[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]


 
                 BRIDGING THE SMALL BUSINESS CAPITAL GAP: 
                              PEER-TO-PEER LENDING

=======================================================================

                                HEARING

                               BEFORE THE

                      COMMITTEE ON SMALL BUSINESS
                             UNITED STATES
                        HOUSE OF REPRESENTATIVES

                    ONE HUNDRED FOURTEENTH CONGRESS

                             FIRST SESSION

                               __________

                              HEARING HELD
                              MAY 13, 2015

                               __________
                               
                               
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
                               

            Small Business Committee Document Number 114-010
              Available via the GPO Website: www.fdsys.gov
              
              
              
                                ___________
                                
                                
                       U.S. GOVERNMENT PUBLISHING OFFICE
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                   HOUSE COMMITTEE ON SMALL BUSINESS

                      STEVE CHABOT, Ohio, Chairman
                            STEVE KING, Iowa
                      BLAINE LUETKEMEYER, Missouri
                        RICHARD HANNA, New York
                         TIM HUELSKAMP, Kansas
                        TOM RICE, South Carolina
                         CHRIS GIBSON, New York
                          DAVE BRAT, Virginia
             AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
                        STEVE KNIGHT, California
                        CARLOS CURBELO, Florida
                          MIKE BOST, Illinois
                         CRESENT HARDY, Nevada
               NYDIA VELAZQUEZ, New York, Ranking Member
                        YVETTE CLARKE, New York
                          JUDY CHU, California
                        JANICE HAHN, California
                     DONALD PAYNE, JR., New Jersey
                          GRACE MENG, New York
                       BRENDA LAWRENCE, Michigan
                       ALMA ADAMS, North Carolina
                      SETH MOULTON, Massachusetts
                           MARK TAKAI, Hawaii

                   Kevin Fitzpatrick, Staff Director
            Stephen Dennis, Deputy Staff Director for Policy
            Jan Oliver, Deputy Staff Director for Operation
                      Barry Pineles, Chief Counsel
                  Michael Day, Minority Staff Director
                            C O N T E N T S

                           OPENING STATEMENTS

                                                                   Page
Hon. Steve Chabot................................................     1
Hon. Nydia Velazquez.............................................     2

                               WITNESSES

Professor Rajkamal Iyer, Associate Professor of Finance, MIT 
  Sloan School of Management, Cambridge, MA......................     4
Mr. Sam Hodges, Co-Founder and Managing Director, Funding Circle, 
  San Francisco, CA..............................................     5
Mr. Zachary L. Green, CEO/Founder, MN8 FoxFire, Cincinnati, OH...     8
Mr. Peter Renton, Publisher, Lend Academy, Denver, CO............    10

                                APPENDIX

Prepared Statements:
    Professor Rajkamal Iyer, Associate Professor of Finance, MIT 
      Sloan School of Management, Cambridge, MA..................    27
    Mr. Sam Hodges, Co-Founder and Managing Director, Funding 
      Circle, San Francisco, CA..................................    30
    Mr. Zachary L. Green, CEO/Founder, MN8 Foxfire, Cincinnati, 
      OH.........................................................    42
    Mr. Peter Renton, Publisher, Lend Academy, Denver, CO........    46
Questions for the Record:
    None.
Answers for the Record:
    None.
Additional Material for the Record:
    ETA - Electronic Transactions Association....................    49


     BRIDGING THE SMALL BUSINESS CAPITAL GAP: PEER-TO-PEER LENDING

                              ----------                              


                        WEDNESDAY, MAY 13, 2015

                  House of Representatives,
               Committee on Small Business,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 11:00 a.m., in Room 
2360, Rayburn House Office Building. Hon. Steve Chabot 
[chairman of the Committee] presiding.
    Present: Representatives Chabot, Luetkemeyer, Hanna, 
Huelskamp, Gibson, Hardy, Velazquez, Clarke, Payne, and Adams.
    Chairman CHABOT. Good morning. The Committee will come to 
order, and I want to thank everyone for being here today.
    When an entrepreneur starts a business, one of the first 
challenges faced is getting the money needed to produce their 
new product or patent a new idea. Often, an entrepreneur will 
reach out to friends and family for early support, and 
sometimes a small monetary investment.
    This common phenomenon of family and friends' investment is 
far more common than is commonly realized. After all, we all 
want to see our friends and family succeed, particularly in a 
new business venture.
    While access to capital has always been a concern for small 
firms, the Great Recession and some legislation, some would 
argue, I would, Dodd-Frank, for example, have made access to 
capital even more difficult.
    Fortunately, there are alternative lending options to 
assist small businesses in getting the financing they so 
desperately need. Today's hearing will examine a growing trend 
across America, the rise of peer-to-peer or P2P lending, and 
what it means for small businesses.
    A recent survey by the New York Federal Reserve found that 
while small businesses primarily still look to large 
conventional lenders for financing, during the first half of 
2014 nearly 20 percent of entrepreneurs looked to an online 
lender for credit. In the United States, the P2P lender with 
the largest market share, Lending Club, has seen the value of 
its total loans funded for small businesses explode from around 
$850,000 in 2007 to over $22 million in 2012.
    This increase in P2P lending for small businesses, if it 
continues, could have a tremendously positive impact on small 
businesses and their growth and on the American economy 
overall.
    Today, we are fortunate to be joined by a distinguished 
group of witnesses who all have insight into this fast growing 
phenomenon. I want to thank our panel for taking time away from 
their jobs and making the trip to Washington for this important 
hearing. We look forward to your testimony.
    It is often said that what keeps a great idea from becoming 
a great business is execution. Well, access to the funds needed 
to start a business plays a huge role in that success. There 
are people all around our country with great ideas. Hopefully 
today, we can examine how innovative funding models can help 
more Americans turn their great ideas into a reality.
    I would now like to yield to the Ranking Member, Ms. 
Velazquez, for her opening remarks.
    Ms. VELAZQUEZ. Thank you, Mr. Chairman. Following the 2008 
financial crisis, the small business credit market tightened 
dramatically, contracting at twice the rate of broader 
financial markets.
    After banks pulled back $116 billion in capital, many 
entrepreneurs were forced to turn to non-traditional sources to 
stay afloat. One alternative to emerge was peer-to-peer 
lending. Peer-to-peer lending allows small businesses to 
directly solicit funding from a pool of interested lenders and 
investors over the Internet. Web-based technologies reduce 
costs and interest rates making peer-to-peer business loans an 
attractive alternative to credit cards.
    Peer-to-peer offers a number of benefits to both small 
businesses and investors. For small business borrowers, the 
biggest advantage is being able to access capital when 
traditional lenders are not willing to make loans. P2P 
platforms also provide loans that are often too small to be 
profitable for most banks, typically under $35,000.
    On the investor side, the communal and open nature of P2P 
lending reduces fraud while technology based risk assessment 
helps inform investors about each individual loan.
    Although peer-to-peer lending provides significant 
advantages, there are drawbacks. Peer-to-peer lending platforms 
reserve the right to reject small business applications just 
like banks. The Federal Reserve found only eight percent of 
business loan applications are accepted by the largest 
platform. The study also found that peer-to-peer loans had an 
average interest rate of over 13 percent, double that of 
traditional sources. Similarly, peer-to-peer loans have higher 
default rates, increasing investor risks.
    As more people learned of the advantages of peer-to-peer 
lending, the industry grew rapidly through the mid-2000s. In 
2008, the SEC took notice in citing investor protection and 
classified peer-to-peer lending loans as securities. This move 
subjected lending platforms to a host of registration 
requirements.
    As a result, many industry participants have raised 
concerns that the current environment is limiting the market's 
growth potential. Very few platforms have taken the costly 
steps of registering with the SEC, preventing many retail 
investors from participating in peer-to-peer lending.
    At the same time, large institutional investors have been 
attracted to peer-to-peer lending by high yield, less 
oversight, and lower costs.
    While increasing access to capital is a laudable goal, the 
peer-to-peer market is now dominated by the same institutions 
it was meant to circumvent, raising concerns about the 
direction of this nascent industry.
    Today's hearing will provide members an opportunity to 
learn about the peer-to-peer lending market and how it has 
facilitated small business' access to capital. With more firms 
turning to Internet based lenders, including crowdfunding 
sites, and peer-to-peer lending, it is important the committee 
examine how we can ensure these platforms increase small 
business access to capital while protecting both, borrowers and 
investors.
    I just want to take this opportunity to thank all the 
witnesses for being here today.
    Chairman CHABOT. Thank you very much. We ask that Committee 
members, if they have opening statements, submit them for the 
record.
    I would like to take just a moment to explain our lighting 
system here. You will each be given five minutes to testify. 
The green light will be on for four minutes, the yellow light 
will come on to let you know you have a minute to wrap up, and 
then the red light will come on. We would ask you try to adhere 
to those five minutes, if at all possible, we will give you a 
little leeway, but not a lot. We appreciate it.
    I would now like to introduce our panel, and I will 
introduce each of you before you testify. Our first witness is 
Rajkamal Iyer, who is an Associate Professor of Finance at the 
MIT Sloan School of Management.
    Professor Iyer's research focuses on the area of banking 
and contract theory, with a particular interest in 
understanding the role of inter-bank markets and the provision 
of liquidity. We appreciate you being here and we will get to 
your testimony in just a minute.
    Our next witness is Sam Hodges, who is the Co-Founder and 
Managing Director of Funding Circle, a peer-to-peer lending 
platform focused exclusively on small businesses.
    Mr. Hodges is responsible for overseeing the overall 
strategic direction and day-to-day operation of Funding Circle 
in the U.S., and we welcome you here as well.
    Our third witness will be Zachary Green. I am very pleased 
to introduce Mr. Green because he happens to be from my 
District. He is the CEO and Founder of MN8 Foxfire in 
Cincinnati.
    Mr. Green previously served in the United States Marines 
Corps and was working as a volunteer firefighter when he 
developed the idea for his small business, which as he will 
tell you in a minute, is meant to keep firefighters safe. We 
thank you for your service to our country and also for making 
the trip from the First District to be with us today.
    I would now like to yield to the Ranking Member, Ms. 
Velazquez, for introducing her witness.
    Ms. VELAZQUEZ. Thank you, Mr. Chairman. It is my pleasure 
to introduce Mr. Peter Renton. He is the Founder of Lend 
Academy, the leading educational resource for the peer-to-peer 
lending industry.
    His blog is the most widely read website about peer-to-peer 
lending, and through his writing and video courses, he has 
helped tens of thousands of people understand this new asset 
class. He is considered the world's leading expert on peer-to-
lending and often consults with companies looking to enter the 
space.
    He is also Co-Founder of the LendIt Conference, the world's 
first conference dedicated to the peer-to-peer lending online 
lending industry, and he is the author of ``The Lending Club 
Story,'' the definitive guide to the world's largest peer-to-
peer lender.
    Thank you and welcome.
    Chairman CHABOT. Thank you very much. Professor Iyer, you 
are recognized for five minutes.

