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Lending Club Moving Forward With Small Business Lending

by Peter Renton on October 16, 2013

Five months ago an astute reader noticed a job ad on LinkedIn for a vice president of small business credit at Lending Club. At the time I confirmed with Scott Sanborn that they were planning on opening a dedicated small business lending operation.

Today, Lending Club announced they have finally filled the role for the head of this new division. Like many of the senior managers at both Lending Club and Prosper they have hired an executive from the banking industry. Sid Jajodia is the former head of small business lending at Capital One Bank.

So, Lending Club is clearly making progress on their small business lending operation and it looks like they are going to create their own underwriting model from scratch rather than acquire one of the existing online small business lenders. This is understandable as there is no true peer to business lender with a long track record, most of the companies have been in operation for less than a year.

I am excited to see what Lending Club comes up with here. I have made no secret of my interest in the small business sector and I am already investing in a dedicated small business lending fund. I hope to have some more information on Lending Club’s plans in coming weeks.

You can also read coverage of this news on Businessweek and San Francisco Business Times.

What do you think? Will you consider lending to small businesses on Lending Club? As always I am interested to hear your thoughts.

{ 22 comments… read them below or add one }

Brendan Ross October 16, 2013 at 10:27 pm

Peter, since this article came out, a half-dozen investors in my Fund have asked me for my thoughts on this topic. I thought I’d share my response here for your readers.

First and foremost, LendingClub’s entry into business lending is further validation for online small business lending.

Small business owners are the borrowers most under-served by banks, and they are therefore paying the highest rates relative to their credit quality. It’s an obvious imbalance that screams opportunity.

As the GP of the first fund to focus exclusively on online business lending, I was happy to see LendingClub post the job, and I’m happy they’ve found the right candidate.

There is so much appetite for credit from local businesses in this country that there is plenty of room for new entrants.

I’d speculate that LendingClub will take a direct approach vs buying from brokers, so they won’t really be touching the same borrowers as my first underwriting partner IOU Central.

If LendingClub’s current product lineup offers any guidance, they will most likely be doing monthly loans of 1-5 years duration. Once again, this offering increases the pie, since the current lenders I purchase from, IOU Central and QuarterSpot, are focused on 6, 9, and 12 month daily or weekly repayment loans.

In the time since I launched my fund, I’ve had conversations with online lenders launching platforms in consumer lending, business lending, solar, real estate, and more. There is no question that thought leading organizations like LendingClub will continue to change this industry, and I believe it will generally be for the better.

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Peter Renton October 17, 2013 at 9:02 am

Thanks for chiming in Brendan. I agree that there is plenty of room for many players in the underserved small business lending market. From what I have been hearing Lending Club will not be focusing on short term loans, so there will be very little crossover with your fund I expect. The great thing for investors is that they will have more options.

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Jason October 17, 2013 at 8:26 am

According to the Cleveland Fed, as of the fourth quarter of 2012, the value of commercial and industrial loans of less than $1 million—a common proxy for small business loans—was 78.4 percent of its second-quarter 2007 level, when measured in inflation-adjusted terms. Small business lending for companies with less than $1m in revenue are down 22% since 2009. See here: http://www.clevelandfed.org/research/commentary/2013/2013-10.cfm

Kabbage, On Deck, and Capital Access Network have done a great job of filling the void that was created after 2008 when the big banks stopped making small business loans and collectively they have lent close to $5 billion to small businesses. However, they only service one category of loans, which are short duration working capital loans and merchant cash advances.

There remains a huge void in the market for 3-5 year loans, which is Lending Club’s most obvious opportunity, since the duration and yields are very similar to their current offering (although the credit underwriting is likely vastly different). In the UK, FundingCircle has become the leading small business lender by providing this type of loan, which somewhat proves that the market exists.

I wish Lending Club luck on this new venture and I look forward to lending to their small businesses!

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Peter Renton October 17, 2013 at 9:10 am

Hi Jason, I have seen those numbers from the Fed as well. And there clearly is an unmet demand for reasonably priced, longer duration loans. What I think will be interesting to see is where Lending Club position themselves exactly. Are they going to go after those companies that could get a bank loan anyway? Or focus on those profitable companies who are routinely rejected by banks? I expect there will be a mix of both.

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Megan/faeriering October 17, 2013 at 12:03 pm

My question is are they going to be as bad in their underwriting of small businesses as they were of individuals when they first started? Just 3.5% ROI on all loans funded in ’08 (Source: lendstats.com).

