StreetShares is a unique small business lender. They have only been around for a couple of years but they are quietly building a business model that has never really been attempted before in this industry. They have created an affinity model that helps build a community between borrowers and lenders that leads to real benefits for both parties.
In the latest episode of the Lend Academy podcast I talk with both co-founders of StreetShares and go into some detail about what makes their business different including their new offering for non-accredited investors.
In this podcast you will learn:
The role of the JOBS Act in the founding of StreetShares.
How their background in the military shaped the idea for StreetShares.
The loan products offered by StreetShares and what differentiates them from the competition.
The typical small business borrower coming to StreetShares.
How their unique affinity approach works.
Why this affinity approach is a lower risk way to lend.
Can this affinity group be applied to groups beyond veterans.
The typical investors on the StreetShares platform today.
Why they believe it is important for StreetShares to invest in every loan.
How their new Reg A+ offering works for non-accredited investors.
Why they decided to offer a flat 5% for their Business Bonds.
Why StreetShares has been called the first marketplace lending credit union.
Why the affinity model leads to a far lower cost for borrower and investor acquisition.
Why they decided to go with the reverse auction model for their accredited investors.
The impact of the slow down in the capital markets on StreetShares.
[expand title=”Click to Read Podcast Transcription (Full Text Version) Below”]
PODCAST TRANSCRIPTION SESSION NO. 71: MARK ROCKEFELLER & MICKEY KONSON
Welcome to the Lend Academy Podcast, Episode No. 71. This is your host, Peter Renton, Founder of Lend Academy.
Peter Renton: Today on the show, we actually have two guests. I’m delighted to welcome the two co-founders of StreetShares, Mark Rockefeller who is the CEO and Mickey Konson who is the COO. These gentlemen met about three years ago and they had a shared vision, they wanted to do something about the lack of capital that was available for small businesses and they created StreetShares which is really one of the more unique companies in our space. They have a very unique approach that they call an “affinity approach”, both on the borrower and investor side. We’ll get into that in some detail. Now they also have made their investment available to non-accredited investors recently, that’s also something that’s quite unique. I’ve been an investor for over a year now, I’ve got to know the platform pretty well, I spent some time with Mark on our recent trip to China and I found them a fascinating company so I wanted to get them on the show. I think we can all learn a lot from StreetShares. Hope you enjoy the show!
Welcome to the podcast, Mickey and Mark.
Mark Rockefeller: Thanks Peter, great to be here.
Peter: I guess let’s just get started. I’d like to start with each of you to just give a little bit of background about yourself, let the listeners know kind of where you come from, sort of your career arc before you started StreetShares.
Mark: Yeah, sure. This is Mark, I’ll go first. This is Mark Rockefeller, I was in the military for nine years, was a military lawyer, a JAG Officer which most folks only know what that is if they’ve seen the movie with Tom Cruise in it and was a military prosecutor and so helped…served across the globe, but had the chance to serve in Iraq. The most interesting job was…actually worked as a criminal prosecutor working under General Petraeus and bringing charges against terrorist suspects in Iraq, so sort of a domestic war crimes tribunal. That was rather interesting work for a young prosecutor.
Peter: Indeed, indeed.
Mark: I was in the military for nine years and then got out and went to work at the DC office of a Wall Street law firm called Milbank, Tweed, Hadley & McCloy so that was basically a securities and bankruptcy type litigation firm, dealt quite a bit with the Lehman Brothers bankruptcy and the aftermath of that, trying to put the pieces back together a little bit and get some investors their money back.
And then in 2012, the JOBS Act passed and I think like a lot of people, took an interest in the potential within the JOBS Act from an access to capital perspective. I have always been interested in opening up some of the securities that are only available to wealthier people, opening those up to the general public and so took an interest in all things, you know, sort of crowdfunding, peer to peer lending, JOBS Act related and then it was at that point when I had sort of a germ of an idea for StreetShares. I was able to meet with Mickey and then he and I began to iterate on the this idea that has since become StreetShares.
Peter: Okay, so then…that’s a fascinating kind of way you sort of approached this. I imagine going from terrorist suspects to Lehman Brothers must have been interesting (laughs).
Mark: Right, but they have some things in common, I imagine (Peter laughs).
Peter: Well let’s not go there (laughs). Anyway Mickey, what about you, what’s your background?
