For a few years now, a number of web portals have enabled individuals and businesses to lend or borrow money as part of the new crowdfunding space. But crowdfunding campaigns seem to have a lot of ambiguity attached to them, a great deal of uncertainties regarding terms and returns on investment.
Wouldn’t it be great to be able to lend and borrow money on simple, clearly-defined and precisely quantified terms, such as a set interest rate for a set period of time?
Well there is just such an opportunity in a rapidly growing lending network out of San Francisco – the aptly named Lending Club, a networking portal that matches lenders with borrowers online. The demand for its services has been growing so rapidly that the company has recently filed for an IPO which could bring in as much as half a billion dollars.
Just where does Lending Club fit into the broader spectrum of online financing services? Or better yet, what sets it apart that would make it a company worth investing in?
The Lending Club Difference
While traditional financing through banks has primarily been interest-based, recent unconventional financing through crowdfunding focuses more on profit-sharing.
An entrepreneur looking for capital would first decide how they prefer to pay for it. If they are willing to pay a fixed interest rate, they go to a bank; if they want to pay with profit-sharing or equity, they go to crowdfunding sites.
Now they have another option that combines both worlds, something right in the middle of the financing spectrum. Lending Club is something of a cross between traditional and unconventional financing, blending interest-based loans with an online forum where borrowers and lenders can meet.
While the company does not lend its own money to borrowers, it focuses on match-making, bringing together investors who have money to lend with borrowers who offer interest on such loans – with a wide range of payment options from fixed rates to variable.
Here’s how the company describes its services in its IPO filing:
“Lending Club is the world’s largest online marketplace connecting borrowers and investors. Our platform has facilitated over $5 billion in loans since it first launched in 2007, including over $1 billion in the second quarter of 2014. We believe a technology-powered online marketplace is a more efficient mechanism to allocate capital between borrowers and investors than the traditional banking system.
“Consumers and small business owners borrow through Lending Club to lower the cost of their credit and enjoy a better experience than traditional bank lending. Investors use Lending Club to earn attractive risk-adjusted returns from an asset class that has historically been closed to individual investors and only available on a limited basis to institutional investors.”
Lending Club thus enables investors with extra cash in their pockets to become something of a banker, lending their cash to individuals or businesses, something which until now has been the domain of institutions. It also enables individuals and businesses to borrow on interest without having to sign-over a percentage of their business as they often need to do through crowdfunding.
Yet Lending Club goes one step further by taking its network into cyberspace instead of opening a chain of office around the nation, greatly reducing costs and greatly increasing efficiency, as the company describes:
“Key advantages we have relative to traditional banks include:
• an innovative marketplace model that efficiently connects the supply and demand of capital;
• online operations that substantially reduce the need for physical infrastructure and improve convenience; and
• automation that increases efficiency, reduces manual processes and improves borrower and investor experience.”
Sounds like they have quite the vehicle on their hands. How has it been working out for them so far? Might their stock be worth buying when it debuts?
Some Numbers to Consider
Lending Club gives potential shareholders some data to evaluate:
• “For the years ended December 31, 2012 and 2013, we facilitated loan originations through our platform of $717.9 million and $2.1 billion, respectively, representing an increase of 188%… Our total net revenue was $33.8 million and $98.0 million, respectively, representing an increase of 190%.”
• “For the six months ended June 30, 2013 and 2014, we facilitated loan originations through our platform of $799.1 million and $1.8 billion, respectively, representing an increase of 125%… Our total net revenue was $37.1 million and $86.9 million, respectively, representing an increase of 134%.”
Thus, calendar year 2013 was an improvement over calendar year 2012 in both loan originations and revenues, while H1 2014 was an improvement over H1 2013. Pretty impressive so far. Tell us more.
• “For the years ended December 31, 2012 and 2013, our adjusted EBITDA was $(4.9) million and $15.2 million, respectively. For the six months ended June 30, 2013 and 2014, our adjusted EBITDA was $3.8 million and $5.9 million, respectively.”
Where EBITDA (earnings before interest, taxes, depreciation and amortization) was once negative, it is now positive. Good. But how’s your bottom line after operating expenses?
• Annual net income: -$12.269 million (2011), -$6.862 million (2012), +$7.308 million (2013)
• First half net income: +$1.737 million (H1-2013), -$16.486 million (H1-2014)
Wow! I can hear investors’ tires coming to a screeching halt. A loss of over $16 million in the first half of this year? What happened? Things seemed to be marching along pretty nicely for a few years there. They started in the hole, but that’s understandable. They got out of it pretty nicely by the end of last year.
But suddenly to have fallen back in the hole, and to a much deeper level than ever before. I thought one of their advantages was efficiency.
It’s not for a lack of business activity, as the loans the company helped facilitate has been increasing:
• Loan originations: $257 million (2011), $718 million (2012), $2.06 billion (2013), $1.8 billion (H1-2014)
I wonder if the following might have something to do with their sudden unprofitability:
• Stock-based compensation expense: $291 thousand (2011), $1.4 million (2012), $6.2 million (2013), $15.4 million (H1-2014).
That’s right… $15.4 million in stock compensations to its employees in the first half of this year.
As PricewaterhouseCoopers explained in a 2012 presentation, “Stock options and equity instruments issued to employees can have a significant impact on financial results in the current year and the future.”
Investopedia explains the use of stock and/or options to reward employees and compensate executives: “New companies tend to be riskier than long standing corporations which have a record of proven performance, so they often use stock options to attract long-term employees… The theory is that executives will work harder since they want their own stock to rise in value, and therefore, have the best interests of shareholders in mind.”
But the question in this case is which shareholders’ interests are they keeping in mind? Public shareholders who buy the stock post-IPO? Or the shareholders inside the company pre-IPO?
The Houston Chronicle adds that “share-based compensation gives a company’s employees equity ownership rights”. Ultimately, then, it transfers company equity to employees and executives, which equity is effectively paid out like wages.
In Lending Club’s case, the company didn’t even have any profit for H1 of 2014 to pay-out in the first place. If there had not been a $15.4 million distribution, the company would have reported a loss of $1.2 million for H1 of this year. The company was already in the red before this year’s compensation, and yet they pushed it deeper into the red anyway, multiplying the company’s H1 losses by 13.75 times.
And this comes after a $6.3 million stock compensation just last year, for a total of $21.7 million in compensations in just 1.5 years. Of course, we are just a few weeks away from a $500 million IPO, which is likely to raise stock values significantly, with those compensations in tow.
Far be it for me to say what companies should do with their money. But their willingness to push their own company that is already in the red deeper into it just to squeeze out one last distribution before going public seems like the same old story in the IPO arena these days… insiders cashing out at the expense of new investors stepping in.
This started as a great tasting story on a really great alternative financing web service, which suddenly turned sour when I saw that $16.5 million loss, the internal compensation that caused it, and the willingness to dump that dirt onto an unsuspecting public. Yuck.