01 Sep 2016

The Big Business of Little Loans

Commercial online lenders are growing up—and getting attention from banks and regulators alike
Re: Kelvin Teo (MBA 2016); Reynold Wijaya (MBA 2016); Evan Baehr (MBA 2011); Will Davis (MBA 2011); Karen Mills
by Nancy Miller


Illustration by Alvaro Dominguez

Before launching Funding Societies, a crowdfunding platform for small businesses in Singapore and Indonesia, Kelvin Teo and Reynold Wijaya (both MBA 2016) visited major online lenders in the United States: SoFi, Lending Club, and Funding Circle, among others.

It was a wide circle. These startups are part of a new ecosystem filling the void left by traditional banks that don’t want to lend to small businesses because they are too risky or because interest rates are too low to make money, says Karen Mills, former administrator of the US Small Business Administration and now on the faculty at HBS. The situation worsened during the 2008 financial crisis, and lending to the sector has never really recovered.

Armed with proprietary algorithms and can-do attitudes, though, alternative lenders—marketplaces, crowdfunders, and peer-to-peer (P2P) organizations—are redefining the market: In the United States, 22 percent of businesses with revenues between $100,000 and $1 million turn to online lenders for loans, and 30 percent of even smaller businesses go online for loans, according to a 2015 survey by several Federal Reserve Banks.

Amid the excitement, abuses have also appeared, with some online lenders reportedly charging as much as 50 percent in interest on some short-term loans. It’s been enough to attract the attention of regulators, with everyone from the Consumer Financial Protection Bureau to the Department of Treasury taking a look at these upstart lenders. Funding Societies’ Teo says the attention can only help the sector: “Regulations would boost investor confidence about P2P and P2B [peer-to-business] lending and set the right operations standard, differentiating quality platforms from the rest.”

Ensuring that quality, Teo says, means focusing not only on growing fast but also on growing well. For Funding Societies, that means a borrower must have at least $250,000 in revenue and meet with a loan officer before the Funding Societies team invests in it. In its first year of operation, the company has not had any defaults on $7.2 million in loans—large for a budding market like Singapore.

At Austin-based online lending platform Able, founders Evan Baehr and Will Davis (both MBA 2011) have devised their own novel incentive to ensure repayments: social and familial pressure. Able will reduce rates on loans if borrowers convince friends and family to back them as well. Baehr and Davis came up with the idea when their first startup was on the brink of failure. They weren’t very concerned about losing institutional money; that’s just business. But losing your parents’ money? Your friends’ money? That weighed on them.

So far, so good. This year Able is on pace to lend $100 million, with zero defaults in its nearly two years of operation. Baehr and Davis estimate that Able has saved borrowers $31,000 per loan on average as a result of its risk-sharing model. And they are creating a unique database on consumer behavior—where lenders can find a new way to measure creditworthiness—that could upset the entire credit scoring industry.

As for the banks that spurned the little guys? South Asia banking giant DBS of Singapore has struck a deal with Funding Societies to refer clients it can’t help now. In return, Teo says Funding Societies will refer clients to DBS when they are mature enough for “grown-up” banking services.

Ditto Able. “We are working with over 100 partner institutions,” says Davis, adding that these partnerships—from banks to incubators—are critical. Despite all the press, Baehr notes that “most [borrowers] don’t know about the online options,” and partner institutions are critical in spreading the word on alternative lending for small businesses.

From Baker Library:

Learn more about the alternative lender market. Read what The Fed, The Treasury, Morgan Stanley, and PwC have to say about peer-to-peer lending, online marketplaces, and the experiences small businesses face when trying to secure funding for growth. Take a step back in time to learn about the origins of the credit industry by exploring Baker Library’s exhibit “Buy Now, Pay Later: A History of Personal Credit.” Attending reunion this Fall? Swing by Baker’s presentation on Saturday for a first-hand look at a RG Dun & Company credit ledger from the 1800s. Learn more about how Baker Library can help you with your information needs.


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