Mickey Konson: Sure thanks Peter, happy to be on. So I’m originally from South Africa, my accent is only tangentially similar to yours, but I worked at McKinsey for a few years over there doing a lot of work in various African countries in the late 90’s, came over here and joined Capital One in 2001. I spent a lot of time there helping to build out their small business unit where I built out all the credit functions and ended up kind of helping to run the global operations of that business.
I had moved on in my last few years to help with the acquisition and integration of various banks and had overall credit responsibility for the retail bank at Capital One in the consumer and the small business side. Similar to Mark, I was pretty intrigued by the JOBS Act and was trying to think about how to get back into small business at a time where all of the sort of big banks were really starting to pull back from that space and so was thinking about doing a funding startup in the business space when Mark and I met. So that’s my background and how we got together.
Peter: So how actually did you meet? Did you meet with the idea of starting a company together or what was the genesis of it?
Mickey Konson: It was blind date (Peter laughs).
Mark: You know, we did, there was a mutual friend who actually heard both of us talking about the JOBS Act and peer to peer lending and Lending Club and Prosper and sort of the rapidly growing industry. This was back in late 2012, early 2013 and so he said you guys have to get together, you guys have to meet. So we met for breakfast one morning in a local diner here outside Washington DC and as we say the waffles were stale, the coffee was cold, but the conversation was actually pretty interesting and began to iterate on this idea around building a marketplace lending platform, but one that was really oriented toward where we thought the industry was going as opposed to where it had been in particular and I’m sure we’ll discuss this a little bit, this idea of using affinity groups to de-risk the lending process which the JOBS Act now made possible because you could bring in retail investors and then have them match these loans. So that was the original idea and like most ideas it grows and evolves and you bounce it off people with a lot of experience and it’s shaped by a lot of different minds, but its really turned into something that we’re quite proud of at this point.
Peter: Great, so then why don’t you just tell everybody who don’t know about StreetShares what you actually offer, what is your product offering?
Mark: Yeah, so we do small business loans between $2,000 and $100,000 as well as lines of credit. The term loans are between 3 months and 36 months at least right now, loans go up to $100,000 and then the line of credit product we just launched last month and has shown to be quite popular. We are based outside of Washington DC and we’ve got about 23 employees right now and we launched in the summer of 2014 so we’re a little over two years old at this point.
Mickey: And I think Peter, it’s probably worth…kind of differentiating our product a little bit from what’s out there, one of the things that…one of our early decisions we made was that we
weren’t going to build another subprime small business lender, you know there’s a lot of those out there. Certainly in some ways you could say that’s where there’s a lot of money, but it wasn’t something that we were going to leave our secure jobs and kind of start a business and not feel incredibly proud about what we do everyday. When you overlay that with the affinities that we’re looking to serve here, our product set is quite different.
We’re incredibly transparent about our rates to our borrowers, we quote everything from APR to any of the other rates that are out there, we have more of a prime plus borrower base than I think is typical in the industry because we want to be really responsible in how we lend. So the idea of being kind of a white hat lender in the industry is one that’s really important for us and has helped sort of shape a lot of the decisions that we’ve made around how we built our business and obviously as its brought to life in the products that we offer, both to our borrowers but also the investors.
Peter: Okay, well I want to talk about the borrowers for a little bit. You talked about the affinity approach, I want to find out like who are the borrowers and can you explain where they’re coming from and who are the typical borrowers that are coming to StreetShares today?
Mickey: Yeah, so we have a…as part of our affinity approach, we have signed several dozen partnerships with many military organizations, both for profit and non-profit. Some of them are organizations that may, for example serve the military community or the veteran small business community for example, VetFed, but some of them are non-military partners. We source a lot of our borrowers through these partnerships so some of it is through social media, some of it is through direct targeting, sometimes through their channels and sometimes through our own unique channels, but we’re pretty focused on building up our own proprietary targeting capabilities within kind of the affinities.
We’ve been really focused on the military veterans small business market which is about 15% of all small businesses so we’ve really focused on that niche and so about two thirds of our borrowers are veterans, they’re military veterans small business owners and about a third of them are not. The typical profile is more upmarket than I think is typical in the industry in terms of the product set that we have out there so they tend to be, using consumer language more prime plus borrowers.
