peer2peer lending

China Ponzi Scheme: Police Crack Down on Shanghai Lender, Wealthroll

May 16, 2016
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The crackdown of newfangled finance firms that emerged from the ashes of the Ezubao ponzi scheme opened up a can of worms.

And the latest head to roll is of Xu Qin, owner of Shanghai-based wealth management firm, Wealthroll Asset Management Co. who confessed to the authorities that his company still owed 5.2 billion yuan ($797 million) to 12,800 investors. Qin and 34 other executives from the firm were arrested on May 13th.

Qin who started the firm in 2011 with an initial investment of 5 million yuan from friends and family allegedly misused investor money on homes, luxury cars and on buying high-end office spaces for the firm in Shanghai.

This emerges in the wake of the shakedown of Ezubao, the Chinese P2P lending site which duped 900,000 investors of $7.6 billion in February this year. Following which, the Chinese police were ordered to shut down illegal online lending sites and take swift action against suspects.

The Ministry of Public Security also launched an online platform in a quest to garner more information from the public and warned of P2P lender defaults in June, when payments will be due.

The country’s banking regulator, China Banking Regulatory Commission (CBRC) and insurance regulator had also alerted the risks associated with investing in these schemes and barred these lenders from raising funds and signaled that close to 1,000 such businesses accounting for 30 percent of the industry could go belly up.

The Ezubao scam that surfaced on February 3rd revealed that 266 executives of Chinese P2P companies had fled and gone into hiding in the last six months. Ratings agency Moody’s has said that 800 platforms have already failed or were recently facing liquidity issues.

P2P Insurance Startup Lemonade Hires Behavioral Economist, Dan Ariely

February 24, 2016
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Lemonade screenshot“If you tried to create a system to bring out the worst in humans, it would look a lot like today’s insurance. @Lemonade_Inc changes that!”

That was a tweet by Dan Ariely, professor of psychology and behavioral economics at Duke University known for his bestseller ‘Predictably Irrational.’ Ariely, a leading behavioral economist is the latest hire at Lemonade Inc, a P2P insurance personal insurance.

Ariely will serve as the startup’s chief behavioral officer where he will design systems using his research to mitigate risks and ensure to align the interests of both the insurers and the insured.

“Dishonesty is influenced a lot by our ability to justify it. If we are dealing with a party that we think is immoral itself than we [are immoral] and justify it. We think that everybody else cheats… it feels like a victimless crime,” TechCrunch quoted him saying.

Ariely’s research has found that people tend to be more honest while filling out forms if they sign at the top of the page. Lemonade’s approach to disrupting the insurance industry will definitely have such applications.

The startup secured a $13 million funding round from Sequoia Capital and Israeli investor Aleph in December last year and has since made many significant hires from leading insurance firms like AIG and has lined up the likes of Berkshire Hathaway’s National Indemnity and Lloyd’s of London as reinsurers.

Investing in the Industry: Break Out of Your Bubble

June 29, 2015
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This story appeared in deBanked’s May/June 2015 magazine issue. To receive copies in print, SUBSCRIBE FREE

debanked bubblesEven if you’re already working in alternative lending and know a lot about your particular area, the industry is growing by leaps and bounds and you might be feeling a little overwhelmed by the multitude of investment opportunities. Amid all the options, finding the right place to invest your money can feel as challenging as picking out the proverbial needle in a haystack.

“Most people don’t know everything that’s out there. There are huge opportunities,” says Peter Renton, an investor and analyst who founded Lend Academy LLC of Denver, Colorado, a popular resource for the online lending industry.

Indeed, there are a growing number of online alternative lending sites that theoretically allow a person to invest in all shapes and sizes of loans. There are sites like Lending Club and Prosper that allow smaller investors to tap into the burgeoning P2P market. There are also a plethora of platforms that cater only to wealthier, more sophisticated investors in a host of areas like small business, real estate, student loans and consumer loans.

Even though there is a surplus of options, prudent investing is not quite as simple as depositing ample funds in an account and clicking the “go” button. Before you get started, you need to carefully consider factors such as your own finances and risk tolerance. You should also have a good handle on the specifics about the online platform—how it works, its history and track record, the types of investments it offers, the platform’s management team, technology and your ability to diversify based on available investment opportunities.

One of the first things you’ll have to think about as a potential investor is whether you have the financial wherewithal to be considered accredited by the SEC. If the answer’s yes, you’ll have a lot more choices of online marketplaces to choose from as well as types of investments. Basically, to meet the SEC’s threshold, you’ll need to have earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expect to earn the same for the current year. Alternatively, you need to have a net worth over $1 million, either alone or together with a spouse (excluding the value of your home). (Check out the SEC’s website for more detailed info.)

accredit investor guideIf you don’t fit the definition of accredited investor, it’ll be more difficult for you to find out about all the investment possibilities that are on the market today. That’s because the platforms that cater to accredited investors aren’t allowed by SEC rules to solicit, so many online marketplaces are hesitant to say much of anything for fear their words will be misconstrued by regulators as an attempt to drum up new business. With limited exceptions, you won’t be able to get more than very basic information from and about these platforms’ unless you are accredited.

But smaller investors do have options. Two San Francisco-based online lending platforms, Lending Club and Prosper, cater to individual investors, and you can still make a pretty penny plunking down money with these venues. You’ll also find a wealth of information about investing with them by perusing their websites as well as by reading the blog posts of media-savvy financiers.

“Right now, Lending Club and Prosper provide a great entry point for people who want to get involved in investing in alternative lending,” says Renton of Lend Academy.

The caveat is that these platforms aren’t yet open to investors in every state, so if yours isn’t on the list you’re out of luck for now. However, with each marketplace you’ve got more than a 50 percent chance your state is on the approved list, so it’s worth digging deeper.

Lending Club is now open to investors in Arizona and Texas as of 6/29/15
Lending Club investor Map as of 6/29/15

Assuming you meet their respective suitability requirements, you can choose to invest on one platform or both. To be sure, they are alike in many ways. Both allow you to invest with as little as $25 and fund one loan, however they recommend you buy at least 100 loans to be properly diversified, which you can do for as little as $2,500. You can manually choose which loans to buy, or enter your investment criteria so loan picking is automated. You can also invest retirement money in an IRA through Lending Club or Prosper.

There’s no fee to get started investing on either platform. For Lending Club, investors pay a service fee equal to 1 percent of the amount of payments received within 15 days of the payment due date. Prosper charges investors 1% per year on the outstanding balance of the loan. As the loan gets smaller, the servicing fee, which is charged monthly, gets smaller too.

To invest in Lending Club, in most cases you’ll need either $70,000 in income and a net worth of at least $70,000, or a net worth of at least $250,000. There may be other financial suitability requirements that vary slightly depending on the state you live in. For Prosper, individual investors must be United States residents who are 18 years of age or older and have a valid Social Security number.

At any given time, Lending Club has more than 1,000 loans visible on the platform and new ones get added every day, according to Scott Sanborn, chief operating officer and chief marketing officer. Prosper, meanwhile, on average has more than 200 loans for people to invest in, says Ron Suber, president.

investing in tech-based lendingReturns tend to be favorable compared with other fixed income investments—a major reason investing in online loans is becoming more desirable. Of course, actual returns will depend on what loans you invest in and the level of risk you take—typically the more risk you take on, the greater your potential return will be. At Lending Club, for instance, Grade-A loans have an adjusted net annualized return of 4.89%, compared with 9.11% for Grade-E loans, according to the company’s website.

To encourage more people to start investing, some savvy investors have started to self-publish online the quarterly returns they accumulate through the Lending Club and Prosper platforms. Renton, of Lend Academy, reported a balance of $476,769 on Dec. 31, 2014 and a real-world return for the trailing 12 months of 11.11 percent. Another well-known P2P investor and blogger, Simon Cunningham—the founder of LendingMemo Media in Seattle—reported a 12-month trailing return of 12.0 percent over the same time period, with a published account value of $41,496. Both investors say they expect returns to drop back somewhat over time, however, as the online marketplaces continue to lower interest rates to attract more borrowers.

Of course, if you’re an accredited investor, you will have access to even more online marketplaces. For instance, there’s SoFi of San Francisco for student loans, Realty Mogul of Los Angeles for real estate loans and Upstart of Palo Alto, California, that focuses on loans to people with thin or no credit history. The list of possibilities goes on and on.

Generally speaking, the more money you have to invest, the more options you have. “In this country today, you’ve got well over a hundred options if you’re willing to put seven figures in,” Renton says.

