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December 11, 2014

Perseverance Pays Off: The Lending Club Story

outside of the new york stock exchange

Rough patches early on can help young startups build toughness for the long fight ahead.

It is easy to overlook in light of today’s IPO, but Lending Club almost joined the legion of early stage companies that get off to a promising start, but run into insurmountable roadblocks and fail. In Lending Club’s case, the challenges weren’t the typical start-up problems of finding product/market fit or fighting off well-heeled competitors. They were even tougher: a six month negotiation with the federal government for company survival paired with an economic meltdown that made people skittish about lending money.

Lending Club not only survived these challenges but ended up as the leader in marketplace lending. The Lending Club story is a testament to the importance of keeping one’s cool during periods of high stress and not giving up on a great idea.

I first met Lending Club founder and CEO Renaud Laplanche while taking a tour of the well-known incubator, Plug and Play Tech Center, in Sunnyvale. It was early in the spring of 2007, and my friend Saeed Amidi, the incubator’s founder, was introducing me to some of the start-ups that were operating there.

I met more than a dozen startup founders that day, most of whom I talked to for just a few minutes. I could immediately tell, however, that Renaud was different. I asked him what his company did, and he said peer-to-peer (P2P) lending, a concept that sounded really interesting. We talked for about 20 minutes, and I was immediately struck by how thoughtful, calm, and confident Renaud was.

We agreed to meet again soon and talked regularly all spring and into the summer.

Lending Club had a very simple idea: using the internet to match people looking to borrow money with people looking to invest. The borrowers would benefit from Lending Club’s lower rates compared to the high interest and fees they were paying to banks on their credit card bills; at the same time, investors would earn better interest rates than on CDs from a bank. This P2P lending model would provide a win-win situation for both borrowers and lenders, while Lending Club would take a small piece of each transaction and operate under a low-cost internet business model.  We felt that P2P lending – now called marketplace lending – was a disruptive strategy to pursue within the enormous market opportunity of consumer finance.

Initially, Renaud had two go-to-market strategies for Lending Club. The first was to initiate loans through Facebook. The second was to make deals with college alumni associations to allow older graduates to fund loans for younger ones.

Launching on Facebook in 2007 turned out to be a brilliant marketing move by Lending Club. Facebook had just opened its platform to outside applications, and Lending Club generated a lot of viral publicity through its Facebook launch. Unfortunately, however, that publicity didn’t lead to many customers. Lending Club has always targeted prime borrowers who aren’t likely to default on a loan. Back in 2007, Facebook was still mainly populated by college students who were neither prime borrowers nor likely lenders.

The alumni association path also proved harder than Renaud expected, primarily because P2P lending was a new concept in 2007, and alumni associations felt that it was too risky to recommend to their alumni.

The challenges related to Lending Club’s initial go-to-market strategy gave me and my colleagues some pause as we contemplated our initial Series A investment. But we were watching Renaud and his team pivot very quickly – he struck us as creative, scrappy and smart. And the idea was clearly a big one. So we decided to pull the trigger, and we invested in the Series A alongside Canaan Partners in August 2007.

Armed with the Series A funds, Renaud soon shifted focus to initiating loans through Lending Club’s own website, and loan volume quickly began to surge. By March 2008, Lending Club was initiating $6 million in new loans a month. There was strong interest from borrowers and while there was still work needed to bring on more investors, we were all optimistic.

Then, in April 2008, Lending Club hit another major pothole – this time with the SEC.

Lending Club, along with other P2P lenders, had pioneered a concept of dividing up consumer loans into small pieces and allowing individual lenders to take pieces of many different loans, thereby enabling diversification for the lenders. This concept made great sense for everyone.  However, Lending Club knew that the SEC would have questions about the division of these loans and proactively engaged the SEC on the topic.  Ultimately the SEC decided that the pieces of loans did not fit with any form of security that the SEC had previously approved.  A new security had to be jointly defined by the company and the SEC and then registered by Lending Club with the SEC (i.e. just like registering shares for an IPO). The problem was that the legal process with the SEC was going to cost Lending Club around $3M – $4M.  Worse yet, we all had great uncertainty as to whether Lending Club and the SEC could successfully come up with a structure that could indeed be registered, since nobody had ever done it before.

