[Editor’s note: This is a guest post from AmeriMerchant. AmeriMerchant is a bronze sponsor and will be in attendance at LendIt USA 2015 on April 13-15. In this post, they talk about the importance of experience in marketplace lending.]
Experience has its benefits, which is why choosing to invest in a marketplace lender with years of involvement and familiarity in the industry is in any investor’s best interest.
With over a decade of experience in alternative and marketplace lending, I’ve seen all the ups and (mostly) downs one could imagine that can occur when an individual blindly stakes their claim in a platform that lacks experience. I saw many companies in our industry, large and small, that “folded up” because their underwriting model couldn’t sustain the global credit crisis / recession circa the 2008-2009 period.
Common thought dictates that it’s best to invest in emerging companies that are on the rise; get in early and then reap the benefits. Investment companies with capital to deploy are always on the hunt for what’s new, but while individuals and organizations will commonly search out new companies in a disruptive industry, this may not the be the right idea with an industry as fickle and young as alternative lending.
For years, alternative lending was littered with “pop-up shops” offering quick working capital solutions to small businesses. Many of these lenders didn’t adhere to any particular set of best practices, which damaged public opinion of our industry before we even got a chance to establish a reputation. Many of these companies didn’t stick to responsible lending because they had access to capital and funded many businesses that never had the ability to repay the money they received. Not only that, these short-lived lending companies set a precedent revolving around the idea that anyone could basically start a run-of-the mill alternative financing company, and we’re still seeing that today. With our industry on the rise, many are trying to get a seat at the dinner table by starting new companies that lack the right amount of experience in dealing with something as delicate as small business lending. With the amount of companies with available capital looking to invest in our industry, many lenders are stretching their “underwriting boxes” to show strong originations and growth today, but will pay the price of high defaults down the road.
Yes, we are part of a new and growing industry that utilizes fresh technology to underwrite small business financing solutions, but new isn’t always better and companies with multiple years of experience over those with just one or two are not only more capable, but stable as well.
So when looking to invest in a marketplace lender, consider the following:
A company that has seen ups and downs: As we all know, the financial industry is always fluctuating and this was made especially apparent during the Recession. Of course, the Recession wasn’t kind to hardly any industry, let alone small business lending, but many alternative lenders that are prominent today were incorporated before the Recession hit. The fact that so many of us have been around for years and have experience in weathering an economic downturn as severe as the Recession should be a welcome sign to investors. As an investor, I would research the default rates of alternative lenders before, during and after the time period 2007-2010.
Anyone can fund, not as easy to collect: In our industry, funding has always been the easy part while collecting payments after a business has been funded has been the challenge. As aforementioned, anyone can start your average alternative funding platform and begin lending to small businesses. But do they have the intellectual capital, experience and technology available to properly service their client base as they grow? Do they have an underwriting / scoring model that has been tested during good times and bad times?
Going too long with repayments: I’m always wary of any company that hands out small business loans with repayment terms across multiple years. While this practice has some benefits for small business owners, it could likely backfire on the lender. When you have a portfolio of multi-year repayment periods and you see a dip in the economy, a portfolio will simply have too much exposure compared to those portfolios with shorter repayment periods. A scenario like this could possibly be crippling to a young marketplace lender’s business model. I have seen many new players offer products with two, three and even five year repayment programs for small businesses, but yet some of these platforms don’t even have two years operating experience, let alone three or five years to test whether or not these longer term business loans will repay.
Our industry is ripe with established players with innovative technology and the wherewithal to continue improving and moving forward down the road. Investors should take a hard look at the kind of company they want to invest in before making a decision. And most importantly, go with those with a vast amount of experience.