The minimums at venues that focus on accredited investors tend to be more than you’d find at Lending Club or Prosper. At SoFi, accredited investors need at least $10,000 to begin investing in the company’s unsecured corporate debt. SoFi’s been in the lending business for several years now and currently focuses on student loans, mortgages, personal loans and MBA loans. Investors, however, can’t currently invest in these loans, says Christina Kramlich, co-head of marketplace investments and investor relations at SoFi. The company plans to eventually offer investment opportunities in the areas of mortgages and personal loans, she says.

funding circle packetAt Funding Circle USA in San Francisco, accredited investors can buy into a limited partnership fund for at least $250,000. Or they can buy pieces of small business loans for a minimum of $1,000 each, though the recommended minimum is $50,000, explains Albert Periu, head of capital markets. There may also be upper limits on your investment, based on your financials. If you’re part of the pick-and-choose marketplace, you’ll pay an annual servicing fee of 1%. With the fund, you’ll also pay an administration fee of 1%. Trailing 12-month net returns for investors are north of 10%, Periu says.

Because it’s still so new, it can be hard for investors to know how to compare marketplaces. For starters, consider the platform’s historical performance. There are a lot of new marketplaces popping up, but it takes time to develop a proven track record. This isn’t to say you shouldn’t dabble with the newer platforms, but if you do, you’ll want above-average returns to balance out the higher risk, says Sanborn of Lending Club. “About three years in, we started to build a track record. At five years in, it was very solid,” he says. “You need time to see how a basic batch of loans is going to perform.”

Before investing, you’ll want to get a sense of how committed senior management is to the company and try and get a sense of whether the company seems to have enough capital for the business to run well. Try to find out about the cash position of the company, how the loans are going to be serviced, what entity is doing the underwriting and how and where your cash will be held.

“It’s not just assessing the risk of the asset and the investment, it’s assessing the risk of the enterprise that is making it available to you,” Sanborn says.

It’s also important to ask questions about the loans themselves. Where do they come from and is the volume sustainable? Ideally, a platform should offer a variety of loans so investors can properly diversify, or you might need to consider investing with multiple platforms to achieve your desired balance.

lending bubbleBefore you get started, you’ll also want to ask about the company’s compliance procedures and controls and how you can recover your money if you no longer want to invest. Data security is another area to explore. Not every company is as protective of customer data as perhaps they should be.

When you’re asking all these questions, try to get a sense of how receptive the platform is to the feelers you’re putting out. Investors should only work with companies that are willing to be open about how they are investing your money, their historical returns and other important data. “I can’t stress transparency enough,” says Periu of Funding Circle.

The technology the platform uses is another key element. Is the technology easy to use, or does the platform create stumbling blocks for investors? Are there ways to automate lending, or do you have to log on every day and manually invest in loans?

Suber of Prosper says investors should also consider whether platforms work with a back-up servicer in case there’s a disruption and whether they run regular tests to make sure everything works as expected. “It’s just like a backup generator and you have to test it every once in a while and make sure it goes on.”

Certainly it pays to do your homework before you invest your hard-earned cash with an online platform. Ask around, attend industry conferences and absorb all you can from publicly available data. The good news is that there will probably be even more information for you to tap into as the industry continues to grow.

“Two years ago [marketplace lending] was very esoteric. A year ago it was still esoteric,” says Funding Circle’s Periu. Now, more and more investors are hearing about marketplace lending and want to make it part of their broader fixed income bucket. Even so, more has to happen for it to become a mainstream investment. “Awareness and education need to continue,” he says.

Once more people understand the extent of what’s out there, Suber of Prosper expects investing in online marketplaces will take off even more than it already has. “A lot of people still don’t know this as an investment opportunity,” he says.

This article is from deBanked’s May/June magazine issue. To receive copies in print, SUBSCRIBE FREE

Would You Bet Your Retirement on Consumer Loans?

March 12, 2015
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I like Lending Club. I have a rather sizable portfolio of their notes. I’m also long-term bullish on platform lending in general, at least long-term enough to feel confident to buy 3 and 5 year notes (and who knows how much things will change by 2020!).

There are limits of course to my optimism. The amount I’ve invested is essentially play money. It’s separate and smaller than some of my other more serious long term investments like mutual funds. I think that’s how everyone should invest on these platforms, even a rather vetted one like Lending Club. Only invest what you can afford to lose.

If you’re going to earn Wall Street yields such as 7-12% (after defaults) in a 0% interest rate environment, know that in the back of your head that you could encounter a Wall Street style loss. And don’t expect a bailout.

It’s important to remember that Lending Club is not peer-to-peer. Investors are not connecting with borrowers and lending them money. Lending Club is connecting with borrowers and investors are lending money to Lending Club. If Lending Club goes bankrupt, you could lose everything. I’ve accepted that risk for play-money.

But this scares me:

Lending Club IRA

Putting your retirement funds in the fate of Lending Club and its young consumer lending model is being marketed as a quick way to lower your tax bill before April 15th.

I said I am bullish. I am not 30+ years bullish. A Lending Club IRA is the same as putting your life savings in a young tech stock, quite literally in fact since Lending Club only went public 3 months ago.

My hope is that Lending Club might actually read this post and re-evaluate the slippery slope of this marketing strategy.

A further explanation of a Lending Club IRA on their website:

Lending Club IRA tax benefits

Lots of tax savings talk, but no mention of how illogical it is for someone to put the fate of their retirement into the hot lending company of the moment.

Is your money safe? Two months ago Lending Club said it had not begun to explore the cost and requirements of licensing its lending operations in all 50 states. Right now, their entire business model relies on the longevity of their relationship with WebBank.

Mark Cuban says we’re in the midst of a major tech bubble. Maybe he’s wrong, but I wouldn’t bet my retirement on it.

Lending Club IRA tax benefits

Hopefully someone doesn’t invest their entire retirement portfolio into something as new and exotic as Member Payment Dependent Notes under the guise of a tax deduction today.

I’m bullish on them. I like them as a company. They should probably fix the way their retirement accounts are marketed.

Just saying…

Lending Club (LC) Q4 Earnings Call

February 23, 2015
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deBankedThe first company to bring platform lending into the public eye will release their 4th Quarter and 2014 earnings on Tuesday, February 24th at 5pm EST. Anyone can join the live webcast by clicking here. If not by a computer, you can also dial in by phone at 888-317-6003. Use conference ID 4117710 ten minutes prior to the start of the call.

Investor attitudes are likely to be affected by the outcome of OnDeck’s earnings. While the two companies have different models, they have generally followed the same ups and downs. Many investors are still not clear how they’re different. Lending Club earns fee income by servicing loans and is not exposed to the risk of the loans themselves. Some critics believe that puts them at odds with their platform lenders over the long term.

Lending Club has already experienced a low of $18.30 a share and a high of $29.29. It closed yesterday at $22.89.

Since going public a few months ago, they announced a partnership with Alibaba and Google.

Lending Club’s Site Went Down

December 3, 2014
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A week away from IPO day, Lending Club is undergoing a supposed unannounced mid-day prolonged “upgrade”. There is no word about it on their twitter account. As many probably know, this down time coincides with one of the day’s four normal feeding times when fresh loans are loaded onto the platform in bulk.

lending club down

Are they just polishing up the old gears before IPO time or did something happen?

The 3rd revision of their S-1 registration was published two days ago.

Keeping Lending Club (and others) Honest

October 19, 2014
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Is Lending Club staying honest?Now that institutional money is flowing into the alternative lending industry, some retail investors are starting to express concern that the rules are changing. Lending Club for example is no longer considered a peer-to-peer lending platform, but rather an online credit marketplace.

Investors don’t exactly make loans to individuals in that marketplace, but that’s sort of how the concept began. Today, a bank issues the loan to the borrower, Lending Club buys the loan and creates a note tied to the performance of the loan, and then sells that note to investors.

Lending Club holds all the power and that worries retail investors who believe that the company is not always forthcoming about what they’re doing. It’s not easy to find dissenting voices when the market is growing rapidly especially since the media is cheering the revolution on.

But in the back corners of the Internet there are groups of investors growing suspicious, if not downright paranoid that all is not right in Lending Club land.

On Peter Renton’s Lend Academy forum for example, healthy discussions are being replaced by collaborative investigations into Lending Club’s practices. As a retail investor myself, I can’t help but be drawn to it. Below is a list of some of the issues:

The Borrower Member ID number is never reused
If a consumer borrows money from Lending Club in 2013 and again in 2014, it would probably be useful for investors to know about the previous Lending Club loan. Instead, borrowers are issued additional Member IDs with each successive loan, masking the history of past loans.

