The Evolution of Credit: From Mesopotamia to Marketplace Lending

Backed credit

Lending is as old as civilization itself. Seven thousand years ago, in the Fertile Crescent known as Mesopotamia, Sargon the farmer had 100 apples. His friend, Hammurabi, had 10 bushels of wheat. They exchanged what they had and now Sargon has wheat and Hammurabi has apples. Everyone bartered to meet their needs. Then Sargon got […]

Backed credit

Lending is as old as civilization itself.

Seven thousand years ago, in the Fertile Crescent known as Mesopotamia, Sargon the farmer had 100 apples. His friend, Hammurabi, had 10 bushels of wheat. They exchanged what they had and now Sargon has wheat and Hammurabi has apples. Everyone bartered to meet their needs.

Then Sargon got a little creative.

He came to Hammurabi with a special offer: 60 apples in return for 10 bushels of wheat with the promise that at a future date, he will deliver another 60 apples to complete the deal. Now, Sargon has the wheat he needs, plus an additional 40 apples. With the extra fruit, he can take the seeds and plant more. In due time, he pays off his friend who is happy to see a 20% rise in income. Everybody benefits.

Thus, began the concept of credit.

It was only a matter of time before some other clever people decided to create a common medium of exchange to scale it up. Currency made it all easier. You could buy apples, wheat, and everything else with silver, gold, and eventually paper.

You could also borrow currency to create leverage. The credit system has underwritten prosperity from Mesopotamia, to the first paper currency minted in ancient China, the deposit and loan banking system which started in ancient Greece, the Renaissance fueled by the Italian Banking system, the first Credit Union in 1852, to the last time 1,000 Smartphones were shipped from Singapore to San Francisco backed by a letter of credit.

From then until now the process hasn’t changed. An individual goes to a lender asking for a loan. He fills out forms, provides information about his assets, income, and current debt levels. The lender reviews the information and makes a decision.

For the most part, lenders are financial institutions who take deposits, which they usually pay very little to depositors to hold, then lend out those deposits to borrowers paying them 10-20%. It has been great for the lenders, who haven’t had any incentive to change or innovate the process.

To pay back the loan plus interest, it’s the borrowers who must take risks. They are the innovators, so they produce. They are the ones forced to sweat.

Credit has propelled man forward from the stone age to the digital age.

The Revolution in Online Lending

The great advancements traditional lending financed came with a downside. The user experience was cumbersome, borrowers were limited to whom the lender decided was a worthwhile risk, and lenders benefited most. A lot of people were left out, and the lenders made huge margins loaning out other people’s money while the people who deposited the money saw very little of those returns.

The peer to peer lending model, launched by Prosper in 2006, introduced the most significant breakthrough in consumer lending. It transformed the lenders into innovators, reinventing the credit system to fix all of these imperfections.

Online lenders are productively disrupting the ancient credit model in 4 ways:

1. Utilize technology to give users a better experience.

An applicant for a loan no longer has to haul himself to a lending institution, wait on line, and fill out paperwork. Everything can be done in the comfort of the user’s home. The user can fill out forms online and submit them to an online lender in one click. The online lender can call information like credit scores and past income histories from its own computer, make a decision, and if approved, wire the loan directly to the borrower’s account.

2. Leverage new methods of gathering data to transform risk algorithms.

With vast amounts of data available at everyone’s fingertips, online lenders can now use new information to underwrite loans. Risk models can now be expanded to include new factors like social media, email histories, even mobile phone usage. Online lenders like Upstart have advanced lending models that go beyond credit scores to evaluate risk based on academic achievements. Cabbage underwrites businesses by looking at the lenders available Amazon information.

Expanding on the traditional credit score and debt to income models, online lenders are discovering a new class of prime lenders.

3. Diversifying sources of capital.

Traditional financial institutions are no longer the only business in town. Peer to peer lending lets individuals lend to other individuals. A borrower can now get money from multiple sources. Every lender is forced to be more competitive. Retail and individual investors can opt to invest in loans rather than put their money in a checking account. They can be just like any financial institution, making double digit returns on money originally designated for their checking account.

4. Increase profits for all stakeholders.

Automating more of the loan process requires less labor costs to service each loan. That creates productivity gains which translates to more profit for all parties involved.

For thousands of years human progress has marched forward under a credit system that benefits one party over the others. The emergence of a new system of credit that rewards all involved will propel the advancement of mankind to heights beyond our wildest imagination.

Sargon would be impressed.

Author:

Gilad Woltsovitch is the Co-Founder and CEO at Backed Inc., responsible for designing the company’s first-class platform, UX and UI. Before Backed, Gilad co-founded iAlbums, a semantic curation engine for media players in 2010 where he served as the company’s CEO from 2011-2014. In 2013, Gilad also served as the entrepreneur in residence for Cyhawk Ventures and joined the Ethereum project, establishing the Israeli Ethereum meet-up group. Gilad holds a Masters of Art Science and Bachelors in Sonology from the Royal Conservatory of The Netherlands in The Hague, University of Leiden.

Getting the Most From Investor Calls

non-monetary considerations

General Guidelines Your firm is in the market to raise capital. You selected an investment banker to represent you in the process. The firm’s vision, financial goals, strategy and performance have been documented for the investors to review. An information library, stocked with materials such as a flip book, financial statements, standard forms and contracts, […]

non-monetary considerations

General Guidelines

Your firm is in the market to raise capital. You selected an investment banker to represent you in the process. The firm’s vision, financial goals, strategy and performance have been documented for the investors to review. An information library, stocked with materials such as a flip book, financial statements, standard forms and contracts, company policies and procedures, and a financial model is available to potential capital providers upon signing an NDA. The preparation of these materials took weeks or perhaps months. Your banker sorted through his/her contact list of investors making dozens even hundreds of preliminary calls. This resulted in a short-list of potentials that want to setup a conference call with your company’s top management. At this point, the many weeks and months of work are finally paying off. Surely, the investor will recognize the opportunity of marketplace lending/fintech and want to invest, right?