To top everything off, the SEC forbade Lending Club from accepting new money from outside lenders while this process was going on. Loan volume slowed down to a trickle.

Initially, we optimistically thought that this process of definition and registration might be a relatively quick affair, but it dragged on through the spring and summer of 2008 as Lending Club struggled with the SEC to define this new security. Throughout this agonizing waiting game, Lending Club wasn’t able to court outside lenders for its platform and was only able to stay in operation by making a few loans with its own funds.

Meanwhile, in the fall of 2008, the country was on the precipice of an economic crisis. Lehman Brothers went bankrupt, and the financial sector was in a panic.

And then, it became worse: Renaud told us in a board meeting that Lending Club would run out of money by the end of 2008.

To his credit, Renaud remained as calm and confident as always. He was convinced that he was close to registering Lending Club’s securities with the SEC and that the company would soon be open for business again. His attitude rubbed off on the board — it was hard not to believe in him.

At that point, though, Lending Club needed to raise funds and raise them fast. We knew we were unlikely to find an outside investor to put up capital. Who would invest in a company that was stuck in limbo negotiating for its life with the government while the rest of the country was in an economic crisis? We knew that we would have to make the investment ourselves.  So, along with Canaan, we invested again.

Within Norwest, there wasn’t really any resistance, even though inside rounds led by existing investors can draw questions within a partnership. Especially in times of trouble. But we still thought that marketplace lending was a hugely important idea, and we continued to believe in Renaud.

Soon after the new round closed, things started to look up. Lending Club completed the registration of its loans with the SEC and opened back up for business in October 2008. Renaud had managed the downtime deftly, getting his team to focus on improving Lending Club’s infrastructure and preparing for the site to relaunch.

As 2009 progressed, Lending Club found no shortage of potential borrowers, and slowly but surely they recruited high net worth lenders to make loans on the platform. Renaud and team steadily became better and better at underwriting borrowers and simultaneously driving down the cost of finding the borrowers.  At the same time, the company was creative in convincing lenders that the high returns from lending on the Lending Club platform more than offset the risks of the new marketplace lending model.  Lending Club kept at it, generating over $50M of loans through the platform in 2009 and over $125M in 2010.

In my mind, the real breakthrough for Lending Club was going to occur when enough lenders developed confidence in the platform that the high rates would attract a rush of capital. I had hoped that would happen by 2010 – it turned out to take a little longer than I expected.

The breakthrough happened in 2011 when we saw someone raise a third-party fund for the sole purpose of investing on Lending Club’s platform. That was when we knew the company was off to the races – they did over $200M in loan volume that year and never looked back.

Over the last several years, loan volume has exploded for Lending Club – they did over $2B in loans on the platform in 2013 and have far surpassed this amount already in 2014. The company has grown along with the loan volume. Renaud himself has grown from being the scrappy, never-say-die entrepreneur to a widely admired executive who was recently named the #1 best startup CEO to work for, ranked over CEOs who are some of the most well-known and highly regarded in the internet world.

Today’s IPO marks a great milestone in the life of Lending Club.  Renaud and his team deserve the kudos they’ve earned for all they have accomplished with the company, bringing affordable loans to a generation of consumers and better investment returns to many thousands of lenders.  And while everyone admires the size and scale that Lending Club has achieved today, those of us who have been with the company from the early days will long remember the dark times of 2008 when, for an unnerving six months, the company was perilously close to shutting down, effectively out of business and almost out of cash.  Watching Renaud navigate those shutdown shoals, we saw just how important his persistence, creativity, calm and confidence were to the survival of the company.  Lessons learned, not to be forgotten.