Lending Club: Platform Success but P2P failure?
Lending club founder was able to build a robust lending platform against significant headwinds, but it's unclear if the resulting product matches the initial vision of a "peer to peer' marketplace.
The service that the Lending Club platform provides is an incredibly compelling one that we can all get behind: let’s all lend money to each other and keep the profits of those nasty big banks and credit card companies to ourselves. Who doesn’t want that, right?
In fact, at scale – the platform has the ability to drive significant value for all sides:
- In a short period of time and at a rate that is on average 24% lower than typically available commercially[1], loan recipients can refinance their credit card debt, take out loans for unbankable initiatives (either too small or too risky), etc.
- At the same time, investors can earn much higher returns than available in traditional marketplaces, and manage that risk through rich credit data and diversification.[2]
- As a broker, Lending Club takes on no loan risk and enjoys a nice cut for bringing these interested parties together
There are clearly both direct and indirect network effects here. Recipients directly benefit from having more investors on the platform and vice versa and everyone benefits from more data leading to more confidence in executing transactions. For these reasons, the story is much harder to sell before scale – all this value is only created if:
- Loan recipients can clear their loan quickly through a deep investor pool
- Investors have enough data to identify good investments and there enough good investments to spread their risk around (a key component of the model is to be able to spread risk across individuals in $25 increments)
- Lending Club doesn’t have to take on significant balance sheet risk itself
So how did founder Renaud Laplanche get Lending Club past these initial hurdles?
He started with the borrower side of the platform – this choice makes sense as it’s the easier sell. For the borrowers, the service only adds benefit whereas investors take on benefits and risks by joining the lending club platform. Because the speed of execution desired by this group would not be ready on day 1 – he went to those who were desperate and had literally no other choice: college students.
Laplanche launched the service in 2007 on Facebook as one of the site’s first applications (when the social media site was primarily geared towards college students). Because there was not yet any investors, he served those loans with $12m of funding raised from Angels.[3] While this turned out to be an excellent marketing move and buzz generator more broadly, ultimately it turned out that college students weren’t the best borrowers.
However, that quickly became the least of their worries as SEC negotiations restricting outside investors for 6 months put a stop on building out that side of the platform and a massive strain on the balance sheet of Lending Club, almost toppling the entire effort.[4] Eventually, the regulators sorted themselves out and the company continued to focus on the borrower side of the platform and building out the data and loan grading system necessary to bring in outside investors.
Ultimately, the investors came and the platform continued to grow, but at a measured rate. The reason for this is that at the end of the day, while the platform can deliver a lot of value to the “peer” investors – it also demands a lot from them. Even armed with the best data in the world, it still takes time, confidence, conviction, and patience to invest in these loans. Most everyday people, even if they have the money to lend, don’t necessarily have the time to figure out how to do it well.
For this platform to take off and reach dramatic scale, it really required a different kind of participant on the other side. In fact, Lending Club didn’t start to have hockey stick growth that made it a household name until 2011 when a third party professional investor raised a fund solely to invest on the platform.[5] Today, while there is still true “peer to peer” lending that occurs, for the most part it is “institution to individual” lending happening. In fact, the now disgraced founder of the site has moved on to start another similar site that is exclusively focused on this institutional lending.[6]
For me, this begs the question – is the peer to peer model I described at the outside of this post something that is truly achievable? Or is it simply too challenging to build scale off the backs of every day people lending money for fun?
Resources:
[1] https://www.lendingclub.com/public/how-peer-lending-works.action
[2] As an example, in the early days of the service newly issued five-year B-rated corporate debt was paying around 7.5%, with defaults averaging 3.4%. In comparison, creditors could earn 14.5% annually on five-year Lending Club notes, of which 4.9% have defaulted over the first three years. https://www.forbes.com/forbes/2010/1220/investing-lending-club-credit-cards-personal-loans-for-fun.html#34858732ea0f
[3]https://www.forbes.com/forbes/2010/1220/investing-lending-club-credit-cards-personal-loans-for-fun.html#34858732ea0f
[4] http://www.nvp.com/blog/perseverance-pays-off-the-lending-club-story/
[5] http://www.nvp.com/blog/perseverance-pays-off-the-lending-club-story/
[6] https://techcrunch.com/2017/04/06/lending-club-founder-renaud-laplanche-is-back-with-a-new-startup-and-60-million-in-funding/
Interesting article and a shame that retail investors in the US are missing out on an opportunity. Meanwhile, the UK, EU and Asia Pacific p2p lending markets are retail investor driven and companies such as Kiva are attracting retail investors in Latin America. I think that is largerly due to fewer regulatory barriers for non accredited investors for those markets. While retail investors in the U.S. arent participating directly, they may still be getting some exposure through institutional holdings.
Thanks for writing Liza! I think the question you pose at the end is really interesting. I think the origins of the accredited investor laws in the US stem from the fact that most people don’t have the expertise or any of the other things you mentioned (time, confidence, conviction, patience) that are requirements for managing and evaluating risk effectively. As a result, the US put in place restrictions on non-qualified investing (e.g., I don’t think most people can participate in IPO pre-sales or private security issuances). Interestingly though, I don’t think these restrictions ultimately applied to individuals when it came to Lending Club (i.e., no laws that I know of that prohibit me from participating), so maybe it’s some sort of hesitation specific in the minds of US consumers that makes them reticent to participate in direct lending. For LC at least, a pivot to focus on institutional lenders seems to make sense given that’s where the scale can be attained.
Thank you for a great article, Liz! I wonder how strong the network effect will be in P2P lending business. In China, there was a massive increase of P2P lending players. Between 2011 to 2013, P2P lending platforms increased from 10 to 800 (Source: “CreditEase: Taking Inclusive Finance Online”, HBS Case 9-316-151 by Michael Chu, Johns S. Ji and Nancy Hua Dai). Once there were funds available, borrowers don’t really care whether the platform itself is small or not it it offers competitive rates. I wonder whether it was the case in the US as well, and if not what made the difference between US and China. Maybe lack of appetite from retail investors as you pointed out?
I very much like the way in which you are framing the ending question of your blog post: “is it simply too challenging to build scale off the backs of every day people lending money for fun?” as I think you are nailing the main issue of peer-to-peer lending model. In my opinion, the customer value proposition for lenders is extremely low, to the point that it can be compared to a gambling experience or just a game “for fun”. I don’t believe lending platform will dominate the lending market, but will instead gradually disappear (or just become channels for institutional-to-individual lending) in favor or more hands-one investment platform like Kick-starter. In those platforms, peer-to-peer investors have the opportunity to read about a business idea and decide more consciously to invest in it, which make the decision more sound or at least the game more fun!