Prosper Funding LLC is Approved by the SEC

Prosper received a late Christmas present from the SEC last month. After 10 months and eight revisions their registration for Prosper Funding LLC was approved on December 27th. This is great news for Prosper investors.

I have had several conversations with Prosper management over the last week to try and get a handle on what this all means for investors. I have also read through a lot of the final amended S-1 registration. It is a complex legal structure that I will do my best to explain to you.

What is Prosper Funding and why is it important?

Right now the legal entity at Prosper is officially called Prosper Marketplace Inc. (PMI). Prosper Funding LLC is a new legal entity that offers bankruptcy protection for investors. In the unlikely event of a bankruptcy at PMI the structure of Prosper Funding will allow notes of investors to be protected from creditors.

One of the common questions I hear from new investors is what will happen to their money if Prosper or Lending Club were to go bankrupt. Prosper has now addressed that problem with Prosper Funding by providing a new level of protection for investors. That is why Prosper Funding is so important – it is the first time a p2p lender has provided this kind of protection for all investors.

How is Prosper Funding different from PMI?

All of the loans are currently held on the balance sheet of PMI. There will be an exchange at the end of this month when these notes will become part of the balance sheet of Prosper Funding. So, this means that the bankruptcy protection will be retroactive to all notes currently outstanding. Also, once this new structure has been setup all new loans issued will become part of Prosper Funding.

The new structure is explained in part by this diagram from the S-1 filing (you can click on the graphic to view it at full size).

Prosper Funding explanation

For practical purposes the only real change is what happens after the loan is originated. Right now WebBank originates all the loans then sells and assigns them immediately to PMI. But going forward WebBank will sell and assign the loans to Prosper Funding. Monthly payments from borrowers will now be paid to Prosper Funding.

How is Prosper Funding able to offer bankruptcy protection?

This is where it gets a bit complicated from a legal standpoint but here is a quick summary from the prospectus:

Prosper Funding has been organized and will be operated in a manner that is intended (i) to minimize the likelihood that it will become subject to bankruptcy proceedings, and (ii) to minimize the likelihood that it would be substantively consolidated with PMI, and thus have its assets subject to claims by PMI’s creditors, if PMI files for bankruptcy.  This is achieved by placing certain restrictions on Prosper Funding’s activities, including its transactions with PMI, and implementing certain formalities designed to expressly reinforce Prosper Funding’s status as a distinct corporate entity from PMI.

There is much more detail in the prospectus which I encourage you to read if you want to know more about how it all works.

Do all employees at Prosper become employees at Prosper Funding now?

No, Prosper Funding will have no employees. It will have its own officers and board of directors as required by the SEC. Two of the five directors will be outsiders not affiliated with Prosper. Prosper Funding will retain PMI to run the platform and service the loans so all employees will remain with PMI.

How is Prosper Funding different from LC Advisors?

As many readers will know Lending Club has had a bankruptcy remote vehicle for almost two years now. It is through their wholly owned subsidiary called LC Advisors. LC Advisors buys notes through a private Special Purpose Vehicle into two funds that invest in Lending Club notes. The minimum investment in these funds is $500,000 and it is the preferred investment vehicle for most large and institutional investors at Lending Club.

Now, I couldn’t really begin to explain the legal differences between the two bankruptcy remote structures but I can say this. At LC Advisors the notes are held in private funds and it is these funds that provide the protection for investors. At Prosper the new issuing structure itself is what will provide the protection – so all investors, large and small are protected.

What would happen now in the event of a bankruptcy at Prosper?

What is different now is that Prosper Funding owns the loans. Prosper Funding will have very limited scope in its operations and so will incur very little debt other than the loans themselves. Furthermore, as it was explained to me, no other creditor can insert themselves between the lender and the loans.