Borrowers may be taking two loans simultaneously
Acknowledging that Member IDs can never be reused, curious retail investors used other data points disclosed by Lending Club to link borrowers together. They believe they discovered a number of borrowers who got two Lending Club loans back-to-back, sometimes within days of each other.

The concern here is that the borrowers were taking on much more debt than the investor was led to believe. For instance, an investor might feel comfortable with the borrower taking a $10,000 loan, but has no idea that another $20,000 is being issued to them days later under another Member ID number.

Whether or not this is actually happening and the scale of how often it is happening is tough to say, but a little detective work by others indicates that it has possibly occurred.

What happens if Lending Club goes bankrupt?
While a poll with so few responses (52 total) on the Lend Academy forum may not be statistically relevant, 75% of the respondents claimed to be concerned in some capacity that Lending Club has no Bankruptcy Remote Vehicle for retail investors. 21% said they were extremely concerned. Absent a BRV, a Lending Club bankruptcy endangers all retail investors from getting paid regardless of whether or not the borrowers are actually paying their loans.

Anil Gupta, the founder of PeerCube wrote the following on the Lend Academy forum in response to the BRV issue:

You are not alone. I am also in the extremely concerned category when it comes to BRV for LC. This segment has been wild-wild west and reminds me of combination of dot-com bubble in 1999 and housing bubble of 2007. Overall, I am very concerned with platform risks.

Premature IPO attempts by p2p platforms is also concerning. I am taking that as indication of founders, VCs and early employees want to cash out and exit while the market is hot. They may be seeing the growth reaching a plateau and increased competition. I believe we will see a lot of shake out when interest rate start to rise. Potentially stepped up government regulations of p2p platforms once investors lose money.

Startup woes?
Retail investors, particularly those that have deployed a substantial amount of their capital in Lending Club notes gripe that sometimes the financial reports they get are missing data, experience glitches, or are just totally wrong. While usually resolved to everyone’s satisfaction, as a seven year old company, one might expect for Lending Club to be much more careful at this stage in the game. With an IPO in the works at this very moment, they should be way past problems such as data in the downloadable files not matching the website.

New fees
In August, Lending Club announced they would begin charging investors 18% of the delinquent amount recovered if the loan is at least 16 days late and no litigation is involved. When investors pushed back, it turned out that was always their written policy, they were just waiving it for everyone’s benefit until now.

While the move means a few more dollars out of every investors pocket, it was noticed that loans that have been restructured at the borrowers request are not marked as current for the duration of the payment plan even if they are in fact current on the payment plan itself. So when loans get restructured, Lending Club begins taking 18% of every payment as if it were a continuing collections problem.

From a firsthand perspective, I had several loans entering into payment plans almost immediately following the issuance of the loans. Basically the loan would be issued, the borrower would make their first payment, they’d plead hardship, go on a payment plan, and then Lending Club would begin deducting 18% of every payment going forward.

In these situations, our interests are not aligned. By entering a payment plan, not only is the amount the borrower is paying monthly reduced, but 18% of each of my payments now belongs to Lending Club instead of me. Basically, the appearance that Lending Club has a personal incentive to place borrowers on a modified plan at my expense and without my consent is a conflict worth monitoring.

Automated Investing under delivers?
For those with too much money or too little time to choose notes to buy themselves, Lending Club offers Automated Investing, a program that will automatically buy notes within parameters you set when they become available. The draw back is that the filters are limited and some investors are complaining that they’re ending up with notes they never would’ve bought manually.

WebBank woes
On October 6th, Lending Club announced that investors would have to sacrifice several days worth of accrued interest to WebBank, the bank that issues the loans for Lending Club.

Citing the move as necessary to keep Lending Club robust in a changing environment, the run up to the IPO has had some investors feel like they are suddenly being nickel and dimed.

Not that this is necessarily bad, but there’s evidence that shows Lending Club is encouraging its own borrowers to refinance their loans to a lower rate. If they do it, it results in the original note being paid off. The payoff returns the cash to the investor who then may have to wait two weeks or more to put that money back into a new note.

It must be said that any time I’ve published a gripe about something Lending Club is doing, my account representative there has called me to try and resolve it. That’s surprisingly good service!

But while I feel safe enough about my investments now to keep them there, there’s nothing wrong with reminding Lending Club and all of the other disruptive financial companies out there that investors are watching their every move.

As long as they have your money, it’s healthy to keep them honest.

Lending Club IPO: The Mirage of Diversifying

September 1, 2014
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Behold, the fool saith, “Put not all thine eggs in the one basket” – which is but a matter of saying, “Scatter your money and your attention”; but the wise man saith, “Pull all your eggs in the one basket and – WATCH THAT BASKET.

– In Pudd’nhead Wilson by Mark Twain

eggs in one basketIs peer-to-peer lending really offering you a chance to diversify your portfolio?

Scores of investors just like myself are jumping on the Lending Club bandwagon. The returns are sweet and the concept has mass appeal. Like a gambler getting overconfident after a long winning streak, it’s easy to get caught up in the excitement.

I have tens of thousands invested in Lending Club loans at this very moment and I think it’s time to take a breather. Other people are in deeper, six figures worth, and then there are those who are placing their entire retirement savings in the hands of everyday borrowers.

Once IRAs and 401(k)s enter the picture, the situation gets serious…

Lending Club risk tiersLending Club appeals to the diversity conscious with their seven risk tiers, A,B,C,D,E,F and G. A rated loans are deemed the least risky but charge the lowest amount of interest. G rated loans carry the most risk but carry interest rates in the neighborhood of 26%.

To diversify, you could spread your funds into all of them or at least across multiple tiers. You can also make many small investments of $25 as opposed to a few investments in larger sums.

Lending Club IRA


In an excellent Bloomberg article, Matt Levine explains that investors on Lending Club’s platform are not really making loans to consumers, Lending Club’s bank is. They sell the loan to Lending Club and Lending Club creates a note and sells it to you. The borrowers owe Lending Club money and Lending Club owes you money. Your relationship is with Lending Club, not the borrowers, and therefore the entirety of your investments however seemingly diversified, are really in Lending Club itself.

A few months ago I wondered if it made sense to buy Lending Club stock over buying their notes.

riskThe note prospectus explains “the Notes are unsecured and holders of the Notes do not have a security interest in the corresponding Loan or the proceeds of the corresponding Loan.” This means these loans are not collateral if Lending Club goes south.

If the company were to file for bankruptcy, you would need to add yourself to the list of unsecured creditors. As stated, “if LendingClub were to become subject to a bankruptcy or similar proceeding, the holder of a Note will have a general unsecured claim against LendingClub that may or may not be limited in recovery to borrower payments in respect of the corresponding member loan.”

Unsecured note holders are still better off than common shareholders in the event of a bankruptcy, but that assumes that the borrowers are still paying their loans.

What if they weren’t? Or worse yet, what if they didn’t have to pay them?

One basket

Lending Club’s S-1 warns of major dangers. “Additional state consumer protection laws would be applicable to the loans facilitated through our platform if we were re-characterized as a lender, and the loans could be voidable or unenforceable,” it says. “In addition, we could be subject to claims by borrowers, as well as enforcement actions by regulators.”

If Lending Club is at some point re-characterized, your portfolio would be killed off instantly. Your eggs however well diversified are in the Lending Club basket. Such a situation happened in a closely related industry where a merchant cash advance company was challenged to be a lender in disguise. In 2008, a class action lawsuit was brought against AdvanceMe Inc in California. The case was settled but AdvanceMe could no longer collect payments and they actually had to give a lot of the money they had already collected back.

In a Lending Club nightmare scenario, note holders could potentially be forced to forfeit any principal and interest they’ve already collected in the event of a harsh judgment or settlement. If Lending Club is only obligated to pay what’s collected to note holders, then what if they’re told give it all back to the borrowers? It’s a nightmare scenario indeed.

Sleep tight

Turtle SleepingIf the goal is to invest in consumer loans, you should spread your investments around. Put some in Lending Club, some in Prosper (their #1 competitor), and at least another. More importantly, don’t invest all of your money in peer-to-peer lending companies or consumers loans as this is not diversifying either. Peer-to-peer lending should be just one component of your overall investment strategy. Stocks, bonds, CDs, and even FDIC insured savings accounts should round out your holdings.

The Lending Club IRA and 401(k) program is wildly risky at best. Would you invest a significant portion of your retirement savings in the hands of just one company? I considered it for a second…

And then I took a deep breath.

The Lending Club IPO has been labeled an awareness event. Millions of people will be learning about it for the first time through the publicity of a stock offering. If you do decide to put some eggs in, WATCH THAT BASKET!