Peter: Okay so then you mentioned, Mark, earlier the affinity approach is somewhat…it helps lower risk. I mean, can you elaborate on that, do you have any actual numbers to back up that claim? What has been your experience?
Mark: Yeah, we do. So when we first got together we had this theory around affinity-based lending and by that what we mean is that you acquire your borrowers through affinity channels and you match them up with backers or investors who share that affinity. So the example here would be military veterans or the military community, for example, backing loans to veteran owned small businesses.
When we got together we had this theory that if you could back loans with capital from retail investors with whom the borrower shares some strong bonds and you make that relationship quite transparent and known to the borrower and we’re trying to do some things that sort of maximize that knowledge of that relationship after the loan is made. What you could do actually is tap into the borrowers’ sense of duty, their sense of obligation to repay the loan. You know, folks borrow and they pay back a loan based on willingness to pay and ability to pay. We felt like there’s a psychological bonds within certain affinity groups that you could tap into to actually increase the borrowers’ willingness to pay, that is move up the credit stack a little bit.
So we launched with this model in July 2014, we looked at several different affinity groups to start with. Veterans were the fairly obvious one to begin with, that’s both Mickey and my background, you know we’re right outside of Washington DC. We could partner with all the veterans’ organizations with kind of multi-year exclusive partnerships, it was a sizable market. As Mickey said about 15% of small businesses in the United States are owned by veterans, it was a space where I had a lot of strong contacts and so we really felt like that was the great affinity group to start with. And then after about two years now of doing that, the affinity-backed loan, even if you equalize or normalize for other factors of credit risk, the affinity-backed loans on our platform are demonstrably less risky than the non-affinity backed loans.
If a borrower is behind on a payment, based on this affinity model they will call us and they will apologize and they will cure because they don’t want to let down the retail investors. So we’re seeing some very strong data, some sort of green shoots that prove our original model so now for us it’s simply a matter of when and where do you move into other affinity groups beyond veterans.
Peter: Okay, but I want us to stick to veterans just for now. I mean you mentioned that it’s less risky and you’re comparing apples to apples. So does that mean you can go down the credit spectrum for veterans because they are less risky? I mean, what’s your approach to underwriting these people? You mentioned you don’t want to do subprime small business lending, I mean, there’s plenty of those out there so what is your approach when you’re underwriting these people?
Mark: We’ve not elected to go down the credit spectrum, but veteran owned businesses on our platform certainly get a discount in our credit model just based on that fact. So we are using the fact that they’re veterans, we are using the data that we’re seeing about this affinity model to make sure that veterans get a better rate. A veteran owned small business looking for a loan in America, I don’t think there’s any alternative lender out there that will give them a better rate than we do because they actually get credit for that veteran status on StreetShares.
Mickey: Yeah, one of the things Peter that we obviously…we’re tracking tremendous amounts of data related to our borrowers that we collect upfront and we do collect a significant amount of data including about service record and so over time we’re able to rebalance our models around what is risky and what is less risky.
As an example for instance we do understand the risk benefit between veterans and non- veterans, but we also understand that veterans do better in certain sectors and so a veteran in a particular sector has an advantage over a non-veteran and so there could be an additional discount provided there. So what we tend to do with that is actually play into those areas in a more strong way and so we tend to target them more with our partners in terms of acquiring borrowers but also tend to lend more money out to those businesses.
Peter: Yeah, that makes sense. I mean affinity groups…veterans, they are somewhat a unique affinity group I would even argue because you’re going into harms way, you’re risking your life. I mean, you hear about the bonds that people have within their units especially, but with all veterans…how transferrable is that to other affinity groups because I would argue that veterans are pretty unique.
Mark: Yeah I think that’s a very fair question. We don’t yet know sort of the outer contours, the outer boundary of this affinity model. We have other affinity groups that we’re looking at, we’ve had a couple of test balloons up in some other affinity groups, we believe that we’ll see some of the same type of credit performance, but I think it’s a very fair question, veterans certainly have a uniquely strong bond. So the question is as you move into other affinity groups, how strong will that be? It’s been quite strong with veterans and so I think if you can even move the needle let’s say 5%, 10% on the risk spectrum based on affinity loyalty, that’s substantial right, that’s meaningful. In the veterans space it’s actually been quite a bit larger than that.
