Zopa Makes Use of Web's Social Connections
May 2, 2008
As credit tightens, small businesses are turning to a pioneering source of financing to start and grow their companies: Zopa, Prosper and similar lending services.
The lenders, startups themselves having put up their shingles in the last couple of years, are finding entrepreneurs are drawn to them because there's typically less paperwork and other hurdles to clear compared with traditional bank lenders. That's especially true for small businesses that may not have the revenue and track record to qualify for most bank loans.
"Credit is getting really tight, especially for new businesses that might be a little speculative," said Scott Pitts, managing director overseeing San Francisco-based Zopa U.S.
Unlike traditional banks that take in federally insured deposits and lend them out several times over, these new trading platforms are trying several business models as the industry seeks to determine which one works best. For the most part, the lending sites are attempting to draw on so-called social capital to facilitate lending, either directly linking borrowers with lenders or providing a channel in which savers can help borrowers repay their loans.
A big downside to these services is their frequent changes as the operators seek to improve their web sites and services. Another drawback from the borrower's perspective is that loan terms are fairly rigid. For instance, Prosper offers three-year loans and Zopa's are for five years. Borrowers seeking longer or shorter loans find themselves in the same position as Henry Ford's early customers, who could get their car in any color as long as it was black. The sites also aren't geared primarily for business loans, as reflected by one prospective borrower on Prosper who noted in his loan request that the lending service asked for his personal income, but not the business' revenue from which the loan would be repaid.
But those drawbacks aren't standing in the way of entrepreneurs looking for money in a frosty credit environment.
Even some established small businesses are finding credit lines pulled or reduced as large lenders review their loan portfolios. Sometimes the criteria -- like the state in which you operate -- seem arbitrary. Small businesses in California or Florida are finding themselves less popular with some national lenders, for example.
The billions of dollars that major financial institutions have written off in recent quarters is money that would have been leveraged several times over into business loans and lines of credit. And with Wall Street gun shy on buying securities backed by loans, lenders who hold onto their loans are at an advantage. Those lenders would include many credit unions and community banks as well as friends and family.
Each of the new lending platforms has its own twist on so-called person-to-person lending.
Prosper said it's finding more prime borrowers turning to the lender, with prime loans hitting a record in February -- accounting for 43 percent of originations that month. Prosper's prime borrowers -- with credit scores of at least 720 -- likely include a number of small business owners or entrepreneurs who need just a few thousand dollars to move their businesses forward. Prosper, like Zopa, lends up to $25,000.
Prosper has 670,000 members and has lent $132 million since its debut in early 2006. Loan applicants write requests. Prosper lenders can then bid to fund a portion of the loan, including the interest rate they seek, in a competitive auction. As more lenders bid, the rate tends to fall. Prosper collects and distributes monthly payments for a small fee.
Recent pitches for capital on Prosper included the owner of an 8-year-old Pilates studio seeking to expand into another neighborhood, a green-building consulting firm, and another small business -- generating $600,000 in annual revenue -- seeking a loan to finance computer equipment.
'Social finance'
One big difference between the two is that Prosper lenders place their capital at risk of nonpayment. Since its public debut two years ago, the service has taken steps to eliminate borrowers with the worst credit records from participating as Prosper seeks to position itself as an alternative source of financing and not simply the place for those who can't get a loan anywhere else.
By contrast, Zopa serves as a facilitator of a loan to a borrower from a partnering credit union. The borrower makes a pitch for other Zopa users to place at least $500 in a Zopa CD, deposited at one of six credit unions. These savers can declare themselves a supporter of a particular borrower so that a small portion of the interest earned on the CD, beyond the 3.75 percent, is applied to the borrower's monthly payment. Each supporter gradually lowers the borrower's monthly payment. Savers can divert as much interest income as they wish to assist a borrower, who they may know or wish to support for other reasons.
Zopa traces its roots to an outfit in the United Kingdom, also called Zopa, which follows a very different business model. Zopa U.S. is seeking to leverage the popularity of social networking on a lending platform, or what company insiders have dubbed "social finance." The company sees it as a big plus that the borrower's supporters don't have their money at risk, given the federal insurance standing behind their Zopa CD.
The rates on Zopa unsecured loans from the credit unions range from 8.49 percent for borrowers with the best credit up to 16 percent. That's competitive with credit cards, another popular source for small business financing, especially in early-stage businesses. Zopa reaches down to those with "near prime" credit quality, requiring a credit score of at least 640, which covers about 70 percent of the U.S. population.
Using these new lending platforms usually isn't rocket science, though one entrepreneur turned to Zopa last year to pursue his vision of building a company focused on rocket science.
"To further our business, my wife and I purchased a decomissioned Atlas-E missile silo. It has a lot of amenities for rocketry -- very remote with no neighbors nearby, lots of space to assemble things. And we have a flame trench where we can test our engines indoors!" the borrower wrote on his Zopa page. "As you can imagine, we could not get a standard mortgage on this non-traditional property."
Addison Avenue Federal Credit Union, the credit union founded for Hewlett-Packard employees and named after the street on which the garage that doubled as HP's birthplace was located -- lent him $25,000 at 9.9 percent. So far, 18 Zopa savers have helped him bring his interest rate down to 9.08 percent.
Other small business owners turning to Zopa and similar services such as Sunnyvale-based Lending Club have more earthbound businesses ranging from designers and photographers to small manufacturers.
Attractive territory
Anyone with a valid Social Security number is eligible to join Zopa and a partnering credit union; which specific credit union gets the prospective Zopa borrower is based on a proprietary formula. The borrower's credit report is checked only once in the process -- a key concern for small business owners whose credit scores could be dinged by multiple credit inquiries.
The Zopa model is also appealing to credit unions in that it helps them attract members from the Internet generation while also pulling in small business loans -- attractive new territory for many credit unions. The company plans to soon expand beyond the original six partnering credit unions.
"We have a full pipeline of interested credit unions," Pitts said.
Provident Credit Union's Chief Credit Officer Jim Ernest said the credit union has a better understanding of a Zopa borrower than a borrower receiving a loan through its traditional channels.
In addition to friends and family, Zopa business borrowers have turned to church groups, clients and customers to rally support in paying off the loan by opening Zopa CDs. And others are surprised to find strangers coming to their aid.
"Zopa is a way to pull in friends and family who wanted to help me, but I didn't want to ask for money," said Jennifer Hogan, a commercial photographer with her own business, San Mateo-based Jennifer Hogan Photography.
"But it's all people who I have never met before that are helping me," she said. "It's exciting that people I don't know want to support me in my endeavors."