AmeriMerchant’s CEO David Goldin shared his own thoughts on the IPO on Bloomberg TV:

Are We in a $300 Billion Market?

August 7, 2014
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stacking turf warEarlier today on a large group conference call with Tom Green and Mozelle Romero of LendingClub, I learned a few more details about their business loan program. In the Q&A segment, one attendee came right out and asked if they believed their competition was merchant cash advance companies and online business lenders.

According to Green, it’s not so much other companies that they feel they are up against but more of the broad challenge of market awareness. Their struggle is about getting people to know that there are non-bank options available and to make people aware of their existence.

It’s the same challenge merchant cash advance (MCA) companies have been dealing with for more than a decade. Notably though, there are many in the MCA industry that feel the market is saturated and thus a lot of the industry’s growth has been fostered through a turf war for the same merchants. Stacking (the practice of funding merchants multiple advances or loans simultaneously) is partially spurred by a belief that there are no more untapped businesses left to fund. The acquisition costs of a brand new untouched business that is both interested and qualified is so high, that it is not a pursuit some funders and brokers can afford to take on.

$300 billion?!Market Size
At present, daily funders, which are a combination of both MCA companies and lenders that require daily payments, are funding somewhere between $3-$5 billion a year. On the call Green said he believed the potential market was far larger than that, though he discredited the $200 billion figure that some independent research had predicted. That was only because LendingClub believes the potential market is substantially higher, more like $300 billion.

$300 billion?! That’s about 100x larger than the current daily funder market combined and starkly contradicts any belief that there’s no merchants out there who haven’t already gotten funded.

LendingClub’s minimum gross sales requirement is $6,250 a month and they have an upper monthly gross threshold on applicants at $830,000 a month, though they’ve had businesses apply who do even more than that. Their sweet spot as Green put it, is the segment doing $16,000 to $416,000 gross per month.

I can’t help but notice that’s the same sweet spot that daily funders have. And we mustn’t forget, LendingClub’s target business owner has at least 660 FICO. If it’s a $300 billion market for good credit applicants, then it’s got to be even bigger for the ultra FICO-lenient companies in MCA.

What’s a business?
LendingClub only needs someone with at least 20% ownership to both apply for and guarantee the loan, an unheard of stipulation in the rest of alternative business lending. One cardinal rule in MCA has been that there needs to be at least 51% or 80% ownership signing the contract. That’s had a lot to do with the fact that most MCA agreements are not personally guaranteed and the signatory is required to have absolute authority to sell the business’s future proceeds.

Summer of Fraud
fraudIn 2013 the MCA industry experienced what many insiders dubbed the summer of fraud. Spurred by advances in technology, small businesses were applying for financing en masse while armed with pristinely produced fraudulent bank statements. Fake documents overwhelmed the industry so hard that today it is commonplace for underwriters to verify their legitimacy with the banks. This is done manually or with the help of tools such as Decision Logic or Yodlee.

Knowing this firsthand, I asked LendingClub if they also take the care to verify bank statements. In the majority of cases they do not. They rely greatly on an algorithm that detects fraudulent answers on the application but the statements themselves are not scrutinized except in very high risk situations. Considering they’re wildly less expensive than MCAs, I find it odd that they are exposed to this type of risk. Fraudulent documents are the norm and in these underwriting conditions, I would expect them to charge as much or more than MCA companies, not less.

At the same time it’s important to mention that at present, business loans on their platform are only funded by institutional investors. Retail investors can only invest in consumer loans. LendingClub has been very transparent about excluding retail investors here for the very purpose of shielding them from unevaluated and unforeseen risk. My guess is that as time goes on, they will do more to validate the bank statements which is the bread and butter of assessing the risk and health of a business.

Check out: LendingClub doesn’t require bank statements for personal loans. Are they missing pieces of the puzzle?

$300 billion
In a FICO flexible environment, it’s possible the potential for daily funders is at least $300 billion. If true, that would mean that for the 16 years that MCA players have been around, they barely reached even 1% of their target audience. I’ve been saying it since I’ve started this blog 4 years ago, every business owner I’ve spoken to has never heard of a merchant cash advance… which means saturation is a myth.

Tom Green was right, the real competition is public awareness. 99% of the potential market is untapped. If you’re fighting with 5 other companies over the same merchant, you gotta:

Keep on looking now
You gotta keep on looking now
Keep on looking now

You’re looking for love
In all the wrong places

Suspicious Listing on LendingClub

August 4, 2014
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While perusing LendingClub’s loan platform today, I came across a highly suspicious borrower. It’s member loan #23954784 who is currently a lab assistant in Albuquerque, NM. The reason for the loan request? “Other”.

This is what I suspect behind the scenes:

LendingClub Breaking Bad

LendingClub Anti-Money Laundering: Too far?

July 16, 2014
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money launderingPerhaps as part of wider governmental banking pressure, p2p platform LendingClub has instituted a new controversial Anti-Money Laundering policy. The new rule is that you can only connect your investment account to 1 bank account for deposits. This isn’t a technical limitation since as of recent, you could update your bank information at any time. I regularly made deposits to LendingClub from 2 checking accounts but no longer can I do this.

What’s even weirder is that if you moved from 1 bank to another, you can’t even update the new correct information. You’re cut off. In such a situation, LendingClub offers a high tech alternative, mailing in a paper check from the new account. Why this is more acceptable I do not know.

In my call to LendingClub to complain, they were adamant that all such restrictions were necessary to prevent money laundering. Recalling the discussion now, I think the investment services rep used the term money laundering more than 20 times. Realizing that they wouldn’t budge, I asked if I could update my account information just one last time so that it reflected my main checking account. The answer was ‘no’, due to possible money laundering of course.

anti-money laundering policy

So what do you do if you changed banks?
LendingClub said fear not, at regular specified intervals which they cannot reveal, they will allow you to update your banking information. So if you need to update your account info, all you can do is check every day to see if the ban message has gone away. Only then can you update. Better make it a bank account you plan to use for the long haul.

Could the move be due to governmental pressure in the banking and lending markets? I suspect it is.

Is Awareness of Alternative Lending Still Low?

July 4, 2014
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are borrowers aware?Prosper’s President Ron Suber and LendingClub’s CEO Renaud Laplanche have previously explained that there is still a large opportunity for growth because most people still don’t know non-bank lending options exist.

As cited on LendingMemo, Renaud Laplanche admitted the reason they are even considering an IPO is “to use it as an opportunity to raise awareness for the company.” He continued by saying that they don’t need capital so the purpose of their IPO aspirations “is a lot of free advertising.”

In casual conversations with business owners, friends, and new acquaintances I’ve asked if they’ve ever heard of merchant cash advance, p2p lending, or companies like OnDeck Capital and LendingClub. The answer is almost always ‘no’.

That means there is still a lot of work to do.

In this CNBC interview Funding Circle acknowledges that many business owners aren’t aware of alternatives and explains what makes them different.

Exponential Finance

June 15, 2014
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DailyFunder Exponential FinanceLast week, DailyFunder was a media sponsor of Exponential Finance presented by Singularity University & CNBC. It was a totally different atmosphere from some of the other events I’ve been to this year already (Transact 14, LendIt, etc.). In the upcoming July/August issue of DailyFunder magazine, I’ve got a column that summarizes the event that I think you’ll like.

Exponential Finance brought together leading experts to inform financial services leaders how technologies such as artificial intelligence, quantum computing, crowdfunding, digital currencies, and robotics are impacting business. And my mind = blown.

DailyFunder Exponential Finance

Some tweets to hold you over:

Robots are going to steal your finance job:

I also had the chance to do a Q&A with a longtime prominent U.S. Congressman. The next issue should be available in about 3 weeks.

LendIt Conference: The State of Alternative Business Lending

May 6, 2014
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LendIt 2014Have you heard? Banks aren’t lending. Nobody at LendIt seems to mind though. Ron Suber, the President of Prosper Marketplace, said earlier today that banks are not the competition. That’s an interesting theory to digest when contemplating the future of alternative lending. If banks are not the competition, then who is everyone at LendIt competing against? I think the obvious answer is each other, but much deeper than that, the competition is the traditional mindset of borrowers.

The biggest challenge the wider alternative lending industry faces is awareness and understanding. Those happen to also be two of Suber’s three edicts for growth. The third is education. Just because alternatives are available today doesn’t mean that potential borrowers know about them or feel comfortable enough to use them. Today we are competing against the old way of thinking.