Peter: Right, okay so I want to move to the other side of the marketplace here and talk about your investors. Obviously you have plenty of veteran investors it sounds like, but can you describe the types of investors…I think you’ve said before you have institutional investors as well as individuals, but who are the typical investors on your platform today?
Mark: Yeah so we have several sources of capital that we use to back the loans as well as our own which is fairly an important point that we co-invest in every loan that we make. We believe that’s the right thing to do, we believe that it brings trust from our investors and so we put our own balance sheet capital into each loan, less than 10% right now, but of each loan.
We have two institutional funds that are providing us with capital, those are in essence multi-year commitments in the several hundred million dollar range and then we have a body of Reg D accredited retail investors. As of April, we launched under Reg A+ to be able to access the non-accredited retail investor base as well and in a short 60 days or so since then the non-accredited base has actually surpassed the accredited base in terms of raw numbers. So we do draw capital from, in essence those four sources; our own balance sheet, institutional investors, accredited retail investors and then now non-accredited retail investors as well.
Peter: So let’s talk about that Reg A+ offering, I mean accredited investors obviously there are lots of options for accredited investors today, but for non-accredited the offerings outside of Lending Club and Prosper are highly limited. So tell us about that process and how it works and what kind of…I guess the size of the offering and just describe what you went through.
Mark: Yeah, this is one of the more interesting things that we’ve done beyond the affinity approach, which is certainly unique as well. Reg A+ is found in section IV of the JOBS Act and so going back to sort of the genesis of StreetShares, you have two founders that were excited about the potential of the JOBS Act. This is really the realization of that potential. Reg A+ took effect in June 2015, so just last summer. We filed that same month with the SEC and it took some time to sort of work its way through the SEC. They were actually quite helpful to us. It really was a case where we were trying to do something I think novel. It was a new statute that the regulators themselves were trying to figure out and they were quite helpful and in actually working with us and our outside counsel to make sure that we could shape investor disclosures and a product here that would make sense.
And so what we came up with was in essence, a fixed return type product. It is a note issued by StreetShares, it is recoursed to StreetShares at a fixed rate. That capital then is used along with our own capital of course, accredited retail investor capital and our institutional capital to back these loans, but it’s not on a loan by loan payment dependent basis as it is with Lending Club and Prosper. We call the product right now Business Bonds, for example, Veteran Business Bonds because it’s a fixed rate note at this time.
Mickey: One thing to just kind of add in there is as we kind of looked at our investor base and researched what they wanted as well as did some research in the unaccredited kind of area…what we found was some of the other investment categories…there are different types of investors, right, so there’s the StreetShares day traders who are on every day, they are looking at every loan, they’re engaging with content, they’re looking at every detail. There’s investors that love the idea of being able to do that but they but they just put it on auto invest and then there are others who just sort of invest their IRA through StreetShares, but as we looked at the unaccredited space I think what we found was for the most part the offerings that are out there are too complex for actually what they’re looking for.
What they’re looking for is they love the idea of investing in kind of a new model, they love the idea of getting yield so we offer a flat 5%. They particularly love the idea that StreetShares have been able to invest in a particular affinity, in our case military veterans, but frankly, they don’t want all the complexity of having to go in and select loans and set up filters and get very lengthy monthly reports. They are looking for a very simple product and so our product is one that’s incredibly simple.
You can sign up for it on your phone in probably literally 30 seconds and you can fund your account. So it’s sort of a very simplified experience for people who want exposure to this asset base and as a result of sort of offering a fixed 5% they’re obviously not exposed to the risk of the underlying loans. We manage that for them and we have a large provision fund in place to ensure that we can meet our obligations to those investors.
Peter: How did you come up with 5%?
Mickey: Yeah, so the way we come up with 5% was we wanted to make sure that it was an exciting enough rate to tempt people to come to something that’s new and innovative. About the highest you can get out there on FDIC-insured products is about 1% right now, maybe 1.15% if you’re at Goldman. That seems to be a very expensive rate so 5% is way out of the reach of any sort of competing type CD product which is really what this is structured like without the FDIC insurance, but there is no direct credit loss and so if you think that Lending Club is going to be in the 6% to 9% range, it doesn’t have to be as high as that because it’s provisioned with a fund on the back end. What we did was we positioned it really between the sort of high rate CD type products that are out there but below the direct exposure risk products that are on the marketplace.
