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When Banks Say No

Dan Bolton, Editor-in-Chief Coffee Fest Minneapolis

Specialty Coffee Retailer June 4, 2010
(415) 839-5063

Commercial Banking Crisis

When Banks Say No
Banks made it difficult to finance small business ventures long before
the current financial crisis. In 2006 when credit was flowing, banks
denied 5 million small business loan applicants because of low
personal credit scores and lack of collateral−regardless of cash flow.
The Mortgage Crisis and Great Recession further tightened credit.
Major U.S. financial institutions wrote down more than $510 billion
in bad investments in 2008 and $550 billion more in 2009. They
expect to write off another $500 billion in losses this year.
Lending across all banking sectors was down 9 percent last year. In 2009 small business owners
unsuccessfully sought $160 billion to finance their ventures. Small business loans were down 4
percent at the largest banks. Bank of America cut back 21 percent. Established institutions like
CIT with multi-billion portfolios in small business holdings declared bankruptcy.
The government closed 140 banks in 2009 and 78 since January and the pace is accelerating.
Saying NO is often the safe response due the number of foreclosures pending. In many cases
banks are preserving capital to protect their investment in local businesses like your own.

Source: Business Week, Associate Press and Fortune

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Technology Advances Make it Easier to Access Risk

Due to the crisis, lenders began exploring alternative
methods of securing private financing, returning to a
two thousand year old system where small investors
were the engines of commerce.
The emergence of Social Lending websites permits family and
friends to join wealthy benefactors and small private investors as
ready sources of capital. Instead of approaching banks and credit
unions or appealing to an angel investor or assigning equity to
silent partners or venture capitalists — a business owner could
conveniently tap the resources of 10 investors at $2,500 each or 100 investors at $250
each or 1,000 investors at $25 or any combination of the above to fund expansion plans,
capital improvements, purchase new equipment and expand inventory.
What gives these emerging financing tools real momentum (and fueled $1 billion in loans)
are favorable interest rates for borrowers and transparency and a low incidence of default.

"As major financial institutions stumble or fail completely, online lending sites…are on the rise.“ CBS News

"...the increased efficiency of cutting out the banks“ The New York Times

Source: CBS News, New York Times, Lending Club Raise a hand to
Peer-to-Peer Lending
• Access to a Large Pool of Lenders
• Convenient Application Process
• Competitive Rates (8-12%)
• Sophisticated Risk Assessment
• Quick Funding Decisions
• Low Default Rates
• Transparency

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A Short History & Some Supporting Research

Source: Raise a hand to

Samovar Tea Lounge
San Francisco

• This independent small chain’s gross

earnings were $3 million in 2009 on sales
of beverages, food, loose tea and fine tea
ware at three locations.
•The first shop opened in 2001 and earns
$1.2 million. A second opened near the
city’s convention center in 2006.
• Cash was tight as Samovar opened its
third shop in Feb. 2009. That summer as
the 2009 holiday shopping and gift giving
season approached owner Jesse Jacobs
began lining up funds to stock inventory
for his online operation and shops.
• Failure to place timely orders for
$100,000 in gift items posed a serious
threat as 4th Quarter revenue is critical to
the chain’s overall profitability.

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Source: Interview, 5/27/10 Jesse Jacobs, owner 6
Finance Options
Prior to seeking financing Jacobs reduced labor
expense, eliminated the least profitable menu
items and bartered for staff morale-boosters in
lieu of bonuses. He created customer coupon
incentives, introduced a value tea and brunch
and marketed aggressively online. He also
shortened the inventory cycle to just-in-time
reducing cash on the shelf by $40,000.
Starting in 2008 he asked key vendors to
extend payment terms and consider converting
receivables to debt. Several converted about half
their receivables at 7% for six months.
He next sought $10,000 from private investors
and paid 8% on $50,000 in short-term loans.
Jacobs, who qualifies for AMEX Plum, also took
advantage of their offer to extend payments for
90 days to a maximum of $30,000.
It was only after all these options had been
visited that Jacobs turned to Prosper with a
request to borrow $20,000.

Source: interview 5/27/2010, Samovar owner Jesse Jacobs .

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Samovar’s Description for Loan on Prosper

“Stellar local business focused on creating
human connection through the ancient ritual of
tea is looking to expand our online business.
After eight outstanding years in business we are
ready to venture online and brave the holiday
season with a new offering of retail tea and tea
ware. We are looking for a bit of capital to help
fund inventory for our retail operations and
would appreciate the support of passionate
Samovar lovers who "get" our business and
want to help us grow.

Source: interview 5/27/2010, Samovar owner Jesse Jacobs .