Other products in the new “share economy” have encountered a similar struggle. Several presenters today cited Uber as having revolutionized the way people use taxis. “A long time ago, people used to stand on corners and hold out their hand to get a cab, but that’s all changed,” was the oft-paraphrased proof that age-old industries were falling like dominoes. But as a New York City resident, I hadn’t quite noticed a change at all. Hailing cabs off the street is still very much the norm. It is only by sheer coincidence that I used Uber for the very first time to travel to JFK airport on my way to this conference.

I first encountered Uber a year ago when an acquaintance dazzled me with his ability to summon a car using an app on his phone. It was then that I became aware, but I did not understand how it worked. It took me 12 months to get comfortable enough to try it myself, and the experience was okay I guess if you discount the fact that my driver went through the E-ZPass lane without actually having an E-ZPass. Needless to say, that led to a major holdup that caused me to almost miss my flight.

If it took me a year to get past the confusion of hailing a cab from my phone, I can only imagine what potential borrowers must think when told they can raise money from their peers, the crowd, or a lender that requires payments to be made every single day.

Perhaps most telling about the awareness challenge, is that many people I’ve spoken to at LendIt had never heard of a 16 year old product known as merchant cash advance. That speaks volumes about how much more work merchant cash companies still have to do in order to gain mainstream awareness.

Even those fully aware were not entirely certain about how to define the product. In the Online Lending Institutional Investors Panel, merchant cash advance was briefly discussed as a topic but it was almost entirely spoken in the context of being something that OnDeck Capital does. That would come as disheartening news to OnDeck since they have spent considerable resources in positioning themselves as anything but a merchant cash advance company. Confusion over what somebody is or isn’t will probably increase especially as alternative lenders from different industries start to compete for the same clients.

Funding businesses instead of people
Brendan Ross, the President of Direct Lending Investments, and the moderator of the Short Term Business Lending panel pointed out that a dentist could pursue two different loan options and get completely different results. With excellent credit a dentist could expect to land a 3-5 year personal loan at 7-8% APR on a P2P platform. If he were to apply for the loan using his dental practice though, he could expect to incur costs over 25% and get nothing longer than 2 years.

Ross, who was a very active moderator, subscribes to the belief that businesses are overpaying for credit. Unlike the consumer loan space, there hasn’t been price compression. The cost of business capital remains high, perhaps higher than what is necessary to turn a reasonable profit. Ross argued that the padded cost serves as a hedge against defaults and economic downturns. “The asset class works even when the collection process doesn’t,” Ross said. “The model works with no legal recovery.”

Building on that premise, Ross asked the panelists if an increase in defaults were simply the cost of doing business towards automating the underwriting process.

Stephen Sheinbaum, the CEO of Merchant Cash and Capital argued that just the opposite had occurred, that automation had led to a decrease in defaults. Others on the panel confirmed a similar outcome, though Rob Frohwein of Kabbage admitted they could potentially weather higher defaults through automation by offsetting it against decreased infrastructure costs.

Noah Breslow of OnDeck echoed something similar to Frohwein in the Small Business Term Lending Panel. He asked this question, “Do underwriters add value or not?” and followed up by saying that 30% of their deals were still manually underwritten, usually the deals that are larger.

LendIt Panel

Is full automation right around the corner?
The debate between humans and computers in risk analysis is a featured segment in the third issue of DailyFunder that is being mailed out this week, but there is another angle that is seldom discussed, whether or not customers want automation. Breslow said today that, “if customers want full automation, we are prepared to deliver it.” They’ve learned over time that “many customers want someone to talk to at some point in the transaction.” Rohit Arora, the CEO of biz2credit expressed much of the same in a recent interview with DailyFunder’s Managing Editor Michael Giusti.

The only dissenting voice was Gary Chodes, the CEO of Raiseworks who seemed to be of the belief that human involvement in underwriting was nothing short of ridiculous. He stated that, “if you look back over the last 20 years, the loss rates on business loans under 24 months has been really low.” To him, that data seemed to be proof enough that complete automation could and should be achieved, though he admitted to performing back-end checks such as landlord verifications. They currently have no physical underwriters however.

Is there a transparency problem?
Tom Green, a VP of LendingClub shared an interesting tale. While trying to convince potential borrowers to ditch a merchant cash advance in favor of a LendingClub business loan, they get pushback on the cost of their money. The reason being? Some borrowers think they’ve already got a great deal or at least a better deal than what LendingClub is offering. The problem stems from the borrower’s belief that the holdback percentage set up in their future revenue sale (the most common way a merchant cash advance is set up) is the APR.

DailyFunder LendItMerchant Cash Advance Companies pay cash upfront in return for a specified amount of a businesses’s future sales. They collect these sales by withholding a percentage of each credit card transaction or bank account deposit until the agreement is satisfied in full. On a dollar for dollar basis, the cost of these programs typically range from 20%-49%, but on an APR basis, substantially higher. The holdback % is not even a factor in the APR. Green said they’ve learned that some small business owners are not sophisticated when it comes to finance.

Ethan Senturia, the co-founder of Dealstruck would probably agree. Earlier today he said, “you need to speak the borrower’s language.” Some understand APR, some don’t. “Dealstruck offers more than just APR comparisons to borrowers,” Senturia said. “Whatever helps them understand.”

When the OnDeck Capital model and merchant cash advance model were questioned as possibly being bad for borrowers, Tom Green was quick to clarify. “There are different capital needs that small businesses have,” he said. And “there is a trade-off between the length of the term and the risk.”

OnDeck Capital’s clients are not entrepreneurs born yesterday. “The typical customer has been in business for 10 years,” Breslow said. Their deals are “structured to protect through daily and weekly payments in addition to the interest rates we charge,” something he reminded everyone was “not single digits.”

Still, transparency issues remain in business lending. Sam Hodges, the Managing Director of Funding Circle explained that when he was previously a small business owner, there were hardly any lenders willing to provide him with an amortization schedule. Ashees Jain, a managing partner of Blue Elephant Capital Management admitted he would find it hard to justify the high rates of merchant cash advance if asked by a regulator, so he’d rather not invest in that market. When it comes to those types of transactions, they “don’t want to have to explain themselves” at some point in the future.

Scott Ryles, the managing member of Echelon Capital Strategies, LLC commented on OnDeck capital’s model as unbelievable. “The arbitrage is huge,” Ryles said. And Eric Thurber the managing director of Three Bridge Wealth Advisors believes that alternative business lenders are at odds with themselves. “They always talk about their risk management,” Thurber said, but he feels that players in that industry are concerned with how much market share they have. That conflicts with risk management in his opinion.

They pay or they don’t
At the end of the day Ashees Jain said as far as unsecured loans go, “borrowers pay or they don’t.” The recovery process on secured loans can be 12-18 months Jain said, a statistic cited by Brendan Ross earlier in the day.

It’s clear at LendIt that there are a lot of products available, but Ryles summed it up nicely. In the consumer space, all the volume is in the 36 month installment loans, he reckoned. For businesses it’s merchant cash advance. “It’s an awareness thing,” Ethan Senturia said in regards to getting businesses to use alternative lending sources.

It is indeed. Awareness, education, and understanding…

Is Alternative Lending a Game of Thrones?

April 8, 2014
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Funding KingsIt was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us…

This blog has been many things over the years, all of it relative to who the reader was. It has encouraged and deterred, informed and confused, made people laugh or stoked their anger. The merchant cash advance industry it spoke of had been small. Annual funding volume was a billion or two or three, a blip of a blip on nobody’s radar. There was a sense of unity, a shared objective amongst competitors. They were guided by one dictum, “grow, but don’t rock the boat.”

But opportunity enticed everyone, the good, the bad, and the unexpected, and it brought a relatively peaceful chapter to an end. Winter is coming, Eddard Stark would likely say of the uncertainty that hangs in the air. Merchant cash advance has become a spoke in the alternative lending wheel that is spinning forward uncontrollably. Non-bank financing has become a worldwide phenomenon virtually overnight, setting the stage for the lords of funding to play a game of thrones. Investors with bottomless pockets are emptying them, government agencies are assessing the landscape or crafting responses, and journalists stand ready to shape public opinion.

This is a transformational moment in human history, perhaps bigger than what Facebook did for social media. Individuals are taking control of the monetary supply. Strangers pay each other in bitcoins, neighbors are bypassing banks for loans and lending to each other instead, and businesses are rising and falling with the funding they get from other private businesses. Winter is coming for traditional banking. The realm calls for a new king.

Wonga’s epic rise is being countered by both regulatory and religious resistance, and the man who dared the world to lend algorithmically has admitted defeat. Peer-to-peer lenders have encountered massive regulatory setbacks on their road to stardom and merchant cash advance companies are currently engaged in a civil war over best practices. Winter is coming indeed.