Mark: And I would add that we sort of likened it almost to a CD type product because it shares many of those same features. I mean obviously, it’s not insured, not FDIC insured of course, but it is liquid, it is very easy to get into and out of and it’s not tied to the credit risk of any particular underlying loan.
Peter: Right, but obviously you still have the platform risk if you go out of business…there’s no bankruptcy remote structure with this provision fund?
Mark: Yes, there is.
Peter: Oh there is, okay, so that’s something. So then what’s the minimum investment? Are you open in all 50 states? What’s going on there?
Mark: Yeah, yeah, so the idea here is to build kind of a community. You know we’ve been called in some circles, sort of a first peer to peer lending or the first marketplace lending credit union. I think there’s a bit of truth to that because we’re sort of bringing people together that have a common bond, for example, veteran status. So the idea here is to build community, not so much take in a whole bunch of capital from these investors and so we’ve actually capped how much they can invest. We launched this product actually at the LendIt Conference in San Francisco in April with a cap of $1,000 per investor. We also launched an exclusive at the time only to the military community. Since then we have increased that cap to $5,000 so that’s the most that you can invest in StreetShares biz bonds and we have opened it up to those outside of the military community so the cap right now is $5,000.
Mickey: Peter, the reason we’re sort of structured in this way is as Mark said is what we’re really trying to build here is a two-sided marketplace as is out there, but a marketplace that actually has interaction between it and so there are pretty significant rewards for investors on that platform to refer both other investors, but also borrowers and we started to see a steady stream of borrower referrals now coming from that investor base which have by far the best sort of conversion and risk characteristics than we have seen from any other channel. And so the idea is to basically build that into a very large base of investors, it’s already surpassed our Reg D investor size that is sort of actively engaged in helping businesses in their community find funding so they can grow their businesses. So that’s ultimately a very important strategic part of what we’ve been building here.
Mark: The main constraint in the industry from a platform perspective right now is borrower acquisition, especially on the small business side. You know our competitors are spending a lot of money to acquire their borrowers. They’re using loan brokers, and other channels with which they have to share the economics. We’re moving really to a very, very strong referral basis where our members become our sales force and from an enterprise value perspective we think that’s something that is going to be unique because we have this strong body of members who have strong affinity together and they’re out there referring businesses to us.
Peter: Okay, okay, interesting. So I want to just go back to…as I said in the introduction, I am an investor on your platform and I know you got this Dutch auction model which I was very curious about. It operates in a similar way to…the old timers here who would remember the Prosper auction model. I’m curious why you went with that and how much are investors…the risk I see is for the investor to mis-price a loan where they’re bidding it down so much that it becomes less…the returns are less generous shall we say, or less appropriate for the risk. So talk us through the thinking behind the Dutch auction model. Obviously this is only for the accredited investors and the institutional investors.
Mark: Yeah that’s right, it’s a very good question. In the beginning when we were raising our first couple of rounds of capital we had a lot of VCs ask us…why are you guys doing an auction? Lending Club and Prosper tried auctions and they moved away from that, that seems sort of outdated. The answer for us is that’s how you can price in from an investor perspective…that’s how you can price in the affinity loyalty. What we found was when the investors could set the price and the way our auction worked, it was actually technically not a Dutch auction, but kind of a modification. We got very geeky about all the different auction models that were out there, you know, studied Lending Club and Prosper and some of the other ones in Europe and elsewhere.
We came up with an auction structure that was sort of unique to us, but in essence the investors could set both the quantity of a given loan that they wanted as well as the rate that they would pay on that loan. Now this is Reg D accredited investors only. They could also see…because StreetShares transparently co-invests in each loan, they could also see the rate at which StreetShares priced our portion so full transparency. The investors by the way could actually all see each other and each other’s bids as well and what we found was…again, this was sort of testing in the early days this hypothesis that we had around affinity-based lending, what we found was that the investors were actually pricing into their bid the affinity loyalty.
So when it was a military veteran and kind of the bread and butter of our investor base were frankly retired, wealthier military veterans who were taking their retirement money and investing with us, when they were bidding on a veteran owned business, they would bid lower even compared to other investors on their right and left and relative to the risk, they would still bid lower. So for us the auction was a way of capturing the affinity loyalty through the pricing and so in essence, a veteran borrower that would come to StreetShares could get a lower rate by virtue of being a veteran and telling that story as a part of their pitch.