Now, in the event of a bankruptcy at PMI, it would not be a smooth process. The S-1/A registration goes into detail about different possible scenarios, many of them dire. PMI owns the software and hardware that runs the platform so if PMI could no longer operate the platform new loans would stop being issued at least temporarily. But there is a backup service provider in place so payments should still be processed from borrowers and distributed to lenders. While the investor money should be protected there would likely be a great deal of disruption if PMI were to enter bankruptcy.

The main point is that the likelihood of significant principal loss with a bankruptcy is much smaller now. Can Prosper guarantee no principal loss for investors? Of course not. There are no guarantees for investors outside of FDIC insured investments. We should keep in mind that peer to peer lending contains a level of risk. With this move Prosper has reduced that risk but the risk is certainly not zero.

All investors should be receiving an email from Prosper in the next day or so explaining this change. This new structure should be in place by the end of the month I have been told. So maybe February will see a big influx of investor money into Prosper. That would certainly be welcome news after the last three months.

Comments

  1. mrssmith says

    I got the email from Prosper explaining this. It certainly makes me FEEL like my investments at Prosper are safer now compared to Lending Club. But I’m interested to see if this news is really influencing existing P2P investors in investing more in Prosper vs. Lending Club. Which platform do you put more of your money in? Will you change given this news? Right now I’m almost 6:1 LC to PMI…

  2. RJL says

    In Prosper’s email, they noted, “The new offering includes a number of new protections for you, from the insulation provided by PFL’s structure to an actual lien on the loans which correspond to the Notes in your portfolio.” Can you explain the part about the lien any further?

    I do think this is a huge development as it answers probably the most common question asked by new P2P investors …

  3. Gary in Irvine says

    This is really awesome news for lenders. It will undoubtedly bring in more large investors, and probably a lot of Lending Club lenders as well.

  4. Kevin says

    I got an email today with the subject “Prosper available in Michigan, effective February 1″

    Music to my ears. I’ve been stuck using folio to get my peer-to-peer lending fix. I wonder if this means Lending Club is not far behind. I started peer-to-peer investing in 2008 but near the end of 2008, Michigan outlawed directly investing loans.

  5. CA-Lender says

    Peter,

    Do you remember the 2001 bankruptcy of Pacific Gas & Electric (utility company)?

    In short, right before their “strategic bankruptcy” they moved $1B or more into Pacific Gas & Electric Corp (the holding company) and filed the BK for the utility company, making the cash in the holding company safe from credits.

    Seems like a very similar structure to what PMI did with setting up PFL.

    • says

      I don’t remember about the PG&E bankruptcy. The difference at Prosper is that I don’t think a bankruptcy there is imminent or even likely. But it does give the investor more protection in case the worst happens.

  6. Lovell says

    Peter, I’m a bit embarrassed, I didn’t know anything about any of this market until tonight/this morning..I used to deal with guy with a similar model in Mexico years ago….Question: why is the deal flow at LC so much higher than Prosper? Also, what if their was principal protection provided to investors….along with a Bankruptcy Remote Structure….would such an entity attract more capital than LC? Also, Folio…..my mind is racing with structures…..is Folio itself an independent clearing house to by P2P paper on the secondary market and….what is the total value of loans that are seasoned 12-24 months? I want to raise capital to invest in this….I specialize in Bankruptcy Remote Transactions. I can create a structure that will pay the High-Grade Fixed Income investor 2% with principal and interest guaranteed and then generate cashflow to invest in Folio paper…thus creating risk capital to invest in risk. We should talk…..you seem to have the most insight I have read tonight….email me.

    • says

      You have a lot of questions here. I will try and answer every one.

      The deal flow at Lending Club is so much higher than Prosper because they are the clear industry leader in terms of size and are more successful at attracting investors.

      There is no bankruptcy remote structure in place for individual investors, but investors through their LC Advisors fund enjoy that protection and many SPVs that invest in Lending Club also have that. Since Prosper put in their own bankruptcy remote vehicle they have enjoyed very rapid growth.

      Folio is a secondary market that is functional but hardly robust. Large investors do not use it because there is no market for large notes sizes of $500 or more.

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