The Kings

funding battleLending Club
In what is perhaps their first step towards an IPO this year, Lending Club is reducing transparency over its loan volume. Up until April 3rd, anyone could see how many loans they issued on a daily basis. Now this information will only be available quarterly. Peter Renton in his Lend Academy blog shared his belief that the move was entirely tied to the impending IPO. “Without this daily loan volume information their stock price will be less volatile and they will be able to “manage the message” with Wall Street every quarter,” Renton wrote.

OnDeck Capital
OnDeck Capital is also in contention for an IPO this year. A year ago a company executive hinted that becoming a public company would not be on the agenda for consideration until 2015, yet I am hearing rumors that they may make a late 2014 go at it. Such rumors hold weight in light of reports that they are cleaning up their ISO channel. Insiders on DailyFunder are saying that resellers with abnormally high default rates are in jeopardy of being cut off.

OnDeck Capital is unique in that outsiders chastise them for their rates being too high while insiders argue their rates are too low to be profitable. It’s a classic example of how tough the court of public opinion can be on a lender even if they are not getting rich off their loans.

Kabbage came and conquered the entire online space before anyone had a chance to blink. PayPal, ebay, Amazon, Etsy, Yahoo, Square, they claimed those territories for themselves and then launched an attack into the brick and mortar space. Kabbage’s secret value is their patents. They are a serious player on a serious path.

CAN Capital
CAN Capital’s greatest weakness is their lifespan. They’ve managed to stay on top after 16 years in the business but that makes them old enough to be Kabbage’s grandfather by today’s tech standards. As a pre-dot com era business, it’s impossible to argue against their sustainability. If anyone has alternative lending figured out for both the good times and the bad, it’s CAN Capital.

The Lords

The Government
alternative lenders fightPeer-to-peer lending has already been under strong scrutiny from the Federal Government. Lending Club and Prosper are regulated by the Securities and Exchange Commission these days, but they may never be free of oversight. Just two months ago, the Federal Reserve published a report on trends in peer-to-peer business lending. They hinted at further regulation.

As small business owners are increasingly turning to this alternative source of money to fund their businesses, policy makers may wish to keep a close eye on both levels and terms of such lending. Because such loans require less paperwork than traditional loans, they may be considered relatively attractive. However, given the relatively higher rate paid on such loans, it may be in the best interest of the business owner to pursue more formal options. More research is required to understand the long-term impact of such loans on the longevity of the firm and more education to potential borrowers is likely in order.
– a 2014 Federal Reserve study

The Merchants
Once upon a time nobody talked about alternative lending online except for the companies offering it. Merchants didn’t talk about it with each other or there were too few businesses to give rise to centralized discussions. Today, merchants communicate and compare notes:

Merchants discuss PayPal’s working Capital program:

Merchants discuss Square’s merchant cash advance program:

Merchants discuss Kabbage:

OnDeck Capital’s 30+ Yelp Reviews:

Potential Lending Club borrowers make their cases:

The Machines
Are computers better predictors of performance than humans? Some people think so. This debate will play a pivotal role in the future of alternative lending.

The Media
Public opinion will be at their mercy.

The Vulnerabilities

funding battleCommissions
The bigger alternative lending gets, the juicier the stories become. Just last week, Patrick Clark of BusinessWeek dove head first into the reseller model, revealing insider commissions, the truth about buy rates, and the alleged antiquated practice of enlisting a broker to secure funding. On trial was a documented 17% commission, an example I believed to be an extreme case. For a long time commissions ranged between 5% and 10% on average. But there are some big names paying up to 12 points and others boasting of 14. All were topped by the mass solicitation I received a few days ago that promised a 20% commission. These kind of figures if they continue will become an easy target for journalists looking to portray the industry in a negative light.

There is a raging civil war within the merchant cash advance community specifically over stacking. This is the instance that a merchant sells their future revenues to two or more parties at the same time, leading to multiple daily deductions from their sales. This debate is bound to spill out into the mainstream if it cannot be resolved on its own.

Some funding companies intend to license their automated underwriting technology to banks, potentially handing the keys of alternative lending’s greatest asset (speed) to traditional bankers. It is unlikely that banks would engage in some of the high risk deals that alternative lenders target but they could recapture the top credit tier borrowers that have been flocking away from them.

Also at stake here is the sustainability of algorithmic underwriting. There are critics that believe computers appear to make great decisions during good economic periods but suffer during downturns. Do the technology based funding companies have enough data to weather a future economic storm?

So many things are happening at once, that it’s impossible to know what fate awaits the realm. Will there be a new king or will alternative lending fall apart like a house of cards?

For those of us climbing to the top of the food chain, there can be no mercy. There is but one rule: hunt or be hunted.
-Frank Underwood

May the best man win.

Merchant Cash Advance Syndication: Crowdfunding?

March 28, 2014
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merchant cash advance syndicationYou might not have known this, but one of the most lucrative opportunities in merchant cash advance is the ability to participate in deals. It’s a phenomenon Paul A. Rianda, Esq addressed in DailyFunder’s March/April issue with his piece, So You Want to Participate?

Syndication is industry jargon of course. You probably know the concept by its sexier pop culture name, crowdfunding. For all the shadowy rumors and misinformation that circulates out there about merchant cash advance companies, they’re similar to the trendy financial tech companies that have become darlings of the mainstream media.

Did you know that many merchant cash advances are crowdfunded? To date, no online marketplace has been able to gain traction in the public domain aside from perhaps FundersCloud, so crowdfunding in this industry happens almost entirely behind the scenes. There is so much crowdfunding taking place that it’s becoming something of a novelty for one party to bear 100% of the risk in a merchant cash advance transaction. Big broker shops chip in their own funds as do underwriters, account reps, specialty finance firms, hedge funds, lenders, and even friends and family members of the aforementioned.

Merchant cash advance companies find themselves playing the role of servicer quite often, which is coincidentally the model that Lending Club is built on. A $25,000 advance to an auto repair shop could be collectively funded by 10 parties, but serviced by only 1. Each participant is referred to as a syndicate. This is not quite the same system as peer-to-peer lending because syndicates are not random strangers. Syndication is typically only open to businesses, and most often ones that are familiar with the transaction such as the company brokering the deal itself.

In the immediate aftermath of the ’08-’09 financial crisis, some merchant cash advance companies became very mistrusting of brokers and deal pipelines were going nowhere. Underwriters had a list of solid rebuttals for deals they weren’t comfortable with. “If you want us to approve this deal so bad, why don’t you fund it yourself!,” underwriters would say. Such language was intended to put a broker’s objections over a declined deal to bed. But with all the money being spent to originate these deals, it wasn’t long until brokers stumbled upon a solution to put anxious merchant cash advance companies at ease. “Fund it myself? I’d love to, but I just can’t put up ALL of the cash.

And so some brokers started off by reinvesting their commissions into the deals they made happen. That earned them a nice return, which in turn got reinvested into additional deals. Fast forward a few years later and deals are being parceled out by the truckload to brokers, underwriters, investors, lenders, and friends. There’s a lot of money to be made in commissions but anybody who’s anybody in this business has a syndication portfolio. The appetite for it is heavy. Wealthy individuals and investors spend their days cold calling merchant cash advance companies, brokers, and even me, trying to get their money into these deals. They know the ROI is high and they want in.

crowdfundingThat’s the interesting twist about crowdfunding in the merchant cash advance industry. You can’t get in on it unless you know somebody. There are no online exchanges for anonymous investors to sign up and pay in. It requires back door meetings, contracts, and typically advice from sound legal counsel. A certain level of business acumen and financial prowess are needed to be considered. These transactions are fraught with risk.

In Lending Club’s peer-to-peer model, investors can participate in a “note” with an investment as small as $25. This is a world apart from merchant cash advance where it is commonplace to contribute a minimum of $500 per deal but can range up to well over $100,000.

Lending Club defines diversification as the possession of more than 100 notes. At $25 a pop, an investor would only need to spend $2,500. With merchant cash advance, 100 deals could be $50,000 or $10,000,000. By that measure, syndication is crowdfunding at the grownup’s table, a table that doesn’t care about sexy labels to appease silicon valley, only yield.

Strange merchant cash advance jargon keeps the industry shrouded in mystery. Did you know that split-funding and split-processing are terms often used interchangeably? Or that they have a different meaning than splitting? Or that the split refers to something else entirely?

Do you know what a holdback is or a withhold? How about a stack, a 2nd, a grasshopper, an ISO, an ACH deal, a junk, a reup, a batch, a residual, a purchase price, a factor rate, or a UCC lead?

