Upstart: An Elegant Lending Platform for a More Civilized Age
Upstart is one of those Silicon Valley companies with a killer pitch. It was founded by a group of ex-Googlers, its resident quant was a Thiel Fellow, and its a crowdfunding business is a buzz-phrase that still has clout when used by ex-Googlers and Thiel Fellows. Upstart raised seed money from Google Ventures and Mark Cuban, and later, in a $5.9 million Series A round, attracted Eric Schmidt and Marc Benioff as investors. It even offers a service that’s as cool as its backers — peer-to-peer lending, the way you would expect a bunch of smart, data-driven entrepreneurs with plenty of funding to do it.
Upstart launched in 2012 using a somewhat controversial income share agreement, or ISA. An ISA would allow people seeking loans to sign away some share of their future income in exchange for the money — think students in need of a college loan or a recent graduate trying to pay down a student loan. Instead of submitting a credit score to a bank, they could submit their transcripts, GPA, and standardized test scores to Upstart. Upstart then used a model developed by Paul Gu, the aforementioned Thiel Fellow, to determine how likely the borrower was to repay. The better your grades, the better your career prospects, the more likely you were to get a loan from Upstart at a good rate.
“Unlike a loan, there is no principal balance to repay with an ISA: depending on the level of success after school, the student may ultimately pay more or less than the amount financed,” wrote the American Enterprise Institute, a conservative think tank, in a February 2014 report. Upstart’s terms called for ISAs lasting between five and 10 years. The AEI argued that “ISAs are better suited for student financing than traditional student loans” because “borrowing from this payment structure (but without the ownership aspects of traditional equity investments), an ISA has students pay more if they are successful in exchange for paying less if their educational investment does not pan out.”
“In addition,” the AEI report continues, “because ISA investors earn a profit only when a student is successful, they offer students better terms for programs that are expected to be of high value and have strong incentives to support students both during school and after graduation.” This, although couched in the unique financial self-interest of the financier, speaks to the “intrinsic humanity of the online lending revolution” that Simon Cunningham wrote about at Lending Memo early in May 2014.
But despite the bullish AEI report and good vibes from press, investors, and borrowers, Upstart stopped offering ISAs that same month. “We’re still huge fans of income share agreements, and their potential to provide a better means of paying for college and funding aspiring entrepreneurs,” Upstart founder and CEO Dave Girouard wrote in the announcement. “From a regulatory perspective, the income share concept has been received warmly to date. And while many regulatory and policy efforts are underway to facilitate the development of the market, these efforts will likely take many years — a timeframe ill-suited for a startup like ours.”
The ISA may be gone, but Upstart is still “a lending platform that goes beyond FICO to offer credit based on the future potential of the individual,” as Girouard put it. Although not quite as cool as the ISA model they developed, Upstart’s fixed-rate loan product is still innovative and, most important, it’s good. With APRs for loans between $3,000 and $25,000 starting at 6.7% (per the Upstart website) and the recently announced capacity to provide next-day funding, it’s good for borrowers — and with attractive modeled returns and an innovative, aggressively data-driven approach to underwriting, it’s good for investors.
Upstart’s clever data management and analysis is the firm’s secret sauce. When determining what loan grade to assign a potential borrower, Girouard said that, “Which factors matter the most is unique to each borrower. If you have little or no credit history, the educational variables matter a lot, because they help us understand your ability to repay the loan. If you have a long and robust credit history, the educational variables tend to matter much less — you’ve proven you’re a good risk. Employment history matters, because ultimately, lenders are always trying to understand if you’ll have the cash flow necessary to repay the loan.”
If you aren’t familiar with them, loan grades are literally grades, except there are three tiers of As: A, AA, and AAA. Here’s Upstart’s breakdown of modeled returns by loan grade.
“At Upstart, you can get a smarter loan that understands more about you than your FICO score — often at interest rates 30% or more below other sites. You can find out in just a couple of minutes exactly what loan you qualify for, and you can get the money the next day,” said Girouard.
Since Upstart abandoned the ISA model in May, Girouard says the company has originated more than 1,000 loans. “The business is growing extremely quickly — more than 50% month to month. We’ve already originated more than $15M in loans, and the platform is performing at or slightly better than our models predicted, so we couldn’t be happier at this point.”
“Our borrowers really come from all walks of life and all parts of the country. A large portion of them are what the industry typically calls ‘thin file’ borrowers — people with just a few years of credit history. But we also have large numbers of borrowers who have 10+ years of credit history. The common thread is that Upstart appeals to digital natives who have an appreciation for simple design and the quality of customer experience.”