Pando

Upstart adds $35 million to continue its millennial-focused, data driven loan platform

By Dennis Keohane , written on July 16, 2015

From The Economics Desk

Non-conventional loan company Upstart started as a crowd-backed peer-to-peer loan service but last year shifted to a more conventional loan product, using the company’s individual financial data analysis as a way to help those who wouldn’t qualify for loans from standard providers.

Since it launched its Upstart loan service, which takes into account standard financial formulas such as credit score as well as other factors to gauge the likelihood that an applicant defaults on their loan, more than 8,700 loans have been originated.

Today, Upstart announced that it has received $35 million in Series C funding to continue the effort to expand the qualification requirements needed to get loans for small businesses, education, or other uses. The new funding comes from a group of backers led by Third Point Ventures and joined by prior investors Khosla Ventures -- who led an inside $10 million Series B in the fall -- First Round Capital, and Collaborative Fund.

What is unique about the funding is that it is not earmarked to go towards funding the Upstart loans but rather to help grow the business.

Upstart’s loan products are all backed by separate investors who can individually get a return on their investment through standard interest rate returns -- which Upstart also takes a share of. Initially, the company, which was founded by a collection of former Google employees and an original Thiel fellow, had a very specific peer-to-peer lending product where investors could “back” individual borrowers, based on their future earning potential, and get a percentage of that future income.

One of those loans went to an entrepreneur named Nathan Sharp who had just graduated from Dartmouth’s Tuck School of Business and didn’t have any money to fund his small business project Nifti, when he connected with Upstart. Because of his background, school performance, and other data-driven factors, Sharp was able to get a $50,000 loan from Upstart -- he didn’t have the work or credit experience for such a loan through the traditional borrowing channels -- to start his e-commerce price tracking site. And Sharp was just one of many who used the service as it was built at the time.

Although that model achieved some success, a little more than a year ago the company decided it need to shift to its own version of a traditional loan with payback periods and APRs. The change has been a boon according to co-founder and CEO David Girouard, mainly because the financial data analysis model it built into its peer-to-peer product turned out to be a good predictor of defaults and the future stability of its borrowers.

“Frankly, in the grand scheme of the startups, it might be what you could call a ‘glove save,’” Girouard said of the pivot. “Our prior model was working moderately, but it just wasn’t growing fast enough for the company we wanted to build. So we had to move to a more mainstream loan product.”

“We made the switch, and it has turned out really well, and just continues to,” said Girouard. “We went in trying to reinvent every little corner of loans and borrowing, and in many ways that was helpful, we really created a differentiated product. We figured that we could pick our spots and probably could have done things more differently.”

The more than 8,700 of Upstart loans have doled out more than $125 million. And yet, Upstart has only had 102 delinquent loans so far -- which is 1.2 percent of all its loans. That number is more impressive knowing that Upstart’s analysis model predicted that there was the potential for 104 delinquent loans.

According to Girouard, the company has plenty of commitments to fund the loans from investors. One hundred percent of those investors -- individuals or institutions like hedge funds -- that have invested in more than 20 loans have seen a positive return on investment.

But impressive numbers may not be enough to overcome the perception that serving as a financial lender isn’t the most common, or maybe even to some in Silicon Valley morally acceptable, startup idea.

Yes, money lending goes back to almost the dawn of coins and bartering. Since it has played a role in many important innovative developments, like, you know the discovery of the Americas, but it has also had an enormous negative human toll. You only need to pick up Shakespeare’s Merchant of Venice or Hamlet to get a picture of how borrowing was viewed about half a millenia ago. And it really has had good PR in the interim; as anthropologist David Graeber’s book Debt: The First 5,000 Years shows, there is a pretty good reason why loans and debt have developed some pretty negative connotations over the centuries:

The very fact that we don’t know what debt is, the very flexibility of the concept, is the basis of its power. If history shows anything, it is that there’s no better way to justify relations founded on violence, to make such relations seem moral, than by reframing them in the language of debt–above all, because it immediately makes it seem that it’s the victim who’s doing something wrong. Mafiosi understand this. So do the commanders of conquering armies. For thousands of years, violent men have been able to tell their victims that those victims owe them something. If nothing else, they “owe them their lives” (a telling phrase) because they haven’t been killed.

But that loans have also played a role in launch of small companies as well as their growth. So, debt, like many of our systems have downsides as well as upsides. And with Upstart, Girouard and crew believe that they have found a way to instill the idea of “financial fitness” to younger generations.

“The core of [Upstart] is an underwriting model that better understand younger, millennial borrowers. Because they don’t have credit and work histories it is more difficult for them to get reasonable interest rates or even loans at all,” Girouard explained. “The world just sees them as risky.”

“So we built this credit model that says there is a lot more about these people that can help you understand the risk, and also that they aren’t actually risky, but the world doesn’t just recognize that,” he added.

The new funding will help the company achieve that goal, without having to use the money for its loans.

“We just want to continue to work on making the experience of getting a loan at Upstart pleasurable, simple, and predictable,” Girouard said.

“The credit model is working well, we are growing, and we are making actual gross profits on our loans. And, we are in a really good place with regulators.”

One concern that Girouard also mentioned was the potential for a startup bubble pop to wash away all the companies innovating in the financial space, but he feels that Upstart’s model is built to withstand that.

We’ll see if Upstart’s loan model can continue to stay on the right side of public opinion and can outlast the potential pop of the credit bubble.