Lending Club and Prosper are going through a rough patch. Renaud Laplanche, the CEO and founder of Lending Club, just resigned amid allegations of financial irregularities, while Prosper recently laid off more than a quarter of its employees.
But those are only the ripples on the pond’s surface. What’s going on underneath is that Wall Street is losing faith in the business model – that is, losing faith in the quality of the loans made on the Lending Club and Prosper platforms.
Not long ago, Wall Street financial institutions couldn’t get enough of Lending Club and Prosper loans. Now the same institutions are cutting back and the effect is severe.
To me, there are two lessons.
This is a Brand New Business Model, and It’s Going to be a Bumpy Ride
Marketplace lending started with the observation that banks pay much less interest to depositors than they charged to borrowers, and that technology should allow someone to decrease that spread, making a profit in the bargain. Lending Club and Prosper grew by substituting proprietary algorithms for traditional bank due diligence. The algorithms seem to work,and institutional investors rushed in.
But marketplace lending has been around for less than 10 years and nobody knows how the algorithms will perform during a down cycle. It’s not a big surprise that Wall Street money managers, aware that the economy might be due for a downturn, are hedging their bets.
The fickleness of Wall Street money managers doesn’t mean the business model of Lending Club and Prosper is broken. To me, there is little doubt that algorithms and big data will replace traditional bank due diligence – not only in consumer lending, but in other parts of the Crowdfunding ecosystem as well. But the algorithms and business models might well have to be adjusted, and nobody should expect a straight line from A to Z.
The fickleness of Wall Street money managers leads to the second lesson.
Wall Street is Fickle
Soon after launching a Crowdfunding platform, you realize there’s a choice where you look for investment capital. You might have begun with the idea of raising money from the public – that is, from retail investors – but you realize quickly that you can also raise money from institutions.
Raising money from institutions is often much easier because, well, institutions have more money. But there are a couple downsides:
- You started off hoping to become a household brand, but if most of your money comes from institutions you risk becoming merely a deal originator for institutions, with far less clout and long-term brand value.
- You started off idealistically hoping to bring high-quality investments to the public, but if most of your money comes from institutions, you aren’t.
The experience of Lending Club and Prosper reveals another downside: Wall Street is fickle. If you build your Crowdfunding business based on large investments from a handful of institutional investors it’s a lot of fun on the way up, but when the institutions pull the plug it’s a hard fall.
Ideally, a Crowdfunding platform can have it both ways, using institutional money to build the business while building its brand with the retail public, to the point where the business can survive and prosper even if institutional tastes change. I don’t know whether that’s possible, but I hope so.
Questions? Let me know.
2 thoughts on “Trouble In Paradise: Lending Club And Prosper”
Mark, great article. Dara Albright has another good commentary up today on Crowdfund Beat. As a platform that is 100% funded by retail capital, and the only one qualified by the SEC to allow non-accredited investors to participate directly in real estate loans, we at Groundfloor wholeheartedly concur with your conclusion and Dara’s.
Our industry is suffering from a structural flaw, the sugar high of too much institutional capital too soon. A broad base of retail capital is more difficult to aggregate at volume, but as Dan Ciporin showed at LendIt, more stable and reliable. No one is talking about this yet, but structures based on retail capital are more accountable as well. There are more shoes to drop, we can be sure.
Co-Founder & CEO
Thanks Brian. You guys continue to do a great job at GroundFloor.