 STATEMENTS OF RAJKAMAL IYER, ASSOCIATE PROFESSOR OF FINANCE, 
  MIT SLOAN SCHOOL OF MANAGEMENT; SAM HODGES, CO-FOUNDER AND 
   MANAGING DIRECTOR, FUNDING CIRCLE; ZACHARY L. GREEN, CEO/
  FOUNDER, MN8 FOXFIRE; PETER RENTON, PUBLISHER, LEND ACADEMY

                   STATEMENT OF RAJKAMAL IYER

    Mr. IYER. Thank you for giving me the opportunity to be 
here this morning. As you have read, I was interested in 
banking and financial intimidation, and that led me naturally 
to look at peer-to-peer markets when I learned that these new 
online markets had been put up to provide access to credit for 
small businesses and individuals.
    What was interesting about these markets was that loans 
were funded by a group of small investors as compared to 
sophisticated lenders and loan officers and other 
intermediaries.
    One of the big problems in credit markets in general has 
been screening of investors, in a sense how do you really 
understand the creditworthiness of people who are borrowing. 
What was fascinating about these markets is to think about 
whether small individuals who are lenders can actually screen 
effectively the borrower's creditworthiness, because at the end 
of the day, if you cannot figure out the risk of whom you are 
lending to, then these markets cannot be sustainable and 
survive in the long run.
    What we did with our co-authors at the University of 
Chicago and Harvard is at that time one of the biggest lenders 
in this market was Prosper, so we got data from Prosper, all 
the loan applications, and the loans which were funded by this 
website.
    In this website what you have is individual lenders can 
basically decide whether they want to fund a loan and they rely 
on hard information and they also rely on soft information, 
which is all the postings which borrowers say about themselves.
    What was very interesting was we found these small lenders 
do remarkably well. In fact, when you look at the default 
rates, the predictability of default rates for these borrowers, 
if you look at the credit score, like Experian or something, we 
found these lenders actually have 45 percent higher 
predictability than just using the credit score. They do much 
better in terms of effectively predicting default than just a 
credit score which banks and many other lenders use.
    Having said that, what we basically kind of say is the 
people who are lending in these markets are not stupid. They 
are not losing money in general.
    What was also interesting is these markets just beyond 
looking at hard information were using stuff which was non-
standard, like they were using soft information to effectively 
screen borrowers.
    What we found was for the low credit score borrowers, these 
markets were relying much more on soft information to basically 
judge the effectiveness of lending. In a sense, given that 
these markets could screen borrowers and also the non-
collateralized nature of lending, because these markets do not 
require collateral, this could be a viable and sustainable 
source of funding for small borrowers who might be limited to 
other costly sources of finance to actually meet their 
requirements.
    One could ask what are the risks of these markets. In 
finance, without risk, there is no return. There is always some 
risk. What we basically thought in a sense was at this point 
investors have risks because there is going to be some default, 
but they can effectively judge the risk. It is not like they 
are not able to price this risk correctly.
    In terms of the platforms, the platforms themselves are not 
leveraging up. They are just acting like an intermediary which 
matches lenders to borrowers. At that point, they are not like 
a bank which basically takes on leverage and lends on its own 
behalf. In a sense, these platforms are just matching 
platforms. They bring together lenders and borrowers and the 
lenders decide what is the rate to lend to, so at some level, 
that is something that does not pose a big risk at this point 
to the system.
    One could ask are borrowers better off borrowing from these 
platforms as compared to banks, do they offer better rates. 
That is a very tricky question because at some level, with all 
the studies, there is a selection of people who go on these 
platforms, so the ideal counterfactual would be to look at the 
same person when he applies for a loan at a lending platform, 
which is a bank, and see what the rate is.
    We do not have that counterfactual at this point because we 
do not see that clearly. In a sense, at this point from the 
study we have done, generally the rates on this platform range 
from six percent to 21 percent, on the average, 14 percent, 
which is pretty much very similar to the lending rates which 
banks offer to small borrowers who are at a certain level of 
credit risk.
    Even if the rates offered by these platforms are very 
similar to banks, they provide an alternative because there is 
no competition at some level, which is always beneficial for 
people to basically have another option to lend.
    Effectively, at this point, given the nascent nature of 
this industry, our take is that regulating this industry would 
inhibit its growth, but having said that, one does need to 
watch the fact of how these industries evolve, to make sure 
that is not a constraint.
    Thank you.
    Chairman CHABOT. Thank you very much. Mr. Hodges, you are 
recognized for five minutes.

                    STATEMENT OF SAM HODGES

    Mr. HODGES. Mr. Chairman, Ranking Member Velazquez, and 
members of the Committee, thank you very much for having me 
here today.
    I am Sam Hodges, Co-Founder of Funding Circle, and also a 
small business owner. Before starting Funding Circle, my 
partners and I were very much like the hard working 
entrepreneurs, aspiring small business owners in each of your 
districts. We built up a chain of fitness centers all across 
the country, and as we pushed to open new locations, we found 
even with strong traction, it was very hard to get access to 
credit.
    That experience really aspired us to start Funding Circle 
as a better way for small businesses to get access to loans. 
Founded in 2010, Funding Circle is now the world's leading 
marketplace lender dedicated to small business.
    Since then, we have lent out over $1 billion to over 8,000 
small businesses across the United States and also the U.K., 
and we are currently lending out about $75 million per month, 
ranging from a logistics business in the Midwest to a health 
care services business in suburban Atlanta, to a multi-unit 
salad company in San Francisco.
    What we are focused on is helping the 28 million small 
businesses in the United States get access to the capital they 
need to grow and to expand.
    Our loans address the core of the small business credit 
gap, term loans of $25,000 up to $500,000. These are loans that 
a small business owner can use to expand her store front, open 
a new location, hire more staff, or potentially launch new 
products.
    Not only are loans delivered very quickly, inside of a few 
days, but they are also delivered in a highly transparent 
fashion. They are also fairly priced with interest rates 
ranging from about six percent up to 21 percent, with payments 
spread over an one to five year term.
    Today, if you ask the average small business owner whether 
they have access to the credit they need to grow and expand, I 
think what you would find is in many cases, the answer is a 
resounding ``no.''
    Even as our economy recovers and despite attempts such as 
the JOBS Act to facilitate the flow of capital to smaller 
companies in the United States, many small businesses remain 
unable to access the credit they need.
    We think that Funding Circle and other marketplace 
platforms like ours can be a meaningful part of the solution to 
this problem.
    To give you a sense of how this works, we and other 
marketplace lenders function by matching supply of capital with 
demand. On the one side of the market are small businesses and 
on the other are a mix of individuals and institutions who lend 
through us. We provide a transparent marketplace that is 
information rich that allows those investors to make good 
decisions as to where to direct their capital.
    This year we anticipate lending over $1 billion through the 
model. Without access to term capital, what we are seeing is 
small businesses are actually commonly entering into short term 
credit arrangements with lenders that often times charge APRs 
between 50 and 100 percent.
    For example, a small business may take a cash advance in 
exchange for allowing the lender to deduct a portion of credit 
card sales in what is generally known as a ``merchant cash 
advance.''
    These are appropriate in some circumstances. For example, 
funding of working capital, purchasing inventory, for example. 
Such short term and high rate products can be misused and often 
times leads small businesses to use these short term financings 
to actually cover longer term funding needs.
    The two attributes, short durations and very high rates, 
drive many small businesses into downward cycles of re-
borrowing, in which they take out more and more debt to roll 
over their obligations.
    We frequently see the damage these arrangements can inflict 
on small business. Otherwise healthy companies are throttled by 
overwhelming and unexpected debt service. If this issue sounds 
familiar, that is because it is.
    Regulators, I think, rightfully saw the same connection 
with payday lending, where very high rates of default and re-
borrowing actually led consumers into debt traps.
    In response to this trend, Funding Circle is committed to 
working with other marketplace lenders, other responsible 
credit providers, and small business advocates to promulgate 
effective self regulatory standards for non-bank small business 
financing.
    Although we would expect these standards to cover a broad 
spectrum of practices, transparency around pricing stands out 
as a particularly important focal point. At Funding Circle, we 
prominently disclose total and periodic costs of the loans we 
offer in an easy to understand format, including our interest 
rate, as well as our fees.
    With this information, a small business owner can evaluate 
the true cost of credit and make a really good informed 
purchasing decision for that loan.
    In contrast, many other lenders quote financing costs as a 
buy rate and refuse to provide actually an annualized interest 
rate or any disclosure around fees. In addition, they often 
times charge hidden fees, and sometimes they will advertise no 
prepayment penalties despite the fact that if a borrower were 
to repay all future payments due including interest.
    In contrast, the very transparency of the marketplace 
lending or peer-to-peer model actually helps ensures that only 
the borrowers who should be able to pay back a loan actually 
take one out. We believe supporting marketplace lenders 
represents a critical opportunity for policy makers to help 
improve small business owners' access to credit, while also 
giving them a reasonable path to growth.
    At Funding Circle, we are striving to build a better 
financial world. We are trying to craft a transparent market 
driven approach that delivers much needed capital to great 
small businesses all across the country. It is our strong 
believe that marketplace lending will be beneficial for these 
small businesses, for the investors who are putting capital 
behind them, and for our country as a whole.
    Thank you again for the time and for everything you are 
doing on behalf of American small business.
    Chairman CHABOT. Thank you very much. Mr. Green, you are 
recognized for five minutes.