Peter: Okay, that’s fair enough. We’re running out of time, but I got a couple of more questions I want to get in here. Firstly in this industry it’s no secret that from the capital market side of this business there’s not as much investor money as there was six months ago. I’m curious to see if you guys have…you guys have a bit of a different model, but if you’ve experienced any of the same downturn that some of the major platforms have experienced in recent months.
Mickey: The short answer is no, we haven’t had any pullback from investors either at the institutional side or at the retail side. We’ve probably signed up at least 500 investors in the past few months and so for a small platform is a big number. So, no we continue to see very strong demand for the assets on StreetShares. Our approach frankly during this tumultuous time has just been to keep our heads down and keep building the business that we’ve been building here which we think is very, very resilient, you know, kind of through the storms that are here, but also the ones that are still coming. And so we’ve focused on doing that, but we have not had any pullback on the investor side.
Peter: That’s good to hear, good to hear. So then finally, what’s your vision here for the future? Is StreetShares going to become the largest small business lender in the country or are you really going to become known for being an affinity lender, what does the future hold for you guys?
Mark: Yeah, we have set out to build a marketplace lending platform that is durable and sustainable right. We are being very sort of firm with our credit standards, we’re returning great rates to our investors, we’re attracting borrowers using a method, this affinity method that is at a much lower cost to acquire, I think, than our competitors and so we’re building something we think is very special here. Down the road, I think we take this affinity model and we can replicate it.
I think a small business borrower, no matter who you are, you can come to StreetShares and your loan from StreetShares will be less risky and therefore less costly to you, offered at a lower interest rate because we can tap into affinity loyalty. No matter who you are we’ll be able to find your affinity group here as we have multiple affinities running simultaneously. So the model here is a multiple affinity, you know, nationwide platform that is able to really offer small businesses beneficial loans. There’s some really extractive, frankly, unhelpful practice out there right now in the SME space. You know, we’re out to build something that is sustainable and that will treat both borrowers and investors fairly.
Peter: Okay Mickey, any final words from you?
Mickey: I would just say that I think that as much as this model is replicable to other affinities, but also potentially into other types of organizations so we are talking to several groups where they’re interested in potentially having a private platform for their existing group of customers. And I think that’s a model that I think can be replicated into private marketplaces. Our technology is built in a flexible way that allows us to stand up within days actually a replica of our platform and that’s something that I think can even be a global opportunity.
So we’re very excited about what we’re building here, I think that we’re looking to avoid a plethora of storms that are coming, everything from compliance to customer backlash, to credit quality and regulatory issues. I think that means that we’re building a more sort of methodical business over here, but it’s one that we believe is going to withstand storms. We always knew these storms were coming and hopefully we’ve built something that will see it through.
Peter: Great, maybe we’ll have a StreetShares South Africa one day, that would be interesting.
Peter: But on that note, lots more to talk about, but we have to let you go. I really appreciate your time today, gentlemen.
Mark: Alright, thank you Peter, we’ve enjoyed it.
Peter: See you.
You know I have to tell you, I sometimes get a little bit envious when I’m in other countries such as the UK or even France or Germany. The fact that they have so many options for non- accredited investors, for everyday investors; in the UK there are dozens and dozens of different options and here in the US we’re still stuck with very limited choices so I applaud the StreetShares guys for going through the pain of a Regulatory A+ offering just to give everyday investors an opportunity to invest in this. I certainly hope that other companies will follow suit. I would love to see many, many offerings for the everyday investor because that is something that has been severely lacking in our country for many, many years.
Anyway, on that note I will sign off. I hope you enjoyed the show and I’ll catch you next time. Bye.[/expand]
Peter Renton is the chairman and co-founder of LendIt Fintech, the world’s first and largest digital media and events company focused on fintech. Peter has been writing about fintech since 2010 and he is the author and creator of the Fintech One-on-One Podcast, the first and longest-running fintech interview series. Peter has been interviewed by the Wall Street Journal, Bloomberg, The New York Times, CNBC, CNN, Fortune, NPR, Fox Business News, the Financial Times, and dozens of other publications.