Call it institutionalized mooching.
When startup Branch Basics plans monthly sales goals, co-founder Kelly Love says one thing is top of mind: Will the cleaning products company be able to make its loan payments to the founders' siblings, parents, and friends?
The Austin-based maker of non-toxic soap borrowed $62,500 from friends and family in the last year in order to unlock $250,000 in funding through a new type of “social network” loan offered by online-lending startup Able.
Able lends money to small businesses—but only after the companies have borrowed a certain percentage of the loan from parents, siblings, friends, and other so-called “backers." It was started by a pair of Harvard MBAs, Will Davis and Evan Baehr, a year and a half ago and launches nationally this week.
Able's launch comes as dozens of online-lending companies sprout up to fill the void left by big banks that pulled out of consumer lending following the 2008 recession. Small businesses, homeowners, and other borrowers who didn't want to take on more credit card debt have turned to the new crop of online lenders that are using technology to lower costs and are racing to acquire customers by offering lower interest rates.
The idea behind social credit is that borrowing from people you care about reduces the risk of not paying back your loans by 30%, according to Able. The lender says that allows it to offer lower interest rates (average Able APR is 12%) and higher loan amounts (average Able loan size is $150,000 over 36 months).
Backers get a reward, too—they get paid back with an average interest rate of 6% (though they only receive the loan's principal after the rest of the loan is paid back to Able. Interest payments to backers start immediately.)
The model is rooted in decades-old behavioral-economic theory and studies of micro-finance groups (pdf) that show the positive effects of peer pressure: People are more likely to pay back their loans when borrowing from close friends or family, rather than a faceless bank. Community networks have also been shown to increase a person's savings and other elements of financial responsibility.
But what works in theory doesn’t always take in practice. It's natural to shy away from the awkwardness of asking your buddies for money, or fear the failure to pay back a loan could sever relationships with friends or family.
"But that stigma is fading," Branch Basics CFO and Able loan recipient Chip Ransler tells Quartz.
Ransler says asking for money to launch a new project or business is “becoming part of the fabric of our culture, as crowdfunding websites have made it common to ask for money for everything from illnesses to going on a trip."
And the subject of money gets even less taboo among millennials, says Able's Baehr. People in their 20s and 30s have grown up with the evolution of crowdfunding sites like Kickstarter and popular payments app Venmo, where users broadcast what they are paying their friends for in a never-ending stream of emoji-laden descriptions.
"Plus, there’s a financial benefit, and a cool factor, involved with investing in a startup,” Branch Basics' Ransler tells Quartz.
As today's business icons shift from Wall Street wizards and corporate CEOs to Sand Hill Road venture capitalists and tech investors, the sentiment is trickling down to everyday folks. They also want to back people they believe in with hopes of realizing big returns. And Able wants to do for loans what crowdfunding has done for donations and sites like AngelList have done for equity investments.
Able has extended $3.5 million in small-business loans during its pilot phase and has just raised $6 million in additional funding from Blumberg Capital and RPM Ventures, as well as $500,000 through AngelList.
The concept of social credit has also taken off for Vouch, a startup launched by former PayPal and Prosper executives that began extending personal loans in Oct. 2014 to refinance credit cards and pay for things like education, cars, or moving expenses. Rates range from 5% to 30%. Since then, Vouch has made $2.5 million of loans to thousands of borrowers, with $1.5 million in loans signed since April alone.
With Vouch, friends and family agree to attest to the borrower's ability to pay back the loan over 12 to 36 months. Putting their money on the line, sponsors provide their payment information and "vouch" for borrowers in small increments of, say, $100 to $500 at a time. If a borrower doesn't pay back a loan, Vouch charges the cosigners for the amounts they pledged. Cosigners don't earn interest since the money is only transferred if a borrower defaults.
For loans at least four months old, Vouch founder Yee Lee says it's default rate is in the low single digits, compared to what he characterizes as an industry average of 15% to 17% for people with credit scores below 650.
"Default can lead to a difficult conversation but, in some cases, we've seen sponsors are happy Vouch allowed them to limit their exposure compared with cosigning for a whole loan," Lee said, noting the company has seen zero instances of people trying to fight the charge.
"The flip side is fewer people go into delinquency because they know their relationships with family and friends are on the line," he said.
For now, it's still early days in the realm of social credit. And the experiment could end up souring a whole bunch of familial relationships—not to mention credit scores. Or, just maybe, it could turn out to be a brilliant approach to lending.
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Tuesday, August 25, 2015
These startups are betting family guilt will make you pay back your loans
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