                 STATEMENT OF ZACHARY L. GREEN

    Mr. GREEN. Good morning. My name is Zachary Green, and I am 
the CEO and Founder of MN8 Foxfire. I would like to personally 
thank Chairman Chabot and the members of the Small Business 
Committee for inviting me here today.
    As a young man growing up in Cincinnati, Ohio, I had three 
distinct dreams. I wanted to become a Marine, a firefighter, 
and an entrepreneur. Dedication, honor, team work, and most of 
all mission accomplishment were some of the life long values I 
garnered from my time in the Corps.
    I recognized that having the opportunity to pursue the 
American dream is because of those who have gone before us, and 
we must never forget we are the land of the free only because 
of the brave.
    Several years later and about 50 additional pounds, I 
fulfilled my second dream of becoming a volunteer firefighter, 
a rich American tradition started by one of our founding 
fathers, Benjamin Franklin. Being a firefighter, much like 
being a Marine, taught me that no obstacle is too large, no 
hill is too steep, and all challenges can be solved through 
leadership, team work, and perseverance.
    After all, in the fire service we have to solve the problem 
at hand. We do not have the option of calling 912 after the 
homeowner calls 911.
    The summers in Parrish Island and TwentyNine Palms were 
unbearable. Marine Corps officer training in Quantico was 
extremely challenging, as is being a firefighter running into a 
burning building when everybody is running out.
    All these pale in comparison to the challenges I have 
recently encountered fulfilling my third dream, becoming an 
entrepreneur. I came up with the idea of MN8 Foxfire while I 
was sitting on the tailboard of my fire engine. As a 
firefighter, some of our biggest risks are accountability and 
disorientation, all of which are compounded exponentially in 
the dark.
    I remember seeing a special about September 11 and how the 
911 Commission report noted several times how photoluminescence 
materials helped people evacuate the Twin Towers before they 
collapsed. I thought of ways I could apply the same technology 
to firefighter accessories, and over the next several months I 
drove from fire station to fire station selling accessories out 
of the trunk of my car.
    Sales steadily increased and my former Fire Chief, Robert 
Rielage, sat me down and said he believed in me and this 
product. He said I should not just treat this as a hobby but 
rather look at a way to really grow a company.
    As I walked out of his office, I remembered the words of 
one of my favorite leaders, Teddy Roosevelt, ``At any moment of 
decision, the best thing you can do is the right thing, the 
next best thing is the wrong thing, and the worse thing you can 
do is nothing.''
    I refinanced my home, maxed out my credit cards, took 
nearly all my family savings to efficiently start my journey to 
entrepreneurship. I am proud to say that now we have more than 
60,000 firefighters using our products.
    Additionally, we have grown our safety line of products 
such as ecofriendly exit signs that never need maintenance, 
batteries or electricity, unlike this one behind me up here on 
the wall, and we have a patented product that goes on the edges 
of stairs to illuminate the stairwells of sports arenas, high 
rises, universities, all over the U.S. and abroad.
    Thanks to the help of the U.S. Department of Commerce's 
Commercial Services Division, we have also exported this 
technology to more than 25 countries throughout the world, 
including the Civil Defense Headquarters of the United Arab 
Emirates.
    In 2013, MN8 Foxfire was awarded the Excellence in 
Entrepreneurship Award, and I was named Entrepreneur of the 
Year by the Ohio Chamber of Commerce. I could not have been 
more proud but every day is a significant struggle.
    One of Foxfire's biggest challenges, one many business 
owners share, is the access to working capital. I love my 
mother very much, but the words of one of my mentors could not 
ring more true, cash is more important than your mother.
    I always thought the more Foxfire grew and the more we 
sold, the less I would have to worry about capital. I could not 
have been more wrong. When I realized that my personal 
investments would not be enough to finance our rapid growth, I 
raised capital from friends and family. With that capital, I 
hired more staff, I bought more inventory, but it still was not 
enough to keep up with our supply chain and overhead costs.
    I next worked with a local venture capital advisory firm 
and raised additional equity funds, and those funds coupled 
with lines of credit from our regional lender, the Bank of 
Kentucky, allowed us to continue to grow.
    Almost every entrepreneur I know has the same reoccurring 
nightmare, running out of money. Several months ago due to 
several unforeseen circumstances, this almost happened. We were 
fortunate to find a new stream of revenue through StreetShares, 
a peer-to-peer lender described by the press as ``Shark Tank 
meets eBay.''
    We presented our business case with historical financials, 
tax returns, and a pitch describing how we would use the new 
funds. StreetShares is a peer-to-peer Internet based 
marketplace that matches borrowers and lenders by shared social 
affinity, such in this case, veterans lending to veterans, to 
drive down rates and the risk of going through a reverse 
auction model.
    Under 36 hours, Foxfire received the money we needed, and 
the interest rate was in the teens. If we had gone through the 
same process with traditional financial institutions, it could 
have taken months. If we had gone to one of the small business 
payday type lenders, they could have charged us an outrageous 
APR.
    The StreetShares' loan had a reasonable APR but was just as 
fast. If it was not for the quick access to an online peer-to-
peer loan, I fear the worse could have happened to Foxfire.
    This is a perfect example of how the free market can act 
faster than a larger traditional institution and keep that 
American dream alive.
    I became an U.S. Marine, I became a firefighter, and thanks 
to new ways to fund start-ups like peer-to-peer micro loans, I 
am on my way to becoming a successful entrepreneur.
    Thank you again for your time today.
    Chairman CHABOT. Thank you very much, I appreciate it. 
Having spent last Sunday with my wife of 41 years and my mom 
who is 90 and my mother-in-law who is 95, I am not going to 
tell them what you just said.
    Mr. GREEN. I did not let my mom proofread this.
    Chairman CHABOT. Good. We do remember it. Thank you. Mr. 
Renton, you are recognized for five minutes.