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Peter Renton October 17, 2013 at 2:41 pm

Megan, I think that comparison is a little unfair. How many investments (of any kind) had a positive return in 2008? That year and the following year were truly extraordinary, unemployment went from 5% to 10% during that time period. I think it is a testament to the strong underwriting at Lending Club that they were able to provide positive returns to investors during such a challenging time.

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Brendan Ross October 17, 2013 at 3:21 pm

Totally agree with Peter.

I always EMPHASIZE how impressive that 3.5% number is.

While I favor business over consumer loans in my Fund, this whole P2P story started with consumer lending, and there is perhaps NO GREATER reason to like the asset class than to learn that it returns 6-10% in good times and delivered 3.5% in 2008.

Everyone now making a living in this industry owes a debt of gratitude to the incredible underwriting done at LendingClub in 2008, because we all use those numbers as an example of how this asset class performs under extreme economic stress.

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David Weinstein October 17, 2013 at 3:19 pm

The small business loans at Lending Club have the highest default rate of any declared “Purpose”. Will the new program somehow tighten the requirements? Will the lender somehow be compensated for the higher risk?

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Brendan Ross October 17, 2013 at 4:27 pm

I don’t think there will be a relationship at all between LendingClub’s consumer loans with a declared purpose of small business, and the lending product(s) they will develop around their forthcoming small business underwriting efforts.

Small business loans are underwritten using a combination of past six months business bank statements, business credit files, and personal credit scores.

The historical bank statements are especially important, because they tell the detailed story of the business, and LendingClub isn’t pulling these today.

The bottom line is that business loans with a personal guarantee are very different from personal loans used for a business purpose.

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dontvote October 17, 2013 at 4:06 pm

I’m a small business owner as well as an investor and I just popped onto this site to see what it’s all about. This structure is the same as most of the unsolicited mail I get offering me 50K working capital loans with daily payback (maybe from 10 different companies). The effective interest rates are significantly higher than a line of credit at a bank or even putting my purchases onto my credit cards (without the forced amortization of the credit card debt). As an investor this would be a good deal if you can source the small businesses but as a borrower I find this level of financing (esp in this rate environment) heart stopping. Let’s say that I’d fire all my employees and darn near shut my business before I took a loan like this.

Oh, the effective interest rates I was offered (simple calculation of total payback/net loan amt annualized):
6m loan of 50K: 33% annual interest
12m loan of 50K: 29% annual interest

Not compelling for a borrower, compelling for a lender, I suppose. I’m not sure what the differentiation between this company and the others in the tank is, except for the fact that Peter is an investor.

I think the compelling thing about p2p lending is that borrowers can get lower rates and investors higher returns because they are taking a bit of the bank’s spread. This ‘opportunity’ looks to be the well established version of a payday loan for a small business.

dontvote

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Peter Renton October 17, 2013 at 4:12 pm

Dontvote, Which site are you talking about exactly?

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dontvote October 17, 2013 at 4:26 pm

See, this is why I’m a comment-or and not a blog-or. I’m talking about IOU CENTRAL from your link above: http://www.lendacademy.com/new-fund-invests-in-small-business-loans/. If you can move my comment please do otherwise, sorry for the confusion. Two windows open is apparently one too many for me.

It’s twice as funny since apparently I didn’t read the post too carefully either.

TL;dr: Brendon’s fund: no idea, seems cool; IOU CENTRAL: same as all other directly lenders in the space and ugly rates for borrowers.

dontvote

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Peter Renton October 17, 2013 at 8:56 pm

I wouldn’t call the rates charged by IOU Central payday lending type rates – they are no higher than some of the rates charged on Lending Club and Prosper. You just need to do some exploration of some of the merchant cash advance offerings online to see APRs two or three times the rates charged by IOU Central.

Having said that, they are certainly a lot higher than bank loans. But there is only a small percentage of business who can qualify for bank loans. So, what are the alternatives for these other millions of businesses? They could use credit cards and many do. But if you need $50,000 quickly then credit cards are not going to work.

I used to be in the printing business. This is a machinery and equipment intensive business. If one of my pieces of equipment broke down and needed to be replaced my whole production ground to a halt. I needed a replacement fast. I would certainly be willing to pay the rates listed above to pay for a replacement so I could get my business running again. Luckily, this never happened to me but I can certainly see situations where taking out a loan like this would be a prudent business decision.

I would be interested to hear Brendan’s take on this because he is a lot closer to these business loans.

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Brendan Ross October 17, 2013 at 9:26 pm

Businesses gratefully accept and assiduously repay these loans every day. Why do they do it? Let’s look at an example.

