Future of entrepreneurialism

The traditional definition of entrepreneurship is expanding to include more creative ways of approaching business, applying business disciplines to social problems and establishing a wider range of success metrics. Four key trends are coming together to facilitate this new era of entrepreneurship: a shift in social consciousness, the democratization of capital, innovative responses to traditional financial systems and the low cost of starting a startup in the globalized world.

Shift in social consciousness
There is a great attitude shift underway towards sustainability and social responsibility. Al Gore, Paul Hawken and others have helped to put global warming, carbon neutrality, poverty and equity firmly on the international agenda. Part of the new social consciousness is also about effectiveness and accountability. Cycling the bottom of the pyramid out of poverty requires getting target populations actively involved. Loans are better than aid.

Democratization of capital
The ability to have more granular attribute knowledge about all economic transactions has triggered the demand to direct capital and consumption based on these affinity attributes. People are willing to pay on average 5-10% more for their attribute choices, for fair-trade, organic and local items, for hybrid cars and for blended value or double/triple bottom line financial returns.

Innovations to the traditional financial system
The shortcomings of traditional financial systems, their hierarchical nature, the lack of universal access and cyclic failures like the current mortgage crisis are triggering innovative solutions such as…

• Microfinance and P2P finance (for example, Kiva is currently active in 40 countries and lending about $750,000 per week)
• Socially Responsible Investing and social capital markets including social venture capital as offered by GoodCap
• Timebanks, gift economies and other non-monetary currency solutions
• Alternative payment mechanisms like developing country cell phone networks as money transfer systems

Low cost of starting a startup in the globalized world
The increasingly low cost of starting a startup makes a whole new tier of businesses possible: the LAMP software bundle provides free technology infrastructure, APIs replace business development and blogs and community interaction replace marketing (social networks become an overlay, a property of every website) and virtual world interactions replace face-to-face meetings.

Prosper reaches $100 million in loan volume

Peer-to-peer lending company Prosper reached a benchmark $100 million in loan volume this week. With the US stock market declines, credit crunch, raising gas prices and ailing economy, borrowers are turning to novel forms of credit such as fledgling peer-to-peer capital platforms offered by Prosper (US), Lending Club (US) and Zopa (UK).

$100 million in loan volume is an important benchmark, however the overall growth rate of new Prosper loans is slowing as the chart below indicates. Prosper's loan volume grew from essentially zero at the beginning of 2006 to $100 million in November 2007 but the S-curve inflected earlier this year at the $50 million loan volume mark.

Source: Prosper performance data. Note: the default view which specifies 0 delinquencies and 0-2 credit checks in the last 6 months should be removed to view the total loan portfolio.

The reason that Prosper loan growth is slowing is the same subprime credit challenge facing large financial institutions and the US economy as a whole. Initially, high interest rates attracted individuals willing to lend to subprime borrowers to the Prosper platform, but many of them have experienced high default rates and withdrawn their capital or curtailed their lending strategies.

Below is Prosper's ROI by credit tier, comparing the annual return for the year ending September 30, 2007 with the year ending August 31, 2007. Negative returns can be expected for credit tiers D, E and HR (high risk), while even the C tier has now slipped to a zero ROI. Prosper continues to be exclusively appropriate for investing in high credit quality, tiers AA, A and B, where the 6-9% ROI is still attractive relative to other investments, however perhaps becoming more risky.

Source: Prosper performance data.

Prime investing with Prosper

Leading P2P lender Prosper has executed an impressive $90 million in loans through its marketplace but continues to remain appropriate only for those wishing to invest in high prime credit quality consumer debt.

10% of the roughly 2,500 loans listed on the site at any time are in the high prime tier (credit ratings AA, A and B), in fact, most of the listed loans do not fund. About a third of the loans that fund and become active and billed are in the high prime credit tier.

The graph below shows an ROI comparison of Prosper's total loan portfolio by credit rating in two time snapshots, August 30, 2005 - August 30, 3006 in blue and August 30, 2006 - August 30, 3007 in yellow. In the last year, AA, A and B loans funded at 11-15% and have an ROI of 6.5-9.5% once adjusted for default.

Source: Prosper performance data. Note: the default view which specifies 0 delinquencies and 0-2 credit checks in the last 6 months should be removed to view the total loan portfolio.

Acceptable Returns?
Is 6.5-9.5% an appropriate return? It depends on a full consideration of the risk and return profile of the investment. Theoretically, high prime consumer credit loans are low risk; the historical default rate for Prosper loans has been 2% for AA and A loans and 4% for B loans. As compared with the stock market, which has on average for the last 80 years delivered a pre-tax return of 8% with a higher level of risk, Prosper loans look more attractive. 6.5-9.5% also provides a healthy risk premium over risk-free t-bills or money market funds and CDs which are currently yielding about 4.5%.