                   STATEMENT OF PETER RENTON

    Mr. RENTON. Thank you. Mr. Chairman, Ranking Member 
Velazquez, members of the Committee, I really appreciate you 
inviting me here today.
    My name is Peter Renton, and I help run three businesses 
that are all focused on the peer-to-peer lending industry. I am 
the Founder and CEO of Lend Academy, which operates the leading 
peer-to-peer lending blog, podcast, and community forum. I am 
also the Co-Founder and CEO of the LendIt Conference, which is 
the first and largest conference series dedicated to the 
broader online lending community.
    I am also a Co-Founder of NSR Invest, which is an 
investment and analytics platform that provides access to peer-
to-peer marketplaces for financial advisors, institutional 
investors, and individuals.
    As you can tell, I am not from this country. I grew up in 
Sydney, Australia, where my father was an entrepreneur, and I 
joined the family printing business one year after graduating 
college.
    Like most entrepreneurs in Australia, I dreamed of one day 
starting a business in this country, and I was able to do that 
in 1991 when I moved to Denver, Colorado to expand our family 
printing business. Since then, I have started several other 
businesses, and in 2003, I proudly became a United States 
citizen.
    I have been investing in peer-to-peer lending platforms, 
now often referred to as ``marketplace lending platforms,'' 
since 2009. I have been covering this industry full time as a 
blogger and analyst since 2010.
    What I would like to do in this testimony is give you a 
little history and overview of the peer-to-peer lending 
industry, particularly as it pertains to small business.
    In this country, peer-to-peer lending began in 2006 with 
the launch of Prosper. Industry leader Lending Club followed 
just a year later. The SEC decided in 2008 that the loans 
issued by these companies were in fact securities and should be 
registered with the SEC. So, both companies went through a long 
and expensive registration process to allow themselves to 
remain open to non-accredited investors and to comply with this 
decision.
    To this day, these companies are the only peer-to-peer 
lending platforms to have undertaken this registration process, 
while there are dozens of platforms today, every other company 
is only open to accredited or institutional investors.
    It should be noted that Lending Club and Prosper are 
primarily consumer lending platforms, that they have been doing 
quasi-small business loans since inception. Many small business 
owners use their personal credit to fund their businesses. I 
have done that myself in the past.
    Since inception, Lending Club and Prosper have originated 
around $200 million in personal loans that were actually used 
for small business purposes.
    In addition to these personal business loans, Lending Club 
has had their own small business lending operation for over a 
year offering term loans of between one and five years. Lending 
Club does not share their loan volume here but my understanding 
is this initiative is still relatively small but is growing 
quickly.
    Prosper has a referral program with OnDeck Capital, the 
largest online small business lender.
    I should explain the variety of products offered by the 
broader online lending industry. There are term loans such as 
what Sam from Funding Circle just described. Lending Club also 
does those. These are one to five year amortizing loans with 
relatively low interest rates.
    There are lines of credit that can be drawn against as the 
need arises. This has a very wide range of interest rates. 
Merchant cash advance is the most high interest option. These 
are short term advances with repayments tied to credit card 
charges.
    There is invoice finance, also known as ``factoring,'' 
where small businesses can get immediate cash for their 
receivables. There is also crowdfunding which is often confused 
with peer-to-peer lending. It is not lending at all. It can be 
an equity based investment or it can be a rewards based 
donation.
    What can government do? I appreciate the fact that you are 
having this hearing and you are interested in learning more 
about this industry. The continued growth of this industry will 
provide many benefits to small business owners and the economy 
as a whole.
    As to what government can do, here I would like to describe 
some of the actions the U.K. government has taken. They provide 
a blueprint for supportive actions that a government can take 
to impact this industry. Number one, since 2012, the British 
Business Bank, which is wholly owned by the U.K. government, 
has been investing in small business loans issued by online 
platforms like Funding Circle in the U.K.
    While the total investment is relatively small, this action 
has given the industry there a tremendous boost in credibility 
and trust among investors and borrowers.
    They have also created a new regulatory framework 
specifically for the peer-to-peer lending industry. Last year, 
the U.K. government announced the creation of a bank mandatory 
referral scheme, where banks that reject small businesses for a 
loan must refer these businesses to alternative lenders.
    I am not saying the U.S. Government should copy these 
actions, but rather they provide some ideas of how governments 
can support this burgeoning sector.
    I firmly believe that small business lending is going 
through a transformation that will have a dramatic impact on 
the growth of small business in this country. I hope and trust 
that you will see the benefits we bring and will be supportive 
of this transformation.
    Thank you.
    Chairman CHABOT. Thank you very much. Each member will have 
five minutes to ask questions should they choose to do so. I 
will begin.
    Mr. Hodges and Mr. Iyer, I will begin with you two. What 
are the common legal and regulatory challenges associated with 
peer-to-peer lending?
    Mr. HODGES. Sir, I can go first. I think the biggest 
regulatory and legal challenge is frankly the complexity of 
having to deal with the overlapping set of Federal as well as 
state level rules, both on the lending or borrowing side, vis-
a-vis how you provide capital to the small business owner, and 
then also on the security side, which is really around how you 
take those loans and then turn them into a product that allows 
an institution or an individual to put money to work.
    We have invested literally hundreds of thousands of 
dollars, probably over $1 million, just in kind of figuring out 
the right framework for doing all that. I think some effort of 
simplification could be very beneficial.
    Chairman CHABOT. Thank you. Professor?
    Mr. IYER. When you really think about it, at some level, 
peer-to-peer markets when they originate loans and sell it to 
investors, you can think of them as junk bonds. They are 
basically issuing bad notes to investors. The problem is one 
has to be very careful of understanding what is the quality of 
the notes they are issuing, which is where the Securities Act 
really comes in to protect investors.
    That is where the whole regulatory regime comes into play.
    Chairman CHABOT. Thank you. Mr. Green, let me turn to you 
next. Could you elaborate on the P2P lender that you worked 
with and what made you confident that was the right option.
    You have a sample of your product here. I know you do 
because I saw it before the hearing. If you wanted to show it, 
I certainly would not have any objection to that.
    Mr. GREEN. Never miss an opportunity; right?
    Chairman CHABOT. So we can see what you are talking about.
    Mr. GREEN. Basically, through a series--we had a very 
generous line of credit through Bank of Kentucky, and one thing 
the Bank of Kentucky has been wonderful about, like Professor 
Iyer mentioned, they did not just look at our financials. They 
looked holistically at our whole entire business plan and what 
we had.
    The problem with working with a much larger traditional 
financial institution, they wanted to see five consecutive 
years of profitability. I had only been in business three 
years, and very few start-ups are profitable in those early 
couple of years.
    We were in a situation where we had to get access to 
capital within the next couple of weeks, and I had been seeing 
all this information on radio ad's and direct mailing pieces, 
and of course, never paying any attention to it until all of a 
sudden it came up as something I needed.
    The reason we went with StreetShares was because they are a 
veteran owned company, and I think it comes down to trust. We 
both as borrowers have to trust the lenders and the lenders 
have to trust the borrowers. By having a marketplace that has 
veterans helping other veterans bidding on those loans, I feel 
it made me more comfortable to accept that loan. It has been a 
great access.
    This is the sign that I want to see all those replaced with 
because you never need any batteries.
    Chairman CHABOT. How is that different from the one we have 
in the hearing room here?
    Mr. GREEN. This uses photoluminescent technology. 
Traditional exit signs use light bulbs and electricity and 
batteries. Those are all bad for the environment, they all cost 
a lot of money to maintain.
    This uses a patented type of photoluminescent material, 
very similar to what was used in the World Trade Towers to help 
people find their way out, and as a result, we can save 
businesses hundreds of millions of dollars in ongoing 
maintenance costs and you never have to replace these.
    They have literally a lifetime guarantee on them. Once you 
put them up, they work all the time, and in an emergency, when 
the power is out, that is the time you really need the exit 
sign with this, the photoluminescent, the glow in the dark is 
going to light up the whole entire area and show people how to 
get out safely.
    Chairman CHABOT. Thank you. Mr. Hodges, let me go back to 
you for a moment. Funding Circle originated in the U.K., I 
believe, which is seen globally as the country leading the way 
for peer-to-peer lending, I believe.
    Could you discuss some of the differences between the two 
countries, if you are aware of them, as it relates to P2P 
lending, and where we might be able to learn from the U.K.'s 
approach?
    Mr. HODGES. Sure thing. I think the biggest difference 
between the U.K. and the U.S. from a regulatory perspective is 
in the U.K., we have a simplified regulatory framework that is 
specific to peer-to-peer or marketplace lenders, whereas in the 
United States, what you are really dealing with is a whole set 
of kind of archaic lending as well as securities rules.
    On the security side particularly, the main laws that 
dictate how these businesses work are the 1933 Act, the 1934 
Act, the Investment Company Act, and the 1940 Act. These are 
laws that did not really anticipate the Internet, and even 
subsequent measures to modify those really have not made it 
easier for businesses like Funding Circle to operate.
    I think that is the biggest difference, specific regulation 
as opposed to kind of a mix of different older regulations.
    I think the second big piece, as Peter mentioned before, is 
the U.K. government has decided that as a proactive measure for 
funneling capital to small businesses, this is a very effective 
thing to do.
    The British Business Bank actually invests in a fractional 
piece of every single fractional loan that we do currently, 
which we are really excited about and it serves as a point of 
credibility.
    In the United States, it would literally take an act of 
Congress to get the SBA to do something similar. There is just 
not necessarily the same kind of level of support.
    Chairman CHABOT. Well, you have come to the right place for 
that. My time has expired. The gentlelady from New York, 
Ranking Member Velazquez, is recognized.
    Ms. VELAZQUEZ. Thank you, Mr. Chairman. Mr. Renton, as the 
CEO of both Lend Academy and LendIt Conference, what are the 
most asked questions you receive from prospective small 
business borrowers looking to use peer-to-peer lending?
    Mr. RENTON. The most asked question I receive is can you 
please fund my loan. That is what most people want. Seriously, 
what small business borrowers want to know is are they getting 
ripped off. They want to basically know that the options that 
are available to them are appropriate, and they also want to 
know what is the quickest, as Zach just talked about, he needed 
funds quickly. That speed is one of the themes. They know a 
bank is going to take one or two or three months. They need 
something quicker than that. They want to know what their 
options are.
    Ms. VELAZQUEZ. Mr. Hodges, how do we balance that? Small 
businesses, they need money, they need it now, and how do they 
know what they have been offered is transparent, that there are 
not hidden fees? How do we balance that?
    Mr. HODGES. For us, it really comes down to transparency. 
From the very moment that a small business comes to our site 
and uses our effective rate calculator to figure out how much 
the cost of financing would be, we are completely transparent 
about the interest rate, our origination fee, and any other 
potential fees that a borrower might pay over the lifetime of 
the loan.
    I think it is ultimately kind of around transparent 
practices, that is what in many ways sets this segment apart 
from other lenders.
    Ms. VELAZQUEZ. Mr. Renton, so many times, right after the 
financial crisis in 2008, where credit was tightened by 
financial institutions, we held so many hearings here about the 
inability of small businesses to access capital, but most 
importantly, smaller loans.
    When we questioned traditional financial institutions, they 
said smaller loans were too costly. Now, we hear that according 
to one industry expert, institutional investors now account for 
80 to 90 percent of the lending taking place on peer-to-peer 
platforms. Are you seeing this trend?
    Mr. RENTON. Yes.
    Ms. VELAZQUEZ. How can we explain that? On the one hand, 
they do not lend through traditional markets; right? Now, they 
are taking advantage of this. Is that because of traditional 
banking regulations that they are trying to circumvent?
    Mr. RENTON. I do not think so. First, let's address the 
first part of that question. There is no doubt that 
institutional investors are looking at this as a class and 
devoting a lot of capital to it.
    I want to defend the retail investor. I am a retail 
investor myself, have been for many years. I have found that 
there was a time a couple of years ago where they had to make 
some tweaks to their systems but today, retail investors get a 
good deal. Retail investors can invest on Lending Club, on 
Prosper, on Funding Circle. They can invest in loans, and the 
playing field is level. They have made it that way.
    As to institutional investors, why they are doing it, 
obviously, they are doing it for yield. These are often people 
or institutions that were not involved in the lending business 
at all. There are some hedge funds, there are some insurance 
companies.
    These are companies that for the most part are new to the 
lending industry. They were deploying capital that might have 
gone into the equities market or the bond market and they are 
deploying it into this industry.
    Ms. VELAZQUEZ. Thank you. You do not see any type of impact 
on the retail investors?
    Mr. RENTON. I do not see a negative impact.
    Ms. VELAZQUEZ. Good. Thank you. Mr. Green, the SBA, Small 
Business Administration, has a nascent presence in the peer-to-
peer lending market. If the Small Business Administration were 
to get more involved, what would you like to see them do for 
small business owners like yourself?
    Mr. GREEN. We actually did start working with the SBA for 
one of the loans that we ended up walking away from, and the 
reason was strictly it took too much time. There was just too 
much paperwork, there was too much red tape, there was just too 
many hoops to run through.
    In a small business, one week in my business is like a year 
in a Fortune 500 business. We do not have the time to go 
through all that type of--for lack of a better word--red tape 
to get through that. If they do get involved, we would like to 
see them speed the process up.
    Ms. VELAZQUEZ. Thank you. My time is up. I had a question 
for you, sir, but----
    Chairman CHABOT. We will give the gentlelady an additional 
minute if she would like to go ahead.
    Ms. VELAZQUEZ. You made a statement before while you were 
giving your testimony where you said that you could effectively 
judge risk over the Internet. Can you explain that a little 
further?
    Mr. IYER. At some level the measure of risk is basically 
how you can predict the likelihood of default based on 
something you are lending on, so credit score, 700, 750, 600. 
If you look at where the credit score predicts default, and the 
interest rate which lenders bid in predicting default, you find 
that the interest rate where these platform lenders come 
together and bid has a much better predictive power in terms of 
default as compared to just using the credit score.
    Ms. VELAZQUEZ. Thank you.
