ago, and we’ve invested over 350 million in that.
We’ve invested more than 1.6 billion dollars now in the over 600 charter schools we’ve funded, and we’ve served more than 800,000 kids, which is nothing really like what we had anticipated.
How it Works
It was the attorneys who just believed in the possibility and were willing to work two years for this. We didn’t have any money or really anything to get it going. It was my co-founder who heard of the original need, saying “There has got to be some way we can solve this problem.” It was my other co-founder, Brad Coburn, who was probably the most sophisticated structured- finance guy in the country.
He would be embarrassed to hear me say that, which is probably why I say it. We used the same securitization engine to access the capital markets for charter schools that he utilized at the height of the mortgage market, which allows investors to fund mortgages without needing actually to know the underlying details in each individual mortgage or underwrite to each thing.
It’s about a diversified pool which we provide to investors. As a result, really what we’ve done is taken charter schools (charter school risk) and packaged them up in a little light blue box with the white ribbon. It’s the same thing, but by presenting it as a group, in a pool, the schools now don’t have to worry about how to get financing.
You just come to Charter School Capital, and we’re like “Yes, here’s your money,” because we have hundreds of millions of committed capital funds always available – always liquid – that we have reserved for schools. And it’s sitting and waiting for you whenever you need it or want it.
We go to the capital markets or the banks that are funding us, and just draw down on a line of credit that’s sitting reserved for the schools, that isn’t being paid for by the schools unless and until they tap into it, like a line of credit. Once the school has sold the payment through receivable to us, they don’t have any more risk around it. They just have the dollars. The discount on that is so small, relative to: the value the schools create for each child they serve, or each student; the additional benefits of scale that the schools get; or solving some near-term crisis. Without this option, in order for them to stay afloat, they would potentially have to lay off.
Imagine Minnesota, “Hey, we’ll just lay off 40% of our teachers and limp through the year so we can survive.” You’re going to have 50 kids, 50 students per teacher. That doesn’t work. Whether it’s a short-term crisis like that, they have to deal with bridging something, or the growth where you then get scale benefits. It far outstrips the cost of any of the financing we’re doing. As more and more schools come on board, as it gets bigger and bigger, our cost of capital that we pass through to the schools keeps dropping, and it keeps coming down.
We’re now at two-thirds lower cost than we were when we started 10 years ago.
True Story: A Literary Work of Art
The original documents that we created, the receivables purchase agreement – as we understand it from attorneys, we’re the only company of our kind who’s actually gotten federal copyright protection for our form of legal agreement which allows all these funds to flow to charter schools as a literary work of art.
If you go to the federal copyright office, the US Copyright Office, you can see JK Rowling’s Harry Potter, a literary work of art, and right next to it Charter School Capital’s receivables purchase agreement. They’re both really stimulating reads. I’m not sure which really has created more value. One has certainly created a lot of joy, and the other has generated not nearly as much money as JK Rowling’s Harry Potter. Both have their purpose and sit there.
Funding Charter School Growth
I think a lot of what we’ve done, we’re doing for the first time. We get most of our ideas from the client-schools we serve. They have utilized our funds to really accomplish some amazing things. The pictures around our offices, the videos that we do, our now 60-person staff, the $1.6 billion that has now gone into charter schools, and we have zero investor losses in our history, which I think really is just amazing if you think about it.
We’ve had some issues that have come up with schools over time, where there have been collections issues or Charter School Capital has had to take any loss that has materialized. It’s so small that it has never affected any of the banks or financial institutions that have funded us. It doesn’t even come close to that.
As a result, we’ve been able to prove that charter schools are really safe, good risks for investors, which is why the cost capital has dropped so much, and why we’ve been able to attract funds that the schools can use however they want it. They can use it to support whatever their mission is, to grow, and expand, and provide the kind of quality education, higher quality education, more customized than the other public options that are available. Some charter schools provide even better education than the very best and most expensive private schools, innovatively utilizing the funds provided by the taxpayers to serve the public and each individual student and family.
By providing just this choice where you can switch from like “Hey, if this school district serves you great, great. Keep going there.” If you want something or need something different and a local charter school can serve you better, you now have the option of doing that.
The charter schools themselves can take on those extra students and provide the extra technology or invest in a program because the funds are now always available reliably, because it’s not about what the individual charter school looks like.
You just come in to us and say “Hey, here I am,” and so long as we check all the boxes that fit with what investors require, whether you’re the top 5% that have access, or you’re the other 95% of schools that most organizations wouldn’t touch with a 10 foot pole.
You’re all welcome here. People here are waiting, ready, and excited to fund your stability and/or growth in the future.
Since the company’s inception in 2006, Charter School Capital has been committed to the success of charter schools. We provide growth capital and facilities financing to charter schools nationwide. Our depth of experience working with charter school leaders and our knowledge of how to address charter school financial and operational needs have allowed us to provide over $1.6 billion in support of 600 charter schools that educate 800,000 students across the country. For more information on how we can support your charter school, contact us. We’d love to work with you!