Let’s say a dentist is considering adding two new hygienist stations to her office. For easy math, let’s pretend that fully outfitting the stations will cost $100,000 total. Our dentist’s patients are flying first class!

If our dentist takes a one year loan at a 30% interest rate, she will pay a total of about $115,000 over the course of the one year period. Why not $130,000? Because this is an amortizing loan, so the principal is going down with every day’s payment.

If it was a “balloon loan” with a single payment due at the end, then at a 30% interest rate it would cost $130,000, but it is an amortizing loan, so each day the principal decreases, just like with a home mortgage.

The $115K will break down into 248 payments, or $464 every business day.

Is it possible for this dentist to earn $464 extra per day on two hygienist stations? I think we can all agree that she can!

So the dentist adds the chairs, makes just a little profit in the first year, and then has 10 or 15 years use of her stations with no more payments.

As a side benefit, the economy just added two hygienists, not to mention the people who manufactured and delivered the stations’ equipment.

To sum up: small businesses often have high margins, so they can generally afford to borrow at higher rates. Lenders need to charge these rates in order to cover the cost of underwriting these small loans. And finally – investors need higher, safer yields than they can get in the stock and bond markets!

Dan B October 18, 2013 at 3:13 am

Peter…………..Just so I understand. Are you saying that when you were in the printing business you couldn’t come up with short term $50k & would have gladly resorted to paying 30% interest? I’m just asking because that is what it sounds like you’re saying. Or are you just throwing it out for “illustrative purposes”………….you know, kind of like Chinese GDP numbers?

Peter Renton October 18, 2013 at 9:00 am

Yes Dan, I am saying in the early days of both my printing companies it would have been hard to come up with $50K quickly if I really needed it. But I believed in the eventual success of both businesses so I would definitely have paid 30% for a $50K loan had I needed it. Luckily I didn’t, although I did rack up personal credit card debt on my first business to the tune of around $12K I believe.

And Brendan, thanks for the detailed example, that is most helpful.

dontvote October 18, 2013 at 12:00 pm

Brendan,

I agree that businesses do accept and repay this money every day. Payday loans are common as well. So are people living with crushing credit card debt. Many people spend close to 100% of their total earnings on basic necessities plus debt service, including small business owners. I also agree that there are uses for these types of financing that are fine. I don’t think I agree with you that small business margins are high. Businesses with strong cash flows and high margins would not be customers of these loans (they would go to a bank, expand credit card financing options etc.).

I’d like to expand/correct your example a bit:

The interest rates I was offered on IOU Central were 30% effective rates. (Borrow 100K, get actual cash of 95K and total repayment is 123.5K, you can recreate the calculation on their site). If our dentist needed 100K he would have to borrow $105,208, get cash of $100,000 and repay $130,000. Your daily repayment is actually $525.

The first class chairs that the dentist put in have some costs associated with them, such as rent, insurance, payroll etc. Lets properly assign some kind of profit margin to the business. Lets say this dentist ran his practice with a margin of 30% (http://www.cbsnews.com/8301-505144_162-37044569/why-your-dentist-costs-so-much/). So our dentist has to make $1,750 *per day* income _in excess of his normal business_ from these chairs just to keep up with our loan payment (that’s an instant sales revenue increase of $437,500 overnight!).

At $100 per cleaning (http://www.humanaonedental.com/dental-health-articles/teeth-cleaning.asp) that’s an average of 18 appointments per day for the two chairs. Maybe that’s possible. I’m not a dentist/hygenist but I’ve never seen that kind of action in my dentist’s office.

Maybe he should go for the 20K chairs instead. That would make all the numbers look better, except for the interest rate :).

Peter,

Saying that there are companies that charge EVEN MORE interest isn’t really relevant. The interest is high.

There is certainly room between bank loans and iou centrals (and merchant loans and loan sharks) for a profitable business like lendingclub to do some good work for both investors and borrowers.

dontvote

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Dan B October 18, 2013 at 3:55 pm

Dontvote makes some very good points. A lot of small businesses aren’t dealing with the volume or the high margins that Brendan seems to be implying. His example is not even remotely average. The volumes that Brendan’s dentist is suggesting is also not something that the snap of fingers or a little bit of advertising will bring. I know someone whose been establishing her practice for 5 years now & she shares 3 dental offices in 3 adjacent cities because the volume just isn’t there for her to have one location to herself in high rent SF Bay Area.