    Chairman CHABOT. The gentlelady's time has expired. The 
gentleman from Missouri, Mr. Luetkemeyer, who is also the Vice 
Chairman of this Committee, is recognized for five minutes.
    Mr. LUETKEMEYER. Thank you, Mr. Chair, and thank all of you 
for being here today. It is a great subject to discuss here. I 
have lots of questions.
    Just a minute ago, Mr. Iyer, you made the comment about 
bidding by the investors. Do these investors say we have to 
have X amount of percent return on our investments or do they 
take what you give? How does this work?
    Mr. IYER. What happens is you post a loan, you say I want 
to borrow $10,000 at 10 percent or whatever. The investor 
decides how much they want to fund. They could say I am willing 
to put in $1,000 for X percent, so there is like an auction 
which happens. As soon as the whole amount gets bid on, the 
lowest interest rate goes to the borrower, exactly what 
happened to Zachary.
    Mr. LUETKEMEYER. Mr. Hodges, you are in the business. Do 
your investors bid?
    Mr. HODGES. In our case, we actually set the price. What we 
found historically is actually the pricing that an auction 
mechanism would dictate is driven more by liquidity than the 
actual underlying credit risk.
    Mr. LUETKEMEYER. What is the actual return your investor 
gets for investing money with you?
    Mr. HODGES. It really depends on how much risk appetite 
they have. If they want to invest in safer loans, then you are 
talking about an effective yield to the investor in the mid to 
high single digits. If they are willing to go out the credit 
spectrum a little bit and take more risk and more volatility, 
then we have investors who are earning in the low teens.
    Mr. LUETKEMEYER. I think you said you have $1 billion you 
are trying to put out or you have had out, this last year. What 
is the percentage of loss you have on that?
    Mr. HODGES. Our global annualized loss level is about two 
percent. It varies a lot by credit tier. Our safest credits are 
A+ credits. It is well under one percent. For riskier credits, 
as you move out, it can be as high as five or six percent 
annualized.
    What we are really trying to do is just provide a fair 
price, a fair and transparent price that gives investors 
sufficient return while at the same time making sure that the 
money the borrower is getting is priced inside their own 
return.
    Mr. LUETKEMEYER. How easy is it for the investor to divest 
themselves of this loan or security that they purchase through 
you? In other words, let's say I invest $100,000 with you, but 
two years from now I want my money back or I think the company 
that I have invested with is going south and I want to get out, 
how easy is it for me to divest myself of that investment?
    Mr. HODGES. This works quite differently in the U.K. where 
we have a good chunk of our business versus the U.S., given the 
actual securities regulations.
    In the U.K., we actually have the world's most active 
secondary market of any peer-to-peer lender, so a meaningful 
share of our fractional notes, the actual investments of loans, 
are actually traded on a secondary basis, which we are really 
excited about.
    Unfortunately, in the U.S., the way the securities rules 
are written, it is actually much harder to do that. There are 
both state level Blue Sky laws as well as Federal laws that 
make it difficult to craft a secondary market.
    Mr. LUETKEMEYER. Once I invest with you, I am locked in 
pretty well?
    Mr. HODGES. Correct. People are taking illiquidity and we 
are very transparent about that.
    Mr. LUETKEMEYER. Do you have a particular industry that you 
specialize in and provide funds for or do you do across all 
industries?
    Mr. HODGES. We are very diversified. No one industry 
accounts for more than about eight percent of the bucket.
    Mr. LUETKEMEYER. Mr. Iyer, you talked about soft 
information. Can you explain what soft information is?
    Mr. IYER. Now there are two models in the peer-to-peer 
market which are competing. One is the model that the 
intermediary platform decides to rate, the other is investors 
like Zachary was saying who decide what is the rate and how 
much they bid. Soft information could be anything which is non-
verifiable. Credit score is hard information, which is based on 
your past credit history, past payments, and other things.
    Soft information could be somebody says I am a veteran 
fighter, I basically did this, X, Y, Z, you have a picture, 
anything that is non-verifiable, subjective, we put it in the 
bucket of non-standard soft information.
    You actually find that for people with low credit scores, 
investors use a lot of soft information as a screening 
mechanism.
    Mr. LUETKEMEYER. They have an algorithm put together that 
they can figure this out.
    Mr. IYER. Yes.
    Mr. LUETKEMEYER. I have seen this before. This is very 
interesting stuff. Mr. Renton, a quick question for you. There 
have been a couple of comments about needing some government 
intervention here, and I always kind of cringe, it is like be 
careful what you wish for here.
    Have there been any abuses that you have seen in the 
marketplace with the different peer-to-peer lending groups or 
people who accumulate money, the crowdfunding? Is there 
something there we need to be watchful for, that we really need 
to take a look at, the rules we have in place, are they 
sufficient right now?
    Mr. RENTON. As far as abuses go, there have really been no 
cases of abuses on the platform level. Of course, there are 
always going to be borrowers who are looking to commit fraud, 
and for the most part, the platforms do a very good job of 
really isolating those and rejecting them.
    As far as on the investor side and the platform side, there 
has been no cases of abuses whatsoever.
    Mr. LUETKEMEYER. At this point, you really do not need to 
have a lot of government intervention, the system is actually 
policing itself well enough?
    Mr. RENTON. Yes, I think it would be nice if there was some 
specific guidelines for this industry, but I think the system 
as it is today is working.
    Mr. LUETKEMEYER. I see my time is up. Thank you, Mr. 
Chairman, and thank all of you for being here today.
    Chairman CHABOT. The gentleman's time has expired. The 
gentleman from New Jersey, Mr. Payne, is recognized for five 
minutes.
    Mr. PAYNE. Thank you, Mr. Chair, and to the Ranking Member. 
Kind of along that line, Mr. Iyer, this question really goes to 
customer service and the possibility of hidden fees and what 
have you. What recourse does a person have with peer-to-peer 
lending sites when something goes wrong?
    Mr. IYER. You mean the borrower or the lender?
    Mr. PAYNE. The borrower.
    Mr. IYER. I guess when you say something goes wrong, he has 
the money, right? Once the bidding is done and you get the 
money, you have the funds, so you are the one who can basically 
make things go wrong. You can default. From that side, the 
intermediary is the one who is held hostile by the borrower.
    The risk is there are hidden fees and things which are----
    Mr. PAYNE. That is what I was getting at.
    Mr. IYER. I guess these markets are quite transparent in 
the sense that they charge hardly any fees which are opaque, 
they are actually very transparent in that sense.
    I guess the risk of borrowers is pretty low because you can 
see exactly what you are getting into.
    Mr. PAYNE. Has there been any research done in economic 
demographics of most lenders, the types of businesses they 
fund, and in what geographic areas?
    Mr. IYER. That is a very interesting question. 
Unfortunately, the lenders are anonymous. In all these peer-to-
peer platforms, you only see the borrowers. You do not know who 
is funding what kind of loans and whether they have expertise 
in funding. That is a question which I do not think I would be 
able to answer.
    Mr. PAYNE. Mr. Renton, we heard earlier on the average, 
eight percent of business loan applications are accepted in the 
peer-to-peer platform. Can you elaborate on why you think that 
may be the case, and what can we do to increase that number, if 
you think it should be increased.
    Mr. RENTON. I think the eight percent number refers to the 
consumer side of P2P lending. On the small business side, Sam 
could obviously give you the exact number for his platform. I 
believe it is much higher than eight percent.
    Having said that, there are still rules and guidelines 
these platforms put in place.
    If you are a start-up with no history, it is going to be 
hard for you to find a loan. If you have never made money in 
the history of your business, you are going to find it hard to 
get a loan through the major online lending players.
    Mr. PAYNE. That is sort of the interesting aspect of this, 
how does someone get started. Your point was you needed five 
years but you only had three. How do you overcome that 
obstacle, Mr. Green?
    Mr. GREEN. This is the entrepreneur's dilemma, you need 
money to buy product and to start marketing, but yet without 
any revenue stream, how do you get that started, what comes 
first, the chicken or the egg type thing. It is tough, and it 
is not only tough to get started, it is even tougher--someone 
said success is the hard part, failure is easy. It is the 
success to continue on and to grow.
    I got nervous when I got these large deals coming in, do I 
have enough capital to be able to put the materials together in 
the early days. Now, I am confident we can do that, but early 
on, it is a constant challenge.
    At the end of the day, you have to have--you can look at 
all the financials in the world, it comes down to do you 
believe in the entrepreneur, do you believe they have a pure 
heart and a good idea and they are solving a problem in an 
unique way, and if they are, put the risk in there and invest.
    Mr. PAYNE. I was going to mention that, in your case, you 
are fortunate that you came up with a great idea, and something 
that is necessary and useful in society. Has that made it a bit 
easier for you to have people kind of go along with investing?
    Mr. GREEN. It does. I think somebody had a really good 
point, they said when you are a successful entrepreneur, you 
need to solve a complicated problem in a very unique and 
eloquent way, you have to have an unfair competitive business 
advantage, and you also have to have really incredible 
marketing sales and distribution.
    When you can put all three of those together, it makes it a 
lot easier to get not only equity based financing but also debt 
based financing. The challenge with debt based financing, most 
of the time the larger banks just only want to look at the 
spreadsheet and they do not look at it holistically.
    Again, what Dr. Iyer shared is so true, and we saw that 
with our small regional lender, they looked at the why rather 
than just strictly the numbers we had in the past.
    Mr. PAYNE. Thank you. I yield back.
    Chairman CHABOT. Thank you. The gentleman's time has 
expired. The gentleman from New York, Mr. Gibson, is recognized 
for five minutes.
    Mr. GIBSON. I thank the Chairman, another informative 
hearing. I thank both the Chairman and the Ranking Member. 
Thanks to the panelists as well.
    Help me better understand this piece here. I can imagine a 
number of factors why individuals would be turned down for a 
conventional loan. Help me understand a little bit better maybe 
with some finer resolution how someone sort of misses that but 
gets into your window, your eight percent, why that would be 
unattractive to a conventional loan yet attractive to the 
industry.
    Mr. HODGES. I guess I can take a first crack at the 
question. I think it is a very good one. I guess my own 
perspective on this is most banks use a check list based 
underwriting approach where a small business needs to meet all 
of a variety of different criteria, number of years in 
business, amount of revenue, type of industry, particularly if 
it is a cyclical industry, they may not lend at all to, amount 
of tax return profitability, particularly in the early days 
when small businesses do not run with tax return profitability, 
and so forth.
    Whereas, in our case at Funding Circle, we are really 
looking to develop a comprehensive perspective on the business. 
We understand on a forward looking basis what is going to be 
the cash flow of the business and can that business support a 
loan. If so, we are happy to lend to them.
    It is really the flexibility of our underwriting model and 
also the flexibility of our pricing that allows us to offer 
credit to many small businesses who otherwise do not have 
access.
    Mr. GIBSON. Thanks. Just to follow up on that, have you 
ever had for Funding Circle an independent audit of some kind, 
and are there any industry ratings in this field?
    Mr. HODGES. To my knowledge, there are no industry ratings, 
per se. There are certainly consumer ratings. For example, we 
use Trustpilot to gather feedback from our customers. We also 
track very carefully our net promoter score. Our net promoter 
score in the U.S. is about 70 percent, which we are really 
excited about, and in the U.K., it is 89 percent. It is 
actually a pretty high level.
    Beyond that, I guess in terms of how we are evaluated, it 
is more around auditing specific operational practices that we 
use, and particularly now that we are partnering with banks, 
actually on a referral basis. We have actually gone through 
pretty extensive audits just to make sure every piece of the 
business is really clean.
    Mr. GIBSON. Any other comments from the panel?
    Mr. IYER. I would just make one comment which is where this 
industry is heading. In a sense initially you used to see stuff 
that people used to post and other people used to bid. Now, 
what is happening is a lot of platforms are doing the screening 
themselves.
    The platform Zachary was talking about allows people to 
bid. The platform Sam was talking about bid inside the 
screening. I think there are merits to both, but I think it is 
something that if somebody gets turned down, they should have 
the option to go on to a reverse auction site, just in case 
they got it wrong and investors have a choice to get funding 
because they might want to lend.
    That is something the market has to decide, but that would 
be a viable alternative.
    Mr. RENTON. I think that is happening. I know people that 
are going to multiple sites at the same time because they want 
to see the different rates. I do not see anything wrong with 
that. I think there are different models out there, as Raj was 
saying. The predominant model today is the fixed price model 
where the platform sets the risk. Whether that wins out in the 
end remains to be seen, but that is certainly the most 
predominant one today.
    Mr. GIBSON. I thank you, gentlemen. Your testimony has been 
helpful to me. I yield back, Mr. Chairman.
    Chairman CHABOT. Thank you. The gentleman yields back. The 
gentlelady from North Carolina, Ms. Adams, is recognized for 
five minutes.
    Ms. ADAMS. Thank you, Mr. Chairman, Ranking Member 
Velazquez, and thank you, gentlemen, for your testimony.
    I agree that small businesses are the engines that drive 
our economy. Over the past several years, we have seen a severe 
credit crunch within our financial markets, banks have not 
given loans at the same rate as previous years.
    With that in mind, Mr. Hodges, let me ask you about Funding 
Circle, which was founded based on your experiences as a 
business owner who had difficulty getting access to credit. 
With Funding Circle being one of the largest peer-to-peer 
lending sources, can you share potential market threats, both 
financially and technologically, that peer-to-peer lenders 
currently face or that you foresee may deter lending?
    Mr. HODGES. At this point, what I would say is even though 
some of us are getting to scale, we are still very much in the 
early days of developing the business. Small business lending, 
term lending, is a $270 billion market in the United States. If 
you put in kind of shorter term lending, it is probably closer 
to 600 or $700 billion. None of us are really meaningful yet.
    I guess what I would say is cutting through the noise, 
small business is a very fragmented market, cutting through the 
noise and making sure that a small business owner really 
understands what your product does and how it is differentiated 
from what else is out there is one of the major things that we 
focus on.
    In terms of kind of competitive threats or big looming 
hazards, there is nothing that is really keeping us up at 
night. It is really just around operating the business in a 
very reliable way and making sure we are scaling in a 
responsible fashion.
    Ms. ADAMS. Thanks. Can you tell us a little bit about the 
demographics of the businesses your company services?
    Mr. HODGES. Sure. Our borrowers are all across the country, 
and they also range very widely in terms of their ethnic, 
education background, certainly gender as well, and we are very 
proud of the lots of different stories of small business owners 
who have had very bad experiences with the banking system but 
who subsequently have taken loans from us.
    In terms of the type of business, it can range all the way 
