Creative Financing: Tips and Tricks from Author Linda Jenkins
Today’s post is an interview with Linda Jenkins, CEO of Gold Alliance Group, a consulting firm for small business owners and others seeking creative financing ideas. She holds a master’s degree in business with experience in architecture and recruiting. She just released the 2nd edition of her book, Creative Financing: How to Get a Small Business Loan without a Banker.
I have included my own comments in italics so as not to be confused with Linda’s
Hi Linda. Thank you for taking the time to share your experience in creative financing with us.
Sure, great to have the opportunity.
First, tell us about yourself.
I’ve managed my consulting firm Gold Alliance Group for five years along with a sister site on small business loan secrets which is an informational and educational site to small business owners. I started out actually in architecture, as an undergraduate of degree in Architecture at Michigan. And I was in that field for fifteen years.
I was not loving it that much. I did it to make a living, and I realized that there’s probably other ways to go out there and make a living. I was kind of looking more to be self-employed in a way that would give me more freedom and be able to help people.
So, I went back to school, got a degree and an MBA in Finance and HR management and worked for several corporations. I worked for large corporations and worked for a couple small businesses as well in headhunting. And while I was recruiting, I decided to explore options for self-employment, and started doing some independent things on the web. Originally, I started out in an eBay business and evolved from there into educating other small business owner as to how to go about starting a business.
So from there, how did you get into ‘Creative Financing’ and the peer lending space?
I think I started out from the investment side. About seven years ago, I read an article in Black Enterprise Magazine focusing on an entrepreneur that was doing well early in peer-to-peer lending on Kiva. I started out as an inventor, loaning small amounts to entrepreneurs around the world. I funded a couple of people in Uganda that were trying to start a local market there and got interested in that whole thing. When Lending Club and Prosper became more prevalent I decided this is great and I can do this for other entrepreneurs in the United States and also make money off it.
So I became an investor on Prosper after that.
Kiva is a great site for micro-loans to small business dreams around the world. Since 2005, more than 1.2 million people have loaned $641 million to small businesses in 84 countries. While you won’t earn interest on your Kiva loans, you do get repaid and the site boasts a 98.8% repayment rate. The site strikes me as a great bridge between crowdfunding, peer lending and supporting humanitarian causes.
While peer lending has been really successful in countries like England and New Zealand, it has only just caught on here in the United States. Prosper Marketplace has been originating loans for nearly a decade but took eight years to originate its first $1 billion in loans. It took the second-largest peer lending platform just six months to originate its second $1 billion in loans this year. Growth is kicking into overdrive. Check out my peer lending sites review of the two peer lending platforms, Prosper and Lending Club.
What would you say is the biggest mistake you made when first starting out as an inventor?
I would say, probably, not diversifying enough. I think that it’s definitely a good idea to do it. You really need to enter into several loans at a time, other than just focusing on one loan amount.
Investment diversification is one of the most important and often overlooked ideas for new investors in peer lending. The idea is that, if one loan in your portfolio of ten defaults then you’ve potentially lost 10% of your portfolio. If you’ve got investments in hundreds of loans, one default may mean less than a percent off your portfolio and the return from other loans will more than compensate.
I’ve seen investors take diversification to the extreme though as well. Some sites recommend investing in as many as a thousand loans. First, there is no way you can look at that many loans so you are basically setting your account on auto-pilot and using a dartboard approach to investing. Second, with the competition for investment right now, there is no way you would be able to do this without seriously relaxing the criteria you use to pick loans. Relaxing you criteria for investing, i.e. investing in loans of poorer quality, is the quickest way to poor returns.
The graph below, from Lending Club data, shows returns across portfolios depending on the number of loans in the portfolio.peer loans investment diversification
You can see that around 150 loans, the additional benefit to diversification for each new loan added to your portfolio quickly fades. While I wouldn’t argue with a portfolio of up to 300 loans, I generally recommend between 150 and 250 loans.
How many loans would you say is enough to be diversified? Do you have a limit? A lower limit? A higher limit?
I think that depends on your strategy. My strategy is more conservative. On Prosper I take advantage of the quick investing services, and I focus on borrowers that have credit ratings that are B or higher.
I am not looking to make huge amounts of money off this. I am looking for a reasonable return on the investments that I do make and getting something better than putting your money in the savings account.
Strategy is extremely important with any investment. Jumping in before you know your own tolerance for risk and need for return is a good start to missing your financial goals. I have seen a lot of investors jump into the high-risk categories of loans, mouths watering from the promise of double-digit yields. They quickly get turned off to peer lending when loans start to default even if their ultimate return is still relatively high. Some investors do not have the risk tolerance for higher-risk loans and really don’t need the return anyway to meet their goals.
A conservative strategy like Linda’s, only investing in the safest categories can still offer a high return relative to other fixed income investments and the default rate is very low. While I don’t usually recommend the highest-risk categories, the middle three categories of loans often provide a good compromise between risk and return for investors that can tolerate the additional risk.
And what surprise you most about peer lending?
I think, probably, the growth rate and the number of resource that just exploded, especially within the last three years. The industry is still in its infancy but you see more and more resources becoming available now. It’s pretty amazing. In my book it even talks about even niche sites that focus on very specific industries and funding. That is what surprise me, that it became so popular so quickly and the resource grew so fast.
If you thought growth to the end of 2014 was fast, I think you’re really going to be surprised by 2015. Lending Club will issue shares on the New York Stock Exchange soon and it could bring a ton of media coverage to peer lending. The largest peer lending site is looking to raise more than $600 million from its issue and that could pay for a lot of growth projects. Lending Club originated more than a billion in loans over just three months this year and the market for peer loans is still just a fraction of the total consumer loans market.