Paul Rianda did a great job detailing the risks of syndication, but there is one thing he left unsaid, and that’s if you’re going to participate in merchant cash advances, you better be able to keep up with the conversation.

At face value, syndication is nothing more than crowdfunding. But if your reup blows up because some random UCC hunting ISO stacked an ACH on top of your split while junking him hard and upping the factor with a shorter turn, you just might curse the hopper that ignored your holdback and did a 2nd. And on that note, perhaps it’s better that the industry refrain from adopting mainstream terminology. We wouldn’t want everybody to think this business is easy. Because it’s not.

One factor to consider is the actual product being crowdfunded. In equity crowfunding, participants pool funds together to buy shares of a business. In crowdlending, participants pool funds together to make a loan. But in merchant cash advance syndication, participants pool capital to purchase future revenues of a business. An assessment is made to predict the pace of future income and a discounted price is paid to the business owner upfront. That purchase price is commonly known as the advance amount.

Syndication has more in common with equity crowdfunding than crowdlending. If you buy future revenues and the business fails, then your purchase becomes worthless. There is typically no recourse against the business owner personally unless they purposely interfere with the revenue stream and breach the agreement. Sound a bit complicated? It is, but crowdfunding in this space is prevalent nonetheless. To get in on it, you need to know someone, and to do it intelligently, you better know what the risks are.

If you want to sit at the grownup’s table and syndicate, consult with an attorney first. There’s a reason this industry hasn’t adopted sexy labels. It isn’t like anything else.

General Solicitation or Crowdfunding?

Will Peer-to-Peer Lending Burn the Alternative Business Lending Market?

January 12, 2014
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For months I’ve been saying that peer-to-peer lenders will be companies to look out for, the latest being on December 29th. Lending Club fully intends to make the leap from consumer lending to business lending which may possibly pit them against the world of merchant cash advance.

In this video, a Bloomberg reporter asks OnDeck Capital’s CEO if his company will get burned by peer-to-peer lending.

If you watched the whole thing, you might also hear the insinuation that OnDeck’s product is similar to factoring since Breslow explains his loan program much like a merchant cash advance account rep would. “You simply pay x cents on the dollar”

I think there is room for both Lending Club and OnDeck. It’s the little funders of the world that will eventually feel a squeeze.

2014 Starts off With a Case of Red bull

January 10, 2014
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business lending red bullWoah, slow down there fellas. Let us digest one thing at a time. We’re not even 2 weeks into the new year and already we’ve learned that:

CAN Capital raised another $33 Million (but that they didn’t need it?)

Merchant Cash Advance was the the feature story on the front page of the Wall Street Journal. Seriously…

Bloggers are learning about this industry for the first time. They’re having a bit of trouble getting it right.

PayPal, which just recently kicked off its own merchant cash advance program (or as they call it, their Working Capital Program) has already issued 4,000 advances.

Regulators are freaking out over the use of social media information in loan approvals.

DailyFunder will begin mailing out the first alternative business lending magazine a week from today. It’s free so sign up!

Merchant Cash Advance Term Used Before Congress

December 18, 2013
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capitol buildingI’d like to think that the term, merchant cash advance, is mainstream enough that a congressman would know what it was. I have no idea if that’s the case though. What I do know is that Renaud Laplanche, the CEO of Lending Club gave testimony before the Committee on Small Business of the United States House of Representatives on December 5, 2013.


In it, he argued that small businesses have insufficient access to capital and that the situation is getting worse. We knew that already. However, he went on to explain that alternative sources such as merchant cash advance companies are the fastest growing segment of the SMB loan market, but issued caution that some of them are not as transparent about their costs as they could be.

The big takeaway here is that he didn’t say they are charging too much, but rather that some business owners may not understand the true cost. I often defend the high costs charged in the merchant cash advance industry, but I’ll acknowledge that historically there have been a few companies that have been weak in the disclosure department. That said, the industry as a whole has matured a lot and there is a lot less confusion about how these financial products work.

Typically in the context Laplanche used, transparency is code for “please put a big box on your contract that states the specific Annual Percentage Rate” of the deal. That’s good advice for a lender and in many cases the law, but for transactions that explicitly are not loans, filling in a number to make people feel good would be a mistake and probably jeopardize the sale transaction itself. If I went to Best Buy and paid $2,000 in advance for a $3,000 Sony big screen TV that would be shipped to me in 3 months when it comes out, should I have to disclose to Best Buy that the 50% discount for pre-ordering 3 months in advance is equivalent to them paying 200% APR?

This is what happened: I advanced them $2,000 in return for a $3,000 piece of merchandise at a later date.

I got a discount on my purchase and they got cash upfront to use as they see fit. Follow me?

Now instead of buying a TV, I give Best Buy $2,000 today and in return am buying $3,000 worth of future proceeds they make from selling TVs. That’s buying future proceeds at a discounted price and paying for them today. As people buy TVs from the store, I’ll get a small % of each sale until I get the $3,000 I purchased. If a TV buying frenzy occurs, it could take me 6 months to get the $3,000 that I bought. But if the Sony models are defective and hardly anyone is buying TVs, it could take me 18 months until i get the $3,000 back.

In the first situation, if the TV never ships I get my $2,000 back. In the second situation if the TV sales never happen, I don’t get the 3 grand or the 2 grand. I’ll just have to live with whatever I got back up until the point the TV sales stopped, even if that number is a big fat ZERO.

Best Buy is worse off in the first situation, but critics pounce on the 2nd situation. APR, it’s not fair! Transparency, high rate, etc.

Imagine if every retailer that ever had a 30% off sale or half price sale one day woke up and realized the sale they had was too expensive and not transparent enough for them to understand what they were doing. If only consumers had given the cashiers a receipt of their own that explained that they would actually only be getting half the money because of their 50% off sale, then perhaps the store owners would have reconsidered the whole thing. 50% off over the course of 1 day?! My God, that’s practically like paying 18,250% interest!!!

To argue that a business owner might not understand what it means to sell something for a discount is like saying that a food critic has no idea what a mouth is used for.

I will acknowledge that issues could potentially occur if an unscrupulous company marketed their purchase of future sales as if it were a loan. That could lead to confusion as to what the withholding % represents and why it was not reported to credit bureaus. I’m all in favor of increasing the transparency of purchases as purchases and loans as loans, but let’s not go calling purchases, loans. Americans should understand what it means to buy something or sell something. Macy’s knows what they’re doing when they have a Black Friday Sale. They do a lot of business at less than retail price. They are happy with the result or disappointed with it. They’re business people engaged in business. End of the story.

In recent years, the term, merchant cash advance, has become synonymous with short term business financing, whether by way of selling future revenues or lending. When testimony was entered that many merchant cash advance providers charge annual percentage rates in excess of 40%, I do hope that Laplanche was speaking only about transactions that are actually loans. As for any fees outside of the core transaction, those should be clear as day for both purchases and loans. I think many companies are doing a good job with disclosure on that end already.

Part 2

The other case that Laplanche made was brilliant. Underwriting businesses is more expensive than it is to underwrite consumers. Consumer loan? Easy, check the FICO score and call it a day. That methodology doesn’t even come close to working with businesses. He stated:

These figures show that absolute loan performance is not the main issue of declining SMB loan issuances; we believe a larger part of the issue lies in high underwriting costs. SMBs are a heterogeneous group and therefore the underwriting and processing of these loans is not as cost efficient as underwriting consumers, a more homogenous population. Business loan underwriting requires an understanding of the business plan and financials and interviews with management that result in higher underwriting costs, which make smaller loans (under $1M and especially under $250k) less attractive to lenders.

Read the full transcript:

LendingClub CEO Renaud Laplanche Testimony For House Committee On Small Business

Merchant Cash Advance just echoed through the halls of Capitol Hill. And so it’s become just a little bit more mainstream, perhaps too maninstream.


The Economics of Lending: Money vs. Goods and Services

May 21, 2013
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dvd or cash?If I were to offer you the choice between a free DVD with a retail value of $20 or a free $20 bill, which one would you take?

Unless the DVD was something you were going to buy anyway or unless it was a rare item that is hard to find, you’d probably accept the cash. I would too, and that’s because I can turn around and exchange the $20 for anything I want. This isn’t to say that someone wouldn’t accept a DVD and give you something of value in return. You could probably do this but it would be a hassle compared to buying something with cash. Cash is the ultimate liquid asset. It has the same numerical value to all that evaluate it and it is acceptable everywhere.