from kind of retailers, service businesses to consumers, 
through light manufacturing and logistics, to B to B 
businesses, businesses that are serving other companies.
    What we have developed is an underwriting framework and an 
origination approach that allows us to serve a very broad base.
    Ms. ADAMS. Peer-to-peer lending is a very good model for 
some communities, but many minority owned firms with the 
capacity to move to the next level need different types of 
access to affordable capital, and still many of these firms 
jump higher for less.
    What models or policy recommendations can you offer to the 
Committee that we might explore that would be beneficial to 
minority owned firms on both traditional and non-traditional 
platforms?
    Mr. HODGES. I think the place that we start is around self 
regulation of non-bank lenders. We are working currently with a 
number of other players in the space to make sure that we all 
have very responsible standards around disclosure, around the 
effective rates that we are charging through, and also our 
collections and servicing practices.
    Historically, if you look at what has gone bad in small 
business lending, those are certainly areas where problems have 
occurred.
    In terms of policy recommendations, I guess what I would 
say is for now many of us are really focused again on self 
regulation. That being said, to the extent that disclosure 
particularly came up as something folks could take a closer 
look at, I do think disclosure around rate and kind of 
effective financing charges might be a good place to start.
    Ms. ADAMS. Thank you. Would any of the other gentlemen like 
to respond to that question?
    Mr. GREEN. I think a great idea knows no color, no 
religion, no background. If you have a great idea and you are 
able to put it out there and the market supports that and they 
see that, hopefully the funding will come along with that.
    Ms. ADAMS. Mr. Renton?
    Mr. RENTON. I would just say one of the great things about 
these online marketplaces is they operate online, so 
geographically, they are completely open to everybody. It is 
not like there are certain banks that do not operate in certain 
areas or you have to travel two hours to go to your local bank. 
The great thing about online is it is convenient to the entire 
country and there is no discrimination whatsoever when it comes 
to access.
    I think having that be a central tenant, and the other 
thing I would say is there has been talk about partnerships 
with CDFIs, which I think is still in its infancy, but CDFIs 
and community banks could very well use some of the 
technological know-how these online platforms have. I know 
there has been some talks in this area. I think that is 
somewhere organizations that serve these underserved areas can 
really benefit.
    Ms. ADAMS. Thank you. I yield back, Mr. Chairman.
    Chairman CHABOT. Thank you. The gentlelady yields back. The 
gentleman from New York, Mr. Hanna, who is the Chairman of the 
Small Business Subcommittee on Contracting and Workforce, is 
now recognized for five minutes.
    Mr. HANNA. Clearly, you are not in the Heifer projects. I 
am thinking back to Michael Milken, he was way ahead of his 
time, and I give him credit for that. I do not think he would 
be in the same jam today if he was doing what you are doing.
    The information that you provide your investors with--I 
love what you do, I think it serves a great purpose, and I 
think in the marketplace it fits as long as there is 
transparency.
    Mr. Hodges, to be frank, you may have a small loss ratio 
but loss ratio's are measured over time. That might be last 
year's, next year's could be much worse.
    I am curious about the due diligence that you provide other 
than the obvious quality of diversity that you have, which is a 
big piece of it, how do you say to people what are your lower 
limits? Maybe this was asked, I apologize for being late. How 
do you inform people who are giving you large amounts of money 
what their true risk is?
    To revisit Mr. Milken, over history, his was extremely low, 
not that much more than any other bond.
    Mr. HODGES. Similar to how we think about the borrower side 
of our business, also on the investor side, it is really around 
transparency and disclosure. What I mean by that is when an 
investor comes to us, be it an individual or institution who 
wants to buy loans or pieces of loans through us, what we 
provide is really detailed information about historically how a 
business credit has performed at different points in the cycle.
    We also provide full disclosure on our current loan book, 
and lastly, on a loan by loan basis, we provide very detailed 
financial information on a go forward as well as historical 
basis that allows them to understand what is the debt service 
coverage ratio, which is really the business' cash flow ability 
to pay back the loan, the level of asset coverage, and also 
some of the characteristics of the business itself.
    Mr. HANNA. What do you look for in a net worth of a guy or 
woman who is going to send you a check to invest?
    Mr. HODGES. In the United States, we limit our marketplace 
to accredited investors only, so they have to meet the SEC 
accredited investor----
    Mr. HANNA. Which is what, $1 million?
    Mr. HODGES. It is $1 million net worth outside of your 
home.
    Mr. HANNA. When you are speaking to minority groups and 
their ability to access what you do, not just minorities but 
anybody who might want to borrow money, there are lower limits 
to the borrower, too. You have lower limits for the investor. 
What are the lower limits for the borrower? How far down the 
food chain do you go?
    Mr. HODGES. Currently, our limits on the borrowing side are 
the business needs to have been around for at least two years, 
so two years' worth of tax return information, so we can really 
assess how that business has performed and make some prediction 
around how we think it will perform in the future.
    Secondly, the individual behind the business needs to have 
a FICO score of 620 or higher. We use that as a qualification 
criteria. It is actually a minority of the signal we use to 
eventually approve the loan.
    The business needs to have been profitable in at least one 
of the last two years. Obviously, if the business has been 
around longer than that, and most of our businesses have, our 
average business has been around for about eight years, then it 
is easier to get a gauge of profitability.
    Those are really the fundamental qualification criteria 
just to be eligible for a Funding Circle loan at this point.
    Mr. HANNA. You feel pretty good about the future. With all 
this due diligence on your part and informing people and 
setting those standards for borrowers, you must have done 
projections on your own expectations of loss, and if your 
returns are X, do you subtract that?
    Mr. HODGES. We have done extensive kind of testing and 
analysis around how our current book would perform either in an 
economic downturn or in an environment with meaningfully higher 
interest rates. What we see is certainly the loss rates, 
default and loss rates would go up meaningfully, but still, an 
investor who is sufficiently diversified, meaning they hold 
pieces of at least 100 loans, actually would not lose any 
principal based on the stress testing we have done.
    Mr. HANNA. Do you feel you are at least 100 percent covered 
on the bottom side?
    Mr. HODGES. Never would say 100 percent covered. There is 
always idiosyncratic risk.
    Mr. HANNA. That is sort of what you just said, but I 
appreciate where you are going. Thank you. My time has expired.
    Chairman CHABOT. Thank you. The gentleman yields back. The 
gentlelady from New York, Ms. Clarke, is recognized for five 
minutes.
    Ms. CLARKE. I thank you, Mr. Chairman, and I thank our 
Ranking Member, Ms. Velazquez. Let me thank our witnesses. This 
is a very intriguing and important subject we are discussing 
today because access to capital, we know, is a fundamental 
building block for small businesses in the United States.
    During the financial crisis of 2008, it led banks pulling 
out $116 billion in the lending market. This has compelled 
small businesses to seek the necessary loans from non-
traditional lending sources, such as peer-to-peer lending.
    We have seen that these peer-to-peer lending marketplaces 
are subject to high risk and potentially fraudulent services or 
activities. What suggestions might you have to improve the 
regulatory climate and oversight environment for peer-to-peer 
marketplaces to counteract practices of fraud or other elicit 
investing practices? Have you thought that through?
    Mr. RENTON. As I said earlier, there has actually been no 
cases of fraud in this country on the platform side. The 
borrower side is a different story, on the consumer side. Sam 
can probably talk about his experiences with fraud.
    Fraud on the platform side, which is a problem in some 
countries, it simply has not been a problem in this country, 
and I think even though there is a myriad of rules and 
regulations that these platforms have to adhere to, for the 
most part that works when it comes to deterring fraud.
    Ms. CLARKE. Are you saying there is no necessity for that 
in the United States? Is that what you are saying?
    Mr. RENTON. Yes.
    Ms. CLARKE. Yes, you are saying there is no necessity to 
put any safeguards or regulations in place because fraud is 
non-existent?
    Mr. RENTON. The safeguards that are in place today are 
sufficient to deter fraud. That is what I am saying.
    Ms. CLARKE. Very well. Sam? Excuse me, Mr. Hodges.
    Mr. HODGES. If I can speak on that directly, I guess on the 
platform fraud side, what I would say is we are already heavily 
regulated. We are regulated as a securities business. We own a 
broker-dealer. All the information we provide to our investors 
who are buying pieces of loans through us have to comply with 
the disclosure standards the SEC has set up and other 
securities law for any private offering.
    Certainly, making sure that what we send to investors to 
make sure they are making good decisions is a really important 
piece of the business, but I think those rules are already 
fully in place.
    On the borrower side, fraud is an expensive problem. We and 
other platforms have been hit extensively by fraud rings in the 
United States, and that is one of the things we are working 
together on, just to make sure we can identify fraud and weed 
it out.
    Ms. CLARKE. You also believe that you have set standards 
sufficient enough to address risk and how the risk is 
distributed among the investors?
    Mr. HODGES. I guess what I would say is yes, particularly 
on the fractional side. On the institutional side, for us and 
many of the platforms is a whole owned business, those are very 
large institutions who are investing millions of dollars, and 
we work with them to structure arrangements where they are 
getting sufficient information as well as sufficient 
diversification to make sure they know what they are getting.
    On the fractional side, as I said, there are already 
extensive rules in place which we follow insidiously just to 
make sure our investors are protected fully.
    Ms. CLARKE. They do know what they get?
    Mr. HODGES. We believe so.
    Ms. CLARKE. Okay. Very well. My second question quickly is 
with the increased popularity of the peer-to-peer lending 
platforms, we are seeing an increased rate of rejection for 
small business applicants through these platforms. This can 
lead to a gap in access to capital for our small businesses 
which can result in small businesses closing their doors.
    What suggestions might you have for Congress to implement 
that would be conducive for small businesses to continue to be 
able to access the capital they need through the peer-to-peer 
lending platforms?
    Mr. HODGES. One idea borrowing from what we have seen in 
the U.K. where we also operate is also having turn down 
requirements, where if a bank is going to go and turn down a 
small business for credit, they actually have the 
responsibility to send that small business somewhere else, so 
the small business owner knows there are other options. If 
there was one policy measure, I think that would be it.
    Ms. CLARKE. Very well. I thank you, gentlemen, very much 
for your testimony here today. I yield back, Mr. Chairman.
    Chairman CHABOT. Thank you. The gentlelady yields back. I 
want to apologize for the mike. I think the gentlelady was 
correct, I do not think it was working properly. We will 
definitely look into it and take care of it.
    I would now like to yield to the Ranking Member who has one 
final question.
    Ms. VELAZQUEZ. Just one final question. I represent New 
York, my congressional district is in New York. Part of my 
district was devastated by Sandy. A lot of small businesses 
suffered because the financial assistance they needed in terms 
of disaster loans took too long for SBA and FEMA to process.
    We all know that when natural disasters strike, if small 
businesses do not get the financial assistance they need, a lot 
of those businesses might have to shut down. Forty percent of 
small businesses do not reopen after a disaster.
    My question to you is in the aftermath of Hurricane Sandy, 
small business recovery was hampered by the slow disaster loan 
process. Did your platform fund any businesses in Sandy 
impacted areas, and do you think peer-to-peer lending is a 
viable option for disaster recovery?
    Mr. HODGES. We certainly have made loans to small 
businesses in the Sandy disaster area. As a matter of fact I 
remember anecdotally a number of businesses who had 
interruptions in their operations and were really looking to 
get back on track and coming in and applying for credit. Yes, 
that is something that we have seen.
    In terms of whether this is an effective measure for 
disaster recovery, to be honest, it is not something we have 
taken a really close look at, but certainly what I would say is 
when we see an opportunity in the market where there are going 
to be a concentration of small businesses who kind of need to 
expand, need to grow, need to invest in their store front and 
equipment, those are opportunities where we just frankly go and 
market more. There is kind of a factor that already makes it 
happen.
    Mr. IYER. There has been some studies done on disasters in 
other places, and they have looked at these markets when they 
were serviced by payday lenders after the disaster strikes as 
compared to when peer-to-peer platforms came up, and they do 
find recovery from these shocks are much better because of 
these people that go to peer-to-peer platforms and post a 
listing for a loan and they get it.
    In a sense, the information of whether people can access 
these platforms, maybe people do not know so they do not post 
it, but if that is available, these platforms are useful.
    Mr. RENTON. I really think it is a great idea. One of the 
things these platforms have an advantage over is speed. They 
can move very quickly. This is still a pretty nascent industry, 
and there is not a whole lot of infrastructure in place 
compared to the traditional banking system.
    I think Sam can probably talk about this, I think if there 
was some sort of arrangement in place that encouraged the 
platforms to really focus on the hard hit areas, they could 
move very quickly, I think.
    Ms. VELAZQUEZ. All these businesses have insurance, but 
they need that immediate financial assistance, such as a bridge 
loan through SBA, until the insurance money come through.
    Mr. RENTON. There are also other online platforms that are 
not really peer-to-peer but that operate in a similar way from 
the borrower side that are even faster. There are companies 
like Cabbage and OnDeck that provide cash to businesses 
literally within minutes. Those are the sort of platforms that 
would also be able to work much quicker than the traditional 
bank.
    Ms. VELAZQUEZ. Thank you.
    Chairman CHABOT. Thank you very much. The gentlelady's time 
has expired.
    I want to thank the entire panel. You all did really a 
great job in testifying here. We really appreciate your time. 
We know you have other commitments, and you came here to help 
members of the Committee to better understand the entire peer-
to-peer lending process, your perspective on it, and as we all 
know, it certainly is an alternative.
    It is one of the important ways that small businesses 
nowadays can have access to capital, and that is a critical 
element in a business being successful, and as we grow small 
businesses, we are growing jobs in this country.
    I think we all agree we need to do a better job doing that, 
so we can have the unemployment rate come down and have every 
American who wants a job have access to one. We want to thank 
you for your contributing to that cause.
    Members have five days to submit statements and supporting 
materials for the record.
    If there is no further business to come before the 
Committee, we are adjourned. Thank you.
    [Whereupon, at 12:20 p.m., the Committee was adjourned.]
                            A P P E N D I X