Also………..talk to any small business owner in the restaurant business & they’ll paint you a picture that doesn’t contain anything close to “high margin”. There are many other examples.

Sure there are of course a number of high margin small businesses. But like Dontvote said, these guys have other loan options under 30%…………especially if they’re doing good volume. That is (in a round about way) what I was trying to coax out of Peter in my earlier comment when he declared he was glad to pay 30% if the need arose. A declaration I still find hard to believe, no offense.

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Peter Renton October 18, 2013 at 4:34 pm

Dan, Maybe one day we will get the answers we are seeking here. Someone will do a study of these companies taking out loans at 25-30% and see how it impacted them long term. Did they become more successful businesses or eventually go out of business. I suspect there will be more more of the former than the latter.

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Dan B October 18, 2013 at 5:57 pm

Peter…………Whether a company succeeds or goes out of business after taking these loans is hardly the issue here & a curious response to the issues & real world specific examples I cited. I would suspect that any small business owner that takes a loan & doesn’t realize the terms of that specific loan would drive them out of business……………..will probably go out of business soon anyway because they’re a little bit, you know, naive to put it mildly. So I don’t see your point.

My point is that the sweet smelling scenario that Brendan Ross cited (as if it was somehow average) & your apparent cavalier concurrence with that scenario is in fact unrealistic & only representative a rather small sliver of the huge amount of small businesses out there……………….most of which don’t have the types of high margins that make these types of loans tenable or desirable. And these non high margin businesses are the ones that have fewer options.

On the other hand, a dentist who can add 2 chairs, snap his fingers & do the volume Brendan cited is likely experiencing so much pent up demand ( for whatever reason) that he/she is an outstanding credit risk at 15%, has many other options & need not pay 30% imo. It’s not a matter of whether the rates will drive him out of business or not.

The other reason I think your comment about success or failure is a bit flippant is because both of us have owned our own businesses & we both know there are many factors that contribute to its success or failure…………….& only one of them is whether we took this or that loan. I ran my last business for 17 years & started it with $3000 & an Amex card. Turned a profit within 2 yrs. It’s not all about the money, as you well know.

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Peter Renton October 18, 2013 at 4:28 pm

Dontvote, First, the reason I said that there are companies that charge even more was to make the point that this is not payday lending in my opinion. This falls somewhere between payday lending and a bank loan. Yes, the interest rate is high, but I still believe these kinds of loans are often a win-win for both the investor and the small business.

While I am not going to refute the numbers in your example, there is one point I want to make. Both you and Brendan are assuming this dentist must recoup the entire cost of this equipment during the loan period or one year. I have no idea of the life of dentists chairs but I would expect 10+ years wouldn’t be uncommon. When looking at the real life of the chair this loan makes more sense in my opinion.

Now, obviously if a business can obtain a bank loan at 6% then they most certainly should. But for starters, banks don’t like loans of $100,000 or less. Their fixed costs are too high to justify these small loans. Which leaves business owners looking for other alternatives and companies like IOU Central filling the void. How high is too high? That will vary depending on the business. But I still maintain these loans can be a sound business decision for the owners obtaining them.

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dontvote October 18, 2013 at 6:20 pm

Two things to wrap this up…

1. Banks don’t like 1 year loans, that’s why lines of credit were invented. Banks routinely open lines of credit for 100K and under (though of course they PREFER 1mm and over). This costs the bank almost nothing over funding. They also offer credit cards to businesses that can generally bridge this funding gap. For a real business (operating, profitable), actually making money, who isn’t in trouble and who hasn’t already maxed out their other credit opportunities there are lots of credit options under 100K. These loans, in my opinion, especially target small businesses who either aren’t savvy enough to explore their options or are in trouble. They charge well above market rates to each type of business, hoping that one pays for the other and that in my opinion is predatory. The guys who charge EVEN more I hold in even lower esteem. Let me be clear that I don’t think this business shouldn’t exist, I just would never pay this much for money and I find it sad when people feel they are forced to. I also don’t think direct mail is awesome but I don’t think that it should be outlawed.

2. Peter, you’ve hit on another significant complaint I have with this type of funding. This example DOES have to recoup the entire cost of the equipment because you have to pay the loan back in 12m by design. If this was a 5 yrs loan it would be different. You can make the argument that being overcharged by 30% on a piece of equipment isn’t so bad when you look at it’s profitability over 10 years but that’s a bullshit argument when you consider how profitable your business could have been if it purchased 1.3 units of the equipment instead of paying that .3 to IOU (and SERIOUSLY, the name? maybe kneecapper LLC?).

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