Palo Alto-based Upstart, a non-traditional loan company that uses a borrower’s future earnings potential as a metric for qualification, launched a new traditional loan product last Wednesday.
Only a couple years old, the company already made an impact on the lives of young entrepreneurs with its innovative loan products.
One is Nathan Sharp, a graduate of Dartmouth’s Tuck School of Business, who used Upstart to give him the financial flexibility to found e-commerce startup Nifti, which has offices in both Boston and New York.
Because Sharp did well at Tuck, he was allowed to borrow $50,000. That amount was based on a 2 percent “return” of his future earnings that he would have to pay back to the “investors,” the backers of Upstar.
Traditionally, there have been two impediments that force young people to give up on their ambitious dreams — money and health insurance.
When the Affordable Care Act extended the number of years children can stay under parents’ health insurance, finding a job for the benefit of health insurance no longer became a necessity.
The financial roadblock, having money to pursue a graduate degree or to set out on innumerable adventures that could lead to finding a passion project, is still difficult to overcome for twenty-somethings. Borrowing money, even for responsible young adults, has always been a near impossibility due to the fact that most recent grads don’t have the minimum credit history to qualify for a loan.
The amount that Upstart lends as well as the loan rate and time of loan is based on the company’s unique underwriting model.
Upstart’s model takes into account the employability and earning potential of borrowers by looking at the school they attended, their area of study, their academic performance (including GPA), and other factors. The company then models the career scenarios and outcomes for each borrower and estimates the likelihood that they could default and the cost of the loan. The loan would then be paid back by the borrower taking a percentage of their pay.
Last Wednesday, Upstart announced a new, more traditional loan that wouldn’t require borrowers to give up a percentage of their earnings. The company is offering its new loans to younger borrowers who wouldn’t qualify for loans based on their credit history by using Upstart’s earning potential model in addition to standard loan qualification procedures.
Borrowing on the Future
Upstart was founded by Reading native Dave Girouard, a Dartmouth grad who ended up moving West after getting an MBA from Michigan. After working for companies big and small in Silicon Valley, including a stint at Apple in the days of before Steve Jobs’ triumphant return, Girouard became the president of Google Enterprise, playing a key role in the development of Google Apps.
Girouard founded Upstart with Paul Gu, one of the first Theil Fellows, who while living in New York had built a regression model to predict people’s future earnings, trying to find a way to turn debt into equity. Girouard and Gu connected and immediately started working on Upstart.
“You want young people trying these awesome and cool ideas … they don’t have spouses, they don’t have mortgages,” Girouard said. “So we started to think about how people borrow from their future earnings stream.”
Some of Upstart’s backers include Google Ventures, Kleiner Perkins, Khosla Ventures, Founder’s Fund, and First Round Capital, as well as Google’s Eric Schmidt, Marc Benioff of Salesforce.com, Mark Cuban, and local angel investor Andy Palmer.
Fourteen months into the Upstart project and the company has 309 borrowers with zero defaults on payment.
A New Way to Get a Loan
Gu and Girouard started to see people trying to borrow money for classes at General Assembly or other non-traditional experiences, but didn’t have a product in place to help them to quickly get a short term loan. Because of various regulations, it was also difficult for young people to get a loan through traditional channels.
As an example, Girouard said that Gu, who is twenty-two and earns a six-figure salary, tried to get a loan for $10,000 but was rejected because his credit history was too short. He tried another lender and was offered a loan with an extremely high APR percentage.
“It’s pretty clear, that they are using underwriting that was invented fifty years ago,” Girouard said. “It doesn’t work for younger people, it doesn’t work for millenials.”
So Upstart came up with a new loan product launched last week, that uses the employment prospects and future earnings potential model to make up for people who have shorter work and lending histories. The company will offer three-year term loans, with fixed interest rates between 6.5 percent and 20 percent APR.
“This is a real data solution to a problem that is five decades old,” Girourd concluded.
While it is easy to argue that Upstart could be taking advantage of young, inexperienced borrowers, the company seems to be pretty selective in who it is giving loans to and hasn’t had anyone miss a payment yet.