                        CONGRESSIONAL TESTIMONY


   ``Bridging the Small Business Capital Gap: Peer-to-Peer Lending''


                            Testimony before


                    The Committee on Small Business


                 United States House of Representatives


                              May 13, 2015


                             Rajkamal Iyer,


                    Associate Professor of Finance,


                     MIT Sloan School of Management

    My name is Rajkamal Iyer. I am an Associate Professor in 
Finance at MIT, Sloan School of Management. I would like to 
express my thanks to Chairman Chabot, Ranking Member Velazquez, 
and members of the committee for the opportunity to be here 
this morning.

    I became interested in the peer-to-peer credit markets when 
I learned how these new online markets have been developed to 
improve access to credit for small businesses and individuals. 
What was interesting about these markets were that the loans 
were funded by a group of small individual investors as 
compared to sophisticated lenders. Given that one of the big 
problems of credit markets in general, is screening for the 
underlying creditworthiness of borrowers, I was interested in 
understanding whether small individual lenders can judge 
creditworthiness effectively.

    Therefore, with my coauthors Asim Khwaja at Harvard 
University, Erzo Luttmer at Dartmouth, and Kelly Shue at the 
University of Chicago, we set out to understand the functioning 
of these markets. The context we studied was an online lending 
platform, Prosper.com, where individuals can lend to their 
peers. Individual lenders decide which peers to lend money to 
by using both hard and (mostly self-reported and non-verified) 
soft information on borrowers to determine their 
creditworthiness. Our paper shows that non-expert individuals 
do remarkably well--they are not only substantially better at 
predicting borrower default compared to predictions based on 
exact credit scores, but also do well relative to an 
econometrician's best predictions given the data available. In 
particular, the interest rate set by lenders predicts default 
45% more accurately than the borrower's credit score.

    Our results show that lenders in peer-to-peer markets are 
able to effectively infer borrowers' creditworthiness using the 
rich information set that these markets provide. We further 
find that lenders rely on nonstandard or soft sources of 
information in their screening process and that such 
information is relatively more important when screening 
borrowers of lower quality. Our results highlight that even 
markets with non-expert individuals can effectively screen for 
borrower creditworthiness. Given peer-to-peer markets' ability 
to effectively screen borrowers, and given their non-
collateral-based lending structure, such markets can offer a 
potential capital source for small borrowers who may otherwise 
be limited to more costly sources of finance.

    So one could ask what are the risks in these markets? One 
could be worried that investors are making bad loans and as 
they cannot judge borrower quality. Given the findings, this 
does not seem to be the case. What are the benefits to small 
businesses? Even if the interest rates offered by these online 
markets are similar to the those offered by banks, the growth 
of these markets could benefit small businesses as it could 
provide them with more funding options. At this point, given 
the nascent nature of these markets, regulating them could 
create impediments for their growth. Having said that one needs 
to keep track of how these markets evolve before designing 
regulatory frameworks to mitigate any possible externalities 
that might arise.

    Thank you again for the opportunity to address the 
Committee. I will be happy to answer any questions.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT] 

    Good morning. My name is Zachary Green and I'm the CEO and 
founder of MN8 Foxfire. I would like to personally thank 
Chairman Chabot and the members of the Small Business Committee 
for inviting me here today.

    As a young man growing up in Cincinnati, Ohio, I had three 
distinct dreams:

          1. To be a US Marine,

          2. To be a firefighter, and

          3. To be an entrepreneur.

    Dedication, honor, teamwork, and most of all mission 
accomplishment were some of the life long values I garnered 
from my time in the Corps. I recognize that having the 
opportunity to pursue the American Dream is because of those 
that have gone before us. We must never forget that we are the 
land of the free ONLY because of the brave.

    Several years later (and about 50 additional pounds), I 
fulfilled my second dream of becoming a volunteer firefighter, 
a rich American tradition started by one of our founding 
fathers, Benjamin Franklin. Being a firefighter, much like 
being a US Marine, taught me that no obstacle is too large, no 
hill is too steep and all challenges can be solved through 
leadership, teamwork and perseverance. After all, in the fire 
service we have to solve the problem at hand; we don't have the 
option of calling 912 after the homeowner calls 911.

    The summers in Parris Island and Twentynine Palms were 
unbearable. Marine Corps Officer training in Quantico, VA was 
extremely challenging, as is being a firefighter running into a 
burning building while everyone else is running out.

    But all of these pale in comparison to the challenges I 
have encountered fulfilling my third dream: becoming an 
entrepreneur.