If this is the case, then why do governments set limits on transactions that only involve cash vs. transactions that involve cash in exchange for a good or service? The reference I’m making here is to usury. Many states govern the interest that can be charged on a loan. This is done to protect borrowers but in doing so, they end up hurting them.

For example:
A manufacturer spends $100 to create a commercial refrigerator, but they sell it to a business for $1,000. That’s equates to a fee of 900%. Once the business books it as inventory, they will attempt to sell that refrigerator to a consumer for an even higher price to make a profit. While it’s a nice windfall for the manufacturer, it’s capitalism at its finest.

But what if the manufacturer lent the business $100 cash in exchange for $1,000 back? Does that change the transaction significantly? In our example above, the manufacturer gave the business an item worth $100 and got $1,000 cash in exchange. The business hopes to sell that item for more and turn a profit but a couple things could happen:

  • Consumers might not be willing to pay more than $1,000 or anything at all for that model/make/color
  • The refrigerator could get damaged and lose its value

If these scenarios were to occur, the business may try to liquidate the inventory for a lesser amount and take a loss, but doing that might not be easy. The refrigerator might have to be inspected and appraised before a buyer is confident to make the purchase. This problem doesn’t happen with cash. People don’t go out and appraise the value of a $100 bill to determine if it’s worth more or less than $100. The other possibility is that the business can’t liquidate it at all and they end up losing the entire $1,000 they spent.

What’s interesting is that if the business had accepted a $100 bill in exchange for paying $1,000 at a later date, that $100 bill wouldn’t have the real risk (discounting hyper-inflation) of becoming worthless tomorrow or becoming the object of a difficult liquidation.

the $1,000 refrigerator questionSo when faced with choices again… would you rather take a refrigerator someone spent $100 to make and try to sell it for more than $1,000 or would you rather someone give you $100 cash and you do whatever you want to try to turn that into more than a thousand bucks? On the one hand you have a refrigerator which might have a decent retail market and on the other hand you have cold hard cash that you can do anything with to try and make the necessary profit. You might choose refrigerator but you might choose the cash especially if you had a rock solid idea for that hundred bucks.

If you’re an expert in your trade, you might be able to build your own higher-quality refrigerator for the same cost of $100 and be able to sell it for $2,000. Sure beats buying a crappy lower quality one and struggling to sell it for more than a thousand doesn’t it? Then you could pay the $1,000 owed and walk away with $1,000 in profit.

Sounds awesome except some states might deem the transaction illegal because to give a business $100 cash in exchange for $1,000 over a certain time period is usurious and predatory to the borrower. But selling a refrigerator valued at $100 to a business for $1,000 is okay, even if the business is never able to sell it.

In the eyes of a state, it is okay for a business to pay a 900% markup for an illiquid asset but it is dangerous to pay a 900% markup for the most liquid asset of all. I don’t understand it. If the idea is to prevent lenders from poaching borrowers or borrowers from making bad business decisions, then why is it okay for someone to sell a product for a lot more than they paid for it? Is a manufacturer selling a $100 refrigerator to a business for $1,000 usurious?

Perhaps your answer would be that a business owner wouldn’t engage in such a transaction if he/she didn’t believe it could be sold for more, either because there is an established retail market or because of sufficient market research. That is a weak defense because businesses get stuck with inventory they can’t sell all the time. Whether the market changed or it was just a bad business decision, Americans attitude towards speculation on a good or service is one of total acceptance. But give a man a dollar and he can’t be trusted to earn back more than a few cents on it. A legislator might evaluate these potential returns on a $1 investment like this:

Turn it into $1.05? sure!
Turn it into $1.15 maybe…
Turn it into $2.00? Let’s make laws to prevent people from thinking that way!

In many states, if you borrow a dollar so you can make three but it cost you a dollar in interest to make this happen, it’s illegal. But if you pay a dollar for an old banana peel with the hope of selling it for $3, that’s a business transaction.

I could rehash examples over and over, but where I’m going with this is that there are things like credit history and risk criteria that prevent people from borrowing a dollar at a relatively low rate. Naturally, the more risky the borrower, the higher the cost. After a certain level though, the law intervenes. If the amount of risk warrants a very high rate of interest, more than what is allowed by law, the government would rather the borrower get nothing than allow the transactions to go through. It’s a very sad position the government takes on its citizens, that the borrower is not capable of generating the return they believe or that that they lack the intelligence to know what they’re engaging in and therefore the transaction should be stopped altogether. In a utopian society, saving people from themselves might seem fair and just, but in reality there are millions of people and businesses with less than stellar credit, disqualifying them from borrowing at all because to compensate for risk would require a rate of interest disallowed by law.

At this time last year, 53% of Americans had credit scores of 700 or better. 700 is that magic threshold and it means that 47% of Americans are going to have a hard time obtaining credit or won’t be able to get it at all. When the laws were written to protect borrowers, I highly doubt the legislators understood they would be locking out almost half the country.

It’s ironic then that in times of financial crisis, government points the finger at banks for keeping credit tight, when it is nearly impossibly to free it up because of how regulated it is.

money exchangeCredit has been screwy the last few years because government intervention is wreaking havoc on the market. The maximum allowable interest rate on an SBA 7(a) loan maturing in less than 7 years is the Prime Rate + 2.25%. That would be 5.5% annually. FICO states that the odds of a borrower becoming delinquent on their loan (90 days or more behind) range from 15% to 87% if their score is less than 700.

How can you expect to make money if you can only charge a maximum of 5.5% when 47% of all Americans have a 15 to 87% chance of going delinquent or defaulting? You can’t and that’s why the Small Business Administration exists. In order to manipulate banks into making wildly unprofitable loans to businesses, the Federal Government via the SBA guarantees up to 85% of the losses banks are stuck with. It’s a bandaid solution to the broken market that usury laws create.

The SBA also empowers banks to crush private sector competition since many non-bank financial institutions do not participate in the SBA program and therefore need to charge vastly higher rates to compensate for risk.

But even the SBA has strict criteria on default coverage. Many borrowers do not meet the SBA’s criteria, leaving the bank unable to lend to them.

It is no surprise then that the end result of continued credit market dysfunction has led to non-bank financial institutions getting creative. If you can’t loan a man a buck in return for two, then buy 2 bucks worth of his future success in exchange for a buck today. That was the original basis behind Merchant Cash Advance financing and the concept is rooted in factoring. Americans accept the buy/sell arrangement in business no matter how much risk each party is taking and so if we start treating cash as an asset, of which there is nothing more liquid, then we’ve finally cured the disconnect of money versus product/service.

For those with heavy debt, critics point fingers at the lenders, disregarding the cash the borrower got as a seemingly empty asset with no value that disappeared over night, a trick they’ll conclude was all part of the lender’s plan to saddle the borrower with evil debt and interest charges.

Somewhere along the line, a few people stopped thinking about how they could turn a dollar into two and started thinking how they could use the dollar to pay for something they already got while worrying about the dollar and interest owed on it at a later date. As this psychology has taken root in our culture, people have painfully learned that the ability to borrow runs out and the reality of owing a lot of money interferes with the comfort of living the way they did before. Lenders have taken losses and legislators have enacted laws to prevent people from hurting themselves. It all comes back full circle as we wonder now why banks aren’t lending and people can’t get credit.

There are many solutions, some temporary, some long-term, some will help a little, and some will help a lot. All of the debates, arguments, and finger pointing don’t change the fact that no matter how much progress we make, there are people out there that are wondering how they can borrow a dollar today to pay for something they already got. Businesses borrow to pay for past due rent, pay off inventory, taxes, payroll, and equipment. There are instances when a cash infusion is appropriate because the business will bounce back and there are instances when a loan will prop an insolvent business up for a short while, only for it to finally fail because the profitability or cash-flow problems were never fixed.

In America we all understand the trading of goods and services for money, but when money is traded for money, we get confused. If you are willing to pay $1,000 for a refrigerator it cost someone else $100 to make with the belief that you could resell it for $2,000, then there is no reason why the manufacturer shouldn’t be able to borrow $100 and go direct to the consumer themselves. The $900 interest fee is justified. Let’s not forget that a competing lender will charge less to try and steal the borrower away. The market will takeover until the perfect balance is met between risk and reward. When we legislate away this natural process we cause dysfunction, creating the needs for bandaids like government guarantees to force a market into existence while disrupting all of the other ones.

Undo the regulations and inspire the masses to turn a dollar into two, a hundred, or a thousand! The possibilities are endless with cash. If you can’t think of a way to turn a healthy profit with the most liquid asset on Earth, then chances are your luck won’t be much better with selling refrigerators or anything else.

– Merchant Processing Resource on iPhone, iPad, and Android