For the moment, Kabbage Inc. is only a blip on the radar screen of banks that specialize in small business banking. The Atlanta-based alternative online lender, three years old and funded by venture capital, currently has about 100,000 customer accounts and $200 million in annualized credit advance volume. It is one of several startup lenders that have recently been moving into the small business space as banks retreated in the wake of the financial crisis, a list that includes borro Ltd., Multifunding, Biz2Credit, Lighter Capital and On Deck Capital.
Kabbage’s particular niche is extending credit advances, ranging from about $500 to $50,000, to merchants who sell products on online exchanges such as eBay, Amazon and Yahoo and need cash to buy inventory. The company’s proprietary decisioning software utilizes the customer’s sales data from such exchanges, as well as from PayPal and shipper UPS and the customer’s social media activity, to render a verdict on a credit request within as little as seven minutes.
Bankers may be hearing more about Kabbage in the years to come if the company fulfills its ambition of moving deeper into the small business lending space, as can be seen from the following interview with chief financial officer Simon Yoo, hired earlier this year from Citigroup.
Q: How did Kabbage get started?
Yoo: Kabbage was co-founded by three individuals, Rob Frohwein, Marc Gorlin and Kathryn Petralia, all based in the Atlanta area. Rob was an intellectual property lawyer and was CEO of a company called LAVA Group, a small technology-focused investment banking and legal firm. Kathryn’s background was in the specialty finance area and Marc is a serial entrepreneur. The business needs they saw were very simple. As Rob posed the question, “What would happen if eBay decided to get into the finance business?”
Q: Do you anticipate Kabbage expanding beyond its current market of online merchants?
Yoo: Yes. I can’t share any statistics right now because it’s so early, but our data-gathering skills are both translatable and scalable from on-line merchants to traditional brick and mortar businesses.
I would call us a data-driven company first and foremost. And one of our core competencies is the ability to underwrite and provide working capital very quickly. The offshoot of this is that we have the ability not only to be disruptive to traditional financial institutions in providing working capital to small-and medium-size enterprises, but also the ability to disrupt other competitors where the data can be monetized in different ways, not just to support the merchant cash advance business.
Q: Why would a small business turn to Kabbage for a loan as opposed to a bank? What can you offer your customers that a bank cannot, or will not?
Yoo: When Kabbage was founded a few years ago, the risk appetite on the part of larger institutions to fund smaller companies wasn’t there. Obviously the financial crisis in 2008 and 2009 hasn’t helped. In any case, the biggest institutions are now focused on the customers that have the larger fee wallets and, unfortunately, Main Street is kind of being left behind.
With Kabbage, the unique proposition we offer is the ease of getting credit, which is in the form of a cash advance, more specifically a merchant cash advance. On average, it takes about seven minutes for a client to get credit, from the time they land on our website, fill in the online application and receive the money in their Paypal account. Good luck trying to get anything done in seven minutes in a traditional banking institution!
In addition, if you’re a small business owner, you often have to rely on your FICO score or your personal credit history to get approval for any kind of credit line. But at Kabbage, we have this proprietary algorithm that enables us to draw data from a number of different sources. We look at anything from Quick Books to Amazon, Paypal and UPS borrower data and come up with what’s called a “Kabbage Score” to determine whether or not we want to provide someone with a credit line.
Q: Have many of your customers have been previously rejected for loans by banks? Is there a risk of “adverse selection” in your business model?
Yoo: They are rejected by banks, but our charge-off rates are under 1%. For banks, the average is more like 5% to 8%. We think our model is quite a bit better than what exists in the marketplace. And we actually benefit from positive selection. First of all, just because you’ve been rejected by a bank doesn’t mean you’re a bad customer. Sometimes you’re rejected because you don’t fit the criteria of the target customer the bank is going after. These institutions are focused on those corporations or institutions with the largest fee wallets. The big banks don’t have much of a risk appetite for smaller companies, especially in a down market.
A common refrain among big banks is that “if we’re going to provide a customer with access to our balance sheet, we’re going to make sure we get paid in other ways.” Who gets squeezed or neglected in that calculus is the small- or medium-sized enterprise that can demonstrate they are fully viable from their operating record. For example, we do not advance money to companies that have been around for less than one year. We have a pretty good insight into how these businesses are performing because we have third-party verified data and we look beyond individual proprietary credit scores.
The state of traditional financial services is under tremendous pressure right now and the infrastructure set up over the last several decades really needs to evolve. Nobody knows what the end business model is going to look like. As a consequence, a lot of the most profitable and fastest growing parts of financial services are migrating away from traditional institutions. You’re seeing them reconstitute themselves in new forms like Kabbage, LendingClub or Square.
Our particular business model is going to invite a lot of competition but I think we have a decent lead and it’s sustainable. There’s no reason why this company cannot be one of the more disruptive forces to the competitive order of financial services and beyond in the context of utilizing Big Data to make credit decisions.
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