Trust

Because financial products are intangible and often complex, trust remains the lifeblood of the industry. Still, nearly a decade after the financial crisis, confidence in the industry remains at painfully low levels. Although many marketplace lenders attempt to position themselves as different from old business models, the situation is the same – and potentially more severe – for the newcomers. Many investors have concerns about the loan origination and due diligence processes employed by alternative lenders. Relevance of new sources of data is unproven, and so are the risk pricing models. Large-scale investors do not want even the lowest level of risk when dealing with unscrupulous business practices.

There are several ways in which marketplace lenders can build trust. For example, improved transparency and disclosure can facilitate risk assessment and cross-platform comparability. In principle, investing through marketplace lenders should require fewer resources to assess loans. For that to be feasible, platforms need to disclose comprehensive information about their credit assessment processes and loan portfolios. Industry-wide standardization can also boost trust. It is natural for people to approach novelty with suspicion. Indeed, many platforms report that fear remains a significant obstacle. They can combat these legacy hurdles by focusing on familiarity, which is anchored to existing trustworthiness. Small and medium enterprises are used to a particular way of approaching things, and it is often easier to deal with the current trusted ecosystem rather than promote change.

Approaching companies from the right angle should be a tactical decision. For example, accountants and other professionals familiar with processes involving sensitive data can be much more receptive to platform offerings. A retail client is likely to choose one of the biggest platforms, those that appear most familiar and long-standing, and are accepted by friends’ networks. Potential fraud, cybercrime and privacy concerns exacerbate trust issues, particularly given the lack of proven track record among marketplace lenders. Therefore, security remains a crucial factor in building greater trust. To be scalable, marketplace lenders should have strong standards with regard to compliance protocols and risk management. They should strive for constant improvement of their security systems and protocols, and be able to tailor them towards specific threats relevant to the company profile.

Value

Platforms need to have disruptive and scalable offerings:

1. Offering a clear value-enhancing proposition (cheaper, faster, more convenient). The core product should have a sustainable competitive advantage (to be tested by consumers, investors). Value offering could also imply a niche strategy, a tailored proposition targeting specific groups that are most receptive to their offering. They can also benefit from focusing on what they do best – originating and underwriting loans – and outsourcing other operational processes to FinTechs that can do them more cost-effectively. For example, instead of spending money on building the reporting infrastructure themselves, platforms can outsource it to outside service providers like Orchard, which are capable of doing it more inexpensively because they perform the same service for a number of other lenders. Platforms can make their businesses significantly more profitable if they are willing to give up a certain portion of that value chain and outsource it.
2. Scalable: start on day one with a scalable proposition. Small regional markets do not attract the best capital providers, investors and suppliers.
3. Moving up: obtain first-mover advantage (involving funding, open architecture).

Marketplace lenders often focus on the technological aspect of their platforms. However, in-depth financial competence remains a critical factor (improved risk pricing models).

Funding

Entrepreneurs in FinTech spend substantial time on attracting capital. We know that from the thousands of companies, only some will survive. The lack of fully funded business plans might chase off large investors to give a proper consideration to the value proposition. The risk can be mitigated through early acceptance by top-tier capital providers. Obtaining funding from leading venture capital providers can create a snowball effect for scale. Due to internal resource constraints, many investors cannot allow themselves to look at investment opportunities below a certain size. For many, the size of the market in online lending is simply not deep enough to be considered at this stage.

My advice: Show the value, show the transparency, show the scalability and work with the best. We are increasingly living in a world where being second tier does not pay off. Capital providers know that. They do not have the time to try – they look for confirmation. Who do you work with, who are your suppliers, who is funding you – these all translate into: who trusts you already?

Operation

Plans without excellence in operational executions are meaningless. Agility is essential, not only in IT but also in marketing. Platforms often find themselves constrained by business models which lack operational flexibility – the ability to adjust to sudden spikes in demand and supply quickly. I observe many alternative lenders underestimating the importance of a borrower acquisition strategy. They rely heavily on investors’/lenders’ growth – how many investors they are able to attract to their platforms. This approach restricts their growth potential. Platforms should strive to achieve greater operational flexibility by developing the ability to “turn the tap on and off” on both the lending and investment sides, and ensuring that the two are always in balance. Only through that can they preserve the growth momentum without being held back by the lack of lending or investments.

Unlike the incumbent players, marketplace lenders also do not have an existing customer base, and need to build it from scratch. This highlights the importance of a cost-efficient customer acquisition strategy and finding scalable customer acquisition channels with a positive contribution on a unit-by-unit basis. Platforms need to be extremely smart about their marketing budgets and optimize their channel mix. This will require clever use of data, technical capabilities, corporate culture that encourages mistakes, a testing mindset and an ability to pivot. For example, by leveraging digital marketing capabilities, platforms can develop smart marketing models, allowing them to change their message on a short timeframe, thus creating a fine interplay between scale and price.

See Table 1 for an overview of the key ingredients to achieving scale.

Partnerships

• Partnerships with established, reputable leaders can validate platforms, thus augmenting trust in the industry. There are several examples of this: British Business Bank–Rate Setter; Lending Club–Union Bank; Funding Circle–Santander; JP Morgan–OnDeck. These partnerships can be with vendors, IT system providers, back-office facilities and investors. They can also serve as a marketing channel or help attract capital, thus contributing to the creation of trust and subsequently promoting greater scale. Partnering with bigger, established players not only promotes better disclosure, but can also help to early identify potential breaches in security and operational processes of the platforms due to strong due diligence requirements conducted by these entities.

Regulations

• Regulations facilitate trust in the sector and, at the same time, provide a fundamental framework for the creation of the robust ecosystem. At present, uncertainties regarding future regulatory developments are one of the key obstacles. It is often difficult to navigate regulatory complexities, especially when operating across several jurisdictions. In retail investing, regulation can act as a “stamp of approval” and safeguard the ecosystem, given the limited extent to which a crowd can assess credit risk. Some platforms (e.g. Zopa) have recently applied for a banking licence, which shows the importance of building trust and being a source of familiarity through the perceived safety of investment within a bank. Lack of any form of authorization can preclude certain types of investors from greater engagement.

Venture Capital Providers

• Platforms require two forms of capital: lending and equity capital. When it comes to the latter, partnering with the right venture and private-equity sponsors is immensely important, as they bring not only the capital itself, but also recognition, validation, experience and skills. Entrepreneurs often tend to fall in love with their ideas and have several biases. An early-stage validation of a business idea via a reputable outside firm, which assesses thousands of business plans and selects only a few, can be a major achievement. Attracting names like KPCB, Sequoia, Andreessen Horowitz, Khosla Ventures, Spark Capital, etc. can offer critical support in marketing, operation and access to funding at a later stage. Similar to commercial firms, some business schools (INSEAD, IESE and Stanford) have venture capital funding arms that could help with content validation and recognition, given their unique insight and enormously valuable networks.

Management Team

• Finally, a diverse management team makes the difference. The most capable entrepreneurs may see their limitations. Starting a business requires a very different skill set than scaling up a business. It might be an emotional decision and difficult for many founders to recognize. Involve professionals with outside views. This is often easier said than done, due to resource constraints and emotional attachments. Nonetheless, nobody can master all the skills required to run a successful alternative lending platform on his own. Those entrepreneurs who share their upside with a professional multidisciplinary team are most likely to succeed.