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Interest Rates
National average for a 36-month unsecured $5,000 loan was 12.32% on May 28.
Jacobs, with good credit, borrowed
$20,000 from Prosper at 9% and paid it
back in 6 months.
Coffee shops historically faced difficulty
obtaining loans from traditional banks. Most
have no significant assets or receivables and
little collateral to secure business loans.
An On Deck $30,000 loan used to buy
inventory at 19% when paid in six months
costs $277 per day. Interest expense is
At Prosper borrowers with good credit
scores pay as little as 9 percent but the cost
rises to 33 percent for those with blemished
credit records.
Investors earn 8.2 percent to 32 percent.
Source: MSN Money, Informa Research Services, Inc
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How it Works: Business Loans in Small Increments
Several hundred lenders may
purchase a note. The note
finances the borrower’s
proposed use. Borrowers pay
down the note in equal
monthly payments with a
portion to Prosper to service
the loan and the remainder
as interest to lenders.

Source: Prosper website Raise a hand to

How it Works: Borrower Profile Borrowers describe the
purpose of the loan and
then submit credit
information analyzed by
Prosper and uniformly
displayed as below:

Source: Prosper website Raise a hand to

How it Works: Risk Assessment
Proprietary ratings based on credit scores and internal benchmarks help lenders predict losses.

Source: Prosper website Raise a hand to


How it Works: Auction

Lenders select projects to fund. An online auction determines interest rate.

Source: Prosper website Raise a hand to


How it Works: Family & Friends

The identity of lenders is carefully guarded.
Borrowers disclose as much information as
needed to present their case. Lenders can ask
questions via email.

Since its founding Prosper has attracted

960,000 members and loaned $197 million
and paid lenders several million in interest.

Source: Prosper website Raise a hand to


Prosper: A Closer Look

Outstanding Loans: $197 million
Founded: 2006

Typical Loan: $4,369 (available from $1,000 to $25,000)

Loans Funded: 32,000 funded loans
Security: Personal guarantee
Interest (borrowers): 10 to 33% Members: 980,000
Fee: 1 percent Approval: Depends on successful bids
Default rate: 6.8 percent Minimum Credit Score: 640
Profile of Successful Applicant: Sixty percent are individuals seeking debt relief. Small business
loans make up 12% of successful applicants with 4% seeking education assistance.
Paperwork: Online application, credit review by Experian
Payments: Monthly payments
Funded: Venture Capital Funds*, Private Family Funds
As new peer-to-peer sites emerge they are becoming more specialized as borrowers define their
needs. Prosper, for example has seen big growth in debt consolidation in the past year.
Source: Accel Partners, Benchmark Capital, DAG Ventures, Fidelity Ventures, Meritech Capital Partners, and Omidyar Net
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Debt Consolidation
Currently the majority of Prosper
(60%) and Lending Club (61%)
borrowers are seeking financial relief
through debt consolidation. Small
businesses comprise the next highest
loan category at 12 percent.

Established Business
On Deck Capital offers borrowers
larger sums. However they must
have operated at least one year at a
non-residential business office, which
discourages debt consolidators.

Source: On Deck Capital, Prosper Raise a hand to


Small Business Specialists

Retail and small manufacturers with good cash flow are the sweet spot for this lender.

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Prosper promotes On Deck to borrowers who meet requirements.

On Deck Capital
competes with both
Merchant Cash
Advance programs and
traditional lenders.

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On Deck Capital: A Closer Look

Outstanding Loans: $58 million
Founded: 2006
Typical Loan: $30,000 (available from $5,000 to $100,000)
Loans Funded: 2,000 funded loans
Security: Personal guarantee
Interest (borrowers): Low 20s to 36% Approval: Two business days, funds in 5 days
Fee: $500 Default rate: Under 10 percent
Profile of Successful Applicant: Small business with good cash flow, lots of small transactions
and $1 million revenue.
Paperwork: Access to borrower’s checking account and at least three previous months
transactions to determine cash flow and accounting reports (60% use QuickBooks).
Payments: Deducted each day from applicant’s checking account. Amount varies but $100
per day is common. A firm borrowing $30,000 for six months pays $277 per day.
Funding: Venture Capital Funds*, Hedge Funds, Private Family Funds

Source: New York Times, May 5, 2010. Providing Loans based on Cash Flow, Not Credit Score.
Contour Venture Partners, First Round Capital, Khosla Ventures, RRE Ventures and Village Ventures Raise a hand to

How it Works: Smooth Sailing

Prosper and On Deck Capital are not FDIC insured
and borrowers do default at rates approaching 20
percent for those with weak credit.
Returns are only as reliable as individual borrowers.
Each Prosper Note corresponds to a listing which sets
forth the relevant details about the loan, including loan
amount, price, yield percentage, and borrower details.
Any payment from a Prosper Note is dependent on
payments Prosper receives on the corresponding loan.
Prosper recommends lenders diversify across a wide
range of choices investing small amounts to reduce the
impact of a possible default.
Shop owners finding it difficult to navigate the narrow
channels of traditional lenders should consider
Dan Bolton, Editor-in-Chief establishing a history with a reputable peer-to-peer
Specialty Coffee Retailer lender for equipment and seasonal inventory buys as an alternative to merchant and vendor advances,
(415) 839-5063 credit card and bank lines of credit.