Chris Larsen, who helped invent financial e-commerce by creating E-Loan <eloan.com> in 1997, is back on the scene mere months after selling the company to Popular Inc. last summer for $300 million. His new company, Prosper.com, is built around the idea of creating “communities” of people with similar interests who lend to and borrow from each other. The idea, he says, isn’t too far away from Jimmy Stewart’s savings and loan in Frank Capra’s film, It’s a Wonderful Life, where ordinary people lent to each other and made them all more prosperous.
Aside from the community idea, the business premise is comparable to the model of Zopa, the Great Britain-based, person-to-person lending site that opened last summer. But while Larsen concedes the similarity, he says he had the idea first.
“This is something Bob [Kagle] and I talked about long before the Zopa guys had come to Benchmark [Europe] —since 2003, in fact,” he says. Robert Kagel is a Benchmark Capital partner who provided much of the original financing for E-Loan, and who served as an E-Loan director. The Prosper idea attracted them, adds Larsen, because while the E-Loan idea created an entire business sector, and while it worked—it originated and sold $26.7 billion in mortgages between 1997 and June 2005—it wasn’t really what they’d wanted to do, which was more along the lines of Prosper.
“We were never a new group that allows people to come together and go after the entire marketplace,” says Larsen. “We were beholden to the capital markets, rather than being able to create a whole new marketplace that’s supported just by people. This is more of a pure model, an opportunity to start from a clean sheet of paper, and design something from the ground up.”
Plus, he adds, the public that could support a Prosper didn’t exist in 1997. “You couldn’t do [Prosper] back then. PayPal very much blazed a trial, and you really couldn’t do this until they had come along.”
Prosper is funded by venture capital funds that include Accel Partners, Benchmark Capital, Fidelity Ventures, and the Omidyar Network. That sort of investor lineup suggests taking Prosper public in fairly short order, since venture capitalists are notorious for having a five-year investment timeline and expect to have a well-defined exit strategy before they write any checks. But unsurprisingly, Larsen says he’s too busy building the business now to address whether he’d take Prosper public, and preferred not to say whether he would, or what sort of exit strategy his venture capital investors have.
Prosper opened with something of a bang the week of Feb. 6, getting plenty of high-profile press in the mainstream media, and, according to Larsen, attracting more than $750,000 to its loan pools in the first week of business. And the first week’s business seems promising: As of Feb. 18, 168 loans were on offer at Prosper’s site, ranging in size from $1,000 to $25,000.
Prosper borrowers, having been given a credit rating by Prosper after being vetted by credit score, fraud check, and income, offer their loan to lenders, who create pools of capital, and can bid for fractions of any particular loan; the capital pool commits the actual money. Prosper charges the borrower 100 basis points as what amounts to an origination fee, and lenders 50 basis points per year and per loan.
Some borrowers on the site seemed to offer pretty good business propositions—a couple who wanted to pay 7 percent on $25,000 to expand their flourishing eBay-based business to Australia, or a $6 million per year, Dunn & Bradstreet-rated auto transport-related business willing to pay 15 percent on a short-term, $25,000 loan.
But the majority of the loans offered seemed to be from people trying to re-finance their credit card debt, or who otherwise couldn’t borrow elsewhere. And the preponderance of this sort of borrower—at least one was trying to raise money for what she said was an unspecified operation for her young daughter—suggests that in the long run, Prosper, and probably Zopa, will have some structural problems.
Among them: Adverse selection—the tendency for loan applications to be dominated by those most in need of credit, and least likely to repay. If poor credit risks overrun the venture, higher quality applicants, and the investors looking for them, will desert both Prosper and Zopa.
Another is whether lenders will feel adequately compensated for their risks. Larsen says he wants his lenders to “capture the 10 percent spreads between short-term money and credit card deposits,” and compares the expected returns at Prosper to the AA corporate credit market, which currently gives investors a 7 percent return, or 6.5 percent after defaults. Zopa says it has provided lenders a 7 percent average return with no defaults in the seven months it’s been open for business, but this is not a period statistically significant enough to predict future performance.
And a 7 percent coupon, while attractive to risky borrowers, may not be considered an adequate risk premium by lenders. Historically, unsecured debt carries very high rates—more along the rates charged by loan sharks, and certainly higher than the 10 percent or so that junk bonds offer. And due diligence and risk analysis in that loan sector is usually very tough—certainly tougher than either Zopa or Prosper are currently conducting. Such lenders were not available for interviews, but over time, and as loan volumes grow, it could very well turn out that historic means emerge in loan performance and defaults. This will certainly disappoint Larsen and his backers.
On the other hand, much of business is betting on horses, and on jockeys, and Larsen has proven himself adept at both picking horses and riding them. His tenure at E-Loan was rocky, but the many reports of his business death have inevitably proven exaggerated. Venture capitalists are not a notably sentimental lot when it comes to their business analyses, and they’d be satisfied about that, or gone. It may be that the time is right for a business built more along the lines of Jimmy Stewart’s small town savings and loan, and less along the lines of Mr. Potter’s hard-eyed empire. (Contact: Prosper.com, Chris Larsen, 415-362-7272)