Maybe, but remember the process is only getting started. Often company managers become hasty thinking all the preliminary work means a deal is close to consummation. For this reason, I always remind the client that the initial call is not to discuss the terms a deal. One should introduce themselves and the company, provide substance to certain key metrics and outline the firm’s overall strategy. Yet, I continually witness clients outline terms or discuss valuation too early in the conversation. This may make an investor feel pressured, suggest price shopping or even worse make your company appear desperate. For an investor’s point-of-view, this suddenly appears like a low-probability transaction. That pushes them away from your opportunity in favor of others.

Deals gain momentum throughout the process. Therefore, it’s important that companies executives continue building rapport with potential capital providers. Setting terms or deadlines too early may derail the momentum and work to your disadvantage. It’s a fragile balance keeping investors on track without pushing them too hard. This is a paradox for companies who try to capitalize from the immense investor interest for marketplace loans and fintech solutions by forcing answers before investors are ready.

Have a capital plan that matches your investor

Source: PeerIQ

What happened after the first-ever securitization of marketplace loans in the United States for Eaglewood Capital Management is phenomenal! From these deals, ECLT 2013-1 and ECLT 2014-1, came a flood of issuers Avant, Earnest, Marlette, Lending Club, Loan Depot, and Social Finance to name a few. PeerIQ estimates a cumulative issuance over $15bn at year-end 2016 (see graph) and an additional $6.3 – $11.2bn expected for 2017. The market is not only growing at an astounding pace, 50% or more annualized growth, but by all measures here to stay.

Angel investors, venture capital and private equity were the predominant form of capital just a few years ago. Now, securitization brings a new set of investors to the space. Money managers, insurance companies, banks, endowments, pensions, investment banks and others can now participate through the securitization market. That is a tremendous opportunity for marketplace lenders and fintech companies alike as access to these investors offers unlimited scalability and diversified sources of funding. It also demonstrates a general acceptance by the industry that there is a shift in the way financial services are delivered. Undoubtedly, this impacts technology providers as well as marketplace lenders.

Along with this new investor base come a different set of questions. For example, the focus for an early stage equity investor typically centers on strategy, scalability and making a multiple on their investment. Expect questions that reflect these concerns. Be prepared to discuss growth constraints, origination volumes, market size, technology, partnerships or other items relevant to the party’s investment objective. Work with your investment banker to develop potential exit strategies for the investor and have them evaluate the potential upside of your business along with the corresponding metrics for valuation. Develop a narrative on the market opportunity and how your company is positioned to monetize from it. Early stage capital is available for companies with huge promise and until few years ago, was the primary source of capital to marketplace lenders.

Diagram: Distinguishing Forms of Capital

 

Access to the public markets is a game changer. Securitization issuers and public companies benefit from cheaper sources of funding and the ability recycle their capital in exchange for standardizing procedures and disclosures. Correspondingly, we now have years of performance data based on billions of dollars of marketplace loans. Public listings are another source of information as the whole world can tap into the financial performance of a publicly listed company. This changes the conversation completely. If your company is this far along, expect questions such as underwriting guidelines, collection procedures, estimated loan losses, reporting procedures, cost of funding, profitability, performance measures and capital markets plans. Do homework on others and play into your strengths as an organization whether it’s underwriting, marketing, funding, growth potential, operational performance, customer acquisition cost, profitability, personnel or technology. Information is becoming more and more available and so as the industry evolves so should you. Be prepared and use your investment banker as a resource.

Allow the Investor to make their pitch

Let the investor talk. Beyond just being polite, listening enables one to learn more about a potential capital partner. This is not to be underestimated, especially with equity investors, who may have different visions for the company. Board meetings may already be challenging, and you want differences discussed before adding a new shareholder. If it is debt you seek, remember banks and debt holders can also be fickle. Too many times, we received calls from clients after banks, loan-flow partners or other creditors abruptly decide to leave a line-of-business or call a loan. So, while money is fungible, it may not be the only asset that a capital provider brings. Remember to be a good listener and ask questions that help evaluate non-monetary considerations such as cultural fit or strategic match. Your investment banker can often help by sharing their personal experiences with an investor.

 

Save the Structuring for Later

Don’t be discouraged by those who aren’t prepared to discuss details on the first call. The purpose of the initial discussions is to get to know the investor(s) and discuss high-level issues and concerns. Chances are that the counterparty has some interest but has not yet budgeted the time to dive into the materials. Why else would they be on the call?

Do not cause deal fatigue. Answer due diligence questions honestly but defer valuation questions to your banker. The banker should guide you regarding the timing of discussions related to deal terms Don’t take anything for granted until you receive an offer in writing; continue talking to other parties until you execute a formal indication of interest. The investment banker will help you compare and analyze offers once received.

This is merely a guideline to help maximize your probability of success. Of course, every situation is unique. Try not to get frustrated with the process. It may seem time-consuming and difficult but good deals don’t come easy. I hope you find the above helpful in finding a suitable investment partner and maximizing shareholder value.

Author:

Written by Phil Toth, Managing Director of Oberon Securities