Beyond the peer lending sites, growth in the overall online loan market has been huge as well. Social Finance (SoFi) has originated more than $1.3 billion to 15,500 borrowers in a very short time. The site offers student loan refinancing, personal loans and mortgage loans at rates from 2.66% on an annual basis. Click through this link to Check out the loans available and open an account.
Do you have any best online resource for borrowers or investors?
Yeah, I do. Of course it depends on what your background and need is as a borrower. If you’re looking for money to fund anything, there’s no risk in putting a project request up on GoFundMe. And the reason I say that is it’s essentially asking for a grant. There’s no pay back, it’s essentially free money. There might be some rewards established with that, but I think everyone needs to try that one out.
Then I would say, if you are kind of a local business and you are looking more for a traditional way with doing business, I would say Prosper is great because it is so well established and they have such an investor base that it would really be in addition to a loan request but also publicity for your business.
Then if you’re more on the creative side, in fact my step-son raises money this way, on Kickstarter. He’s a film editor and got money in 2011 from Kickstarter for a film project. I think any creative project is great for the site. If you’re more of what a venture capital firm would go after, like a small business investment, I think Crowdfunder makes a whole lot of sense.
Linda really lays out the all-inclusive realm of alternative finance here with a great list. There are a ton of new resources but you first need to understand your project and which site is most suitable.
Within crowdfunding, there is rewards-based and equity investing. Rewards-based crowdfunding is the most popular with sites like Kickstarter and GoFundme. You post a campaign on the site and ask for a specific amount to make the project a success. For sites like Kickstarter, you will normally offer some kind of reward to supporters like a sample product or consulting. On other sites, just helping you reach your dreams may be enough for supporters.
In equity crowdfunding on sites like Crowdfunder, you are pitching big money investors to take an ownership stake in your company for their investment. Right now, only people with a net wealth of $1 million or more and meeting certain income requirements can invest in equity crowdfunding but when Title III of the JOBS Act is passed, everyone can invest. There are a lot of regulatory filings and work you will have to do but you can raise a ton of money and even bring on some really great investors that will offer advice on how to grow the company.
In the lending space of course there is Lending Club and Prosper as well as some of the other sites that offer online loans. Peer loans are going to be much easier to get and quicker than the crowdfunding alternative but they will cost you the interest on the loan.
So tell us about the book ‘Creative Financing.’
I originally wrote the book in 2012 and just came out with the updated edition including all the new resources and what is happening in the industry. Basically, I think that this book is great for anyone that has ever had a problem with getting a loan from a bank or perhaps being in the worst situation of, perhaps having a line of credit with a bank and then having the loan fail. There are certainly so many business owners out there that need an alternative to their local bank. I think peer lending is a great way to do that. My book tries to educate small business owners about the alternatives and then points them in the right direction for resources.
What should investors know about the risk in peer lending?
It’s possible that the person you’re lending to could default on you and could lose your principal. There are certain networks out there that are working on models on how to protect the investors, but at the moment, it’s still a possibility that you could lose your principal.
Risk of loss certainly something to remember when investing in peer loans but anyone investing in the stock market over the last decade will tell you that risk of loss is a factor in any investment. Peer loans are unsecured credit so there is no recourse if a borrower defaults like there is with a mortgage or auto loan. After a period of time, the peer lending platforms send non-paying loans to a debt collection agency to get the borrower back on a schedule. From my experience, about 30% of these borrowers eventually get back on a payment schedule while the other loans are charged off.
Even after accounting for defaults and loss of principal on some loans, returns for peer lending investors have been very good. The table below shows returns for each risk-category as well as for all loans originated through Prosper. A return of 9% on a fixed-income investment is really amazing and the loss rate of 7% is relatively low compared to other investments.
Any expectations for returns going forward? Possibly higher rates next year? How’s that going to affect peer lending?
I actually think that the overall opportunity for returns might go down a little. The only reason I say that, is because there’s probably going to be more regulations coming into this industry. Right now it’s in its infancy and everyone’s jumping in, everyone’s excited about it. But at some point in time, there’s going to be more exposure to things like fraud, right?
And when that happens, the government probably going to jump in and there’s going to be more regulations. I think that the returns will be in the 10% to 7% range going forward.
I’m not sure there is the potential for any more fraud in peer lending than there is in other investment types. Loan applications are verified by the lending websites and loan amounts are relatively limited. That said, there’s always the potential for someone to try to abuse the system. The thing people need to remember is that this would be a small fraction, way less than even a percent, of the people in peer lending.
I do agree that as the peer lending industry grows, regulators will start to look at it more closely. Right now, the space avoids a lot of the heavy regulatory burden seen at banks. That is actually one of the reasons helping peer lending to grow right now because banks are so bogged down with higher regulatory costs that make lending difficult. Increased regulation will eventually come to peer loans and it may eat into returns. Even returns of 7% to 10%, as Linda forecasts, will be very good compared to other investment alternatives.
What’s next for you? Besides getting the second edition of your book out?
Right. I think I’m going to focus on what I call the four pillars of business and that’s getting customers, getting the work done, doing the work and collecting the money. So, I’m going to focus on that, both in the blog articles I do and also, maybe writing a few new e-books within the topics and for small business.
Thank you Linda Jenkins and I want to thank you, the reader, for joining us. I hope you will join us for more interviews and follow the blog on Facebook and Twitter. Please consider sharing this article with your friends using the social share buttons on the left.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.