    I came up with the idea of MN8 Foxfire while sitting on the 
tailboard of my fire engine. As a firefighter, some of our 
biggest risks are accountability and disorientation, all of 
which are compounded exponentially in the dark. I remembered 
seeing a special about September 11th and how the 9/11 
commission report noted several times how photoluminescence 
materials helped people evacuate the twin towers before they 
collapsed. I thought of ways in which I could apply this same 
technology to firefighter accessories. During the next several 
months, I drove from fire station to fire station selling MN8 
Foxfire accessories out of the trunk of my car. Sales steadily 
increased, and my former Fire Chief, Robert Rielage, sat me 
down and told me how much he believed in me and this product. 
He said I shouldn't just treat this as a hobby, but rather look 
at how to really grow the company. As I walked out of his 
office, I remembered the words of one of my favorite leaders, 
Theodore Roosevelt: ``In any moment of decision, the best thing 
you can do is the right thing, the next best thing is the wrong 
thing, and the worst thing you can do is nothing.''

    I refinanced my home, maxed out my credit cards, and took 
nearly all of my family's savings to officially start my 
journey to entrepreneurship. I'm proud to say that we now have 
more than 60,000 firefighters using Foxfire products. 
Additionally, we have grown our safety line of products such as 
eco-friendly EXIT signs (that never need maintenance, batteries 
or electricity), and a patented product that goes on stair 
edges that today illuminate the stairwells of sports arenas, 
high-rises, and universities all over the US and abroad. Thanks 
to the help of the US Dept. of Commerce's Commercial Services 
division, we have also exported this technology to more than 25 
countries throughout the world, including the Civil Defense 
headquarters of the United Arab Emirates.

    In 2013, MN8 Foxfire was awarded the ``Excellence in 
Entrepreneurship'' award; and I was named ``Entrepreneur of the 
Year'' by the Ohio Chamber of Commerce. I could not have been 
more proud, but every day is a struggle.

    One of Foxfire's biggest challenges--one many small 
business owners share--is the access to working capital. I love 
my mother very much, but the words of one of my mentors could 
not ring more true: Cash Is More Important Than Your Mother. I 
always thought the more Foxfire grew and the more we sold, the 
less I would have to worry about capital. I could not have been 
more wrong. When I realized that my personal investments would 
not be enough to finance our rapid growth, I raised capital 
from friends and family. With that capital, I hired more staff 
and bought more inventory, but it was still not enough to keep 
up with our supply chain and overhead costs. I next worked with 
a local venture capital advisory firm and raised additional 
funds. Those funds coupled with lines of credits from our 
regional lender, Bank of Kentucky allowed us to continue to 
grow.

    Almost every entrepreneur I know has the same reoccurring 
nightmare: running out of money. Several months ago, due to 
several unforeseen circumstances, this almost happened. We were 
fortunate to find a new stream of access to capital online 
through StreetShares, a peer-to-peer lender described by the 
press as ``Shark Tank meets eBay''. We presented our business 
case with historical financials, tax returns, and a pitch 
describing how we would use the new funds.

    StreetShares is a peer to peer internet-based marketplace 
that matches borrowers and lenders by shared social affinity--
such as in this case, veterans lending to veterans--to drive 
down the rates and risks of a loan through a reverse auction 
model. Our loan was funded from a pool of investors who 
competed to take a portion of our loan, each setting their own 
rate of return. These investors reviewed Foxfire's pitch and 
bid to fund a part of our loan. StreetShares combined all the 
lowest bids into a single loan for us. They bid down our rate 
because they knew we were a veteran-owned business, and many of 
the investors were veterans themselves. In under 36 hours, 
Foxfire received the money we needed. The interest rate was in 
the teens.

    If we had gone through this same process with a traditional 
financial institution, it would have taken months. If we had 
gone to one of the many small business ``payday'' type lenders 
online, they would have charged us an outrageous APR. The 
StreetShares loan had a reasonable APR, but was just as fast. 
If it were not for the quick access to an online peer-to-peer 
loan, I fear the worst could have happened. This is the perfect 
example of how the free market can act faster than larger, 
traditional institutions, and keep the American Dream alive.

    I became a US Marine, a firefighter, and thanks to new ways 
to fund startups like peer to peer micro loans, I am on my way 
to becoming a successful entrepreneur.

    Thank you again for your time today.
                              Testimony of


                              Peter Renton


                             Founder & CEO


                              Lend Academy


                               before the


                      Committee on Small Business


                 United States House of Representatives


                             May 13th, 2015

    My name is Peter Renton and I help run three businesses 
that are all focused on the peer to peer (P2P) lending 
industry. I am the founder and CEO of Lend Academy, which 
operates the leading P2P lending blog, podcast and community 
forum. I am the co-founder and CEO of the LendIt Conference, 
the first and largest conference series dedicated to the 
broader online lending industry. I am also a co-founder of NSR 
Invest, which is an investment and analytics platform that 
provides access to P2P marketplaces for financial advisors, 
institutional investors, and individuals.

    As you can tell, I was not born in this country. I grew up 
in Sydney, Australia where my father was an entrepreneur and I 
joined the family printing business one year after graduating 
college. Like most entrepreneurs in Australia I dreamed of one 
day starting a business in this country and I was able to do 
that in 1991 when I moved to Denver, Colorado to expand our 
family printing business. Since then I have started several 
other businesses ad in 2003 I proudly became a United States 
citizen.

    I have been investing in P2P lending platforms (now often 
referred to as marketplace lending platforms) since 2009 and I 
have been covering this industry full time as a blogger and 
analyst since 2010. What I would like to do in this testimony 
is give you all a little history and overview of the P2P 
lending industry, particularly as it pertains to small 
business.

    Short History of P2P Lending

    In this country P2P lending began in 2006 with the launch 
of Prosper, industry leader Lending Club followed just a year 
later. The SEC decided in 2008 that the loans issued by these 
companies are securities and should be registered with the SEC. 
So both companies went through a long and expensive 
registration process to remain open to non-accredited investors 
and comply with this decision. To this day these companies are 
the only peer-to-peer lending platforms to have undertaken this 
registration process. While there are dozens of platforms today 
every other company is only open to accredited or institutional 
investors.

    It should be noted that Lending Club and Prosper are 
primarily consumer-lending platforms but they have been doing 
quasi-small business loans since inception. Many small business 
owners use their personal credit to fund their businesses; I 
have done that myself in the past. Since inception Lending Club 
and Prosper have originated around $200 million in personal 
loans that were used for business purposes.

    In addition to these personal business loans Lending Club 
has had their own small business lending program for over a 
year offering term loans of between 1 and 5 years. Lending Club 
does not share their loan volume here but my understanding is 
that this initiative is still relatively small although it is 
growing quickly. Prosper has a referral program with OnDeck 
Capital the largest online small business lender.

    Brief Explanation of Products Offered

    I should explain the variety of products offered by the 
broader online lending industry:

          1. Term loans - typically 1-5 year amortizing loans 
        with relatively low interest rates.

          2. Lines of credit - to be drawn against as the need 
        arises, has a wide range of interest rates.

          3. Merchant Cash Advance - high interest, short term 
        advances with repayments tied to credit card receipts.

          4. Invoice Finance - also known as factoring where 
        small business can get immediate cash for their 
        receivables.

          5. Crowdfunding - is not lending at all. Can be an 
        equity based investment or a rewards-based 
        ``donation''.

    What Can Government Do?

    I appreciate the fact that you are having this hearing and 
that you are interested in learning more about this industry. 
The continued growth of this industry will provide many 
benefits to small business owners and the economy as a whole.

    As to what government can do here I would like to describe 
some of the actions the UK government has done. They provide a 
blueprint for supportive actions that a government can take to 
impact this industry.

          1. Since 2012 the British Business Bank, wholly owned 
        by the UK government, has been investing in small 
        business loans issued by online platforms like Funding 
        Circle. While the total investment is relatively small 
        this action has given the industry there a tremendous 
        boost in credibility and trust among investors and 
        borrowers.

          2. They have created a new regulatory framework 
        specifically for the P2P lending industry.

          3. Last year the UK government announced the creation 
        of a bank ``mandatory referral scheme'' where banks 
        that reject small businesses for a loan will have to 
        refer these businesses to alternative lenders.

    Now, I am not saying that the US government should copy 
these actions but rather they provide some ideas of how 
governments can support this burgeoning sector.

    I firmly believe that small business lending is going 
through a transformation that will have a dramatic impact on 
the growth of small business in this country. I hope and trust 
that you will see the benefits we bring and will be supportive 
of this transformation.
[GRAPHIC] [TIFF OMITTED] T4651.014

    The Electronic Transactions Association (ETA) applauds the 
Committee for its hearing on ``Bridging the Small Business 
Capital Gap: Peer-to-Peer Lending.''

    ETA represents over 500 companies from around the world, 
many of which are small businesses. Small business are the 
backbone of our economy and jobs. ETA member companies are 
vital to the success of small business by facilitating not only 
the payment needs of existing merchants, but in bringing new 
businesses into the payments system. Additionally, many of 
ETA's small business members are helping to develop new 
technology to make payments more flexible, faster, and safer.

    ETA believes that small businesses should have multiple 
financing options available to them, which is why we commend 
Chairman Chabot and Ranking Member Velazquez for holding this 
hearing on the important topic of peer-to-peer (or 
``marketplace'') lending for small businesses.

    Marketplace lending is serving an important need, 
particularly as traditional lenders and regulators have 
tightened available credit for small businesses. These new, 
technology-enabled lenders have stepped in to fill the need for 
small business in all 50 states. And while traditional 
financial institutions provide valuable service to millions of 
businesses, marketplace lending increases available options for 
small businesses.

    A recent industry report \1\ calculated that the first $1 
billion lent by one of the largest marketplace small business 
lenders generated 22,00 jobs and boosted the U.S. economic 
activity by $3.42 billion.
---------------------------------------------------------------------------
    \1\ OnDeck, How Delivering Our First $1 Billion to Small Businesses 
Has Helped Drive the US Economy, Analysis Group (May 2014).

    In addition to filling the funding needs for small 
businesses, many marketplace lenders, have utilized technology 
to develop more accurate underwriting tools thereby reducing 
the time it takes to move from application to approval to 
disbursement of funds to the small business. And, as you know, 
for small businesses, time is critical, the ability to deliver 
funding quickly, means opportunities will not be missed. The 
same study indicates that one of the main reasons half of all 
businesses did not apply for financing from a traditional bank 
---------------------------------------------------------------------------
is that the process would take too long.

    ETA applauds the House Committee on Small Business for 
holding the hearing on this important topic, and we look 
forward to working with Committee members to strengthen the 
marketplace lending market to allow small businesses access to 
the financing they need.

    The Electronic Transactions Association (ETA) is the global 
trade association representing more than 500 payments and 
technology companies. ETA members make commerce possible by 
processing more than $5 trillion in purchases in the U.S. and 
deploying payments innovations to merchants and consumers.

    For more information go to: www.electran.org

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