Prosper's $50m loan pool - high risk, high reward?

Prosper has reached a milestone of $50 million in P2P loans extended, however $10 million of these may end in default. Despite the high rate of Prosper defaults, much higher than traditional consumer credit defaults, lenders should not and may not mind if they are receiving appropriate returns.

P2P lending is emerging as a new credit category, not just in the visible ways of loan origination and delivery but also in the financial sense of how risk and reward are defined. P2P lenders are able to accept higher default rates since they are also theoretically realizing higher returns. Some portion of the 10% traditional spread in bank lending between borrowing and lending accrues to the lender.

It is clear that Prosper loans default at higher rates than traditional unsecured consumer credit loans. The chart below shows Prosper defaults in pink and Experian (as a proxy for the consumer credit market as a whole) defaults in blue. In every credit tier, Prosper loans have higher defaults. In the prime market of AA, A, B and C credit tiers, Prosper narrowly underperforms Experian. However as credit quality worsens, so do Prosper defaults with Prosper loans defaulting at double traditional rates in the E and HR (high risk) tiers.


Default data can be found at the Prosper website by scrolling to the bottom of the Performance page and selecting the Estimated ROI link. Lender ROI estimates are trickier, ranging from a blended portfolio ROI of -1% using the Prosper site data to 17% using the data from Eric's Credit Community.

The marketplace aspect of Prosper is working as sub-prime borrowers have seen the opportunity and are creating most of the volume on the site, 75% of listings and 60% of fundings. Although many loans receive funding that probably would not in traditional credit settings, the majority (75%+) of listings do not get funded.

Prosper is only about a year old and the P2P lending market needs to achieve much higher volumes before meaningful performance can be evaluated. The question is whether rates of return can be delivered which are appropriate given the higher risk from the higher defaults and if lenders can learn how to price default risk effectively in this new credit product.

P2P Finance - Does it work?

$20 million in loans have been funded to date through P2P lending marketplace darling Prosper, not bad given that the site launched publicly less than nine months ago. But is it working? How are these loans performing?

In another victory for transparency (the first being that borrowers willingly consent to having their credit ratings posted publicly), Prosper also makes default statistics publicly available.

Below is a simple analysis comparing Experian default rates by credit tier to the percentage of Prosper loans that are 1+ months late and 3+ months late on a payment.


Although the news appears to be encouraging, since Prosper currently only has 3,372 loans active and billed (below), it is really too early to form definitive conclusions. From this early data, Prosper loans seem to outperform traditional loans in the C, D, E and HR credit tiers, but under-perform traditional loans in the higher credit tiers, AA, A and B. Outliers, potentially fraudulent activity and really just too little data and too short of a track record are influencing these numbers, however it will be interesting to see if the trend can be maintained.

Social finance has arrived with crowd funding

Peer-to-peer micro-finance is expanding from lending marketplaces like Prosper and Zopa to peer-to-peer affinity-driven financial support for a wide variety of arts, humanitarian and software development projects.

The phenomenon has many names: crowd funding, crowd sourcing, social finance (coined here?), and virtual affinity group capital. Crowd funding is the natural extension of memes like the long tail, smart mobs and social networking and is an obvious capability of an increasingly linked online populace. Social finance is Money Now! - instant market support for good ideas attached to validated reputations.

Several websites are accommodating crowd finance: bands via Sellaband (description), movies via A Swarm of Angels, and citizen vlogging via HaveMoneyWillVlog (using a Wordpress plugin) which importantly lists the deliverable(s) and has feedback loops for on-project progress. Austin TX-based Fundable is a clearing house site for social finance and sees many uses for its platform including project financing for individuals, non-profit organizations, relief efforts and software development projects as well as other social finance practicalities such as splitting the cost of purchases and club dues collection. Fundable's beta site is a bit under-built (needs better listing and search functionality) and their 7% fee is steep (Prosper takes 1% of funded loan amounts).

Social finance projects are most often open-source, and are sometimes executed in interaction with the funding sponsors. A minimum contribution of $10 is generally required and the total amount to be raised is a few hundred or a few thousand dollars. PayPal (perhaps finding itself much more extensible than initially envisioned) handles the mechanics of the crowd pledges and fund disbursement, sometimes including some degree of escrow functionality for the commitment of funds and return of pledges if the project does not fully fund.

The funding levels are still fairly low for social finance projects but as the model becomes more proven, hopefully the OpenBasicResearch.org idea could be used for longer-term science research funding and looking out even further, the economy could shift to include freelancers with consistent regular affinity support as dependable sustenance.

It is exciting to see the power of virtual affinity groups in providing capital in both lending and grant financing models. The next obvious capability of virtual affinity groups will be in providing political support. The impact of social finance, text and video blogs and video clip websites like Blip.tv and YouTube will likely be significant in the 2008 presidential elections.