This story appears in the May 25, 2015 issue of Forbes.
When Jennifer Kirk, who owns Posh Puppy Boutique, a pet grooming and supply shop in Rocklin, Calif., had an opportunity to expand her business last year, she turned first to her bank, which made her wait three weeks before rejecting her loan application. Then she learned about Kabbage, which let her apply online--linking directly to her bank, PayPal and QuickBooks accounts (as well as her social media feeds)--and then ran an automated program to assess her creditworthiness.
Six minutes later she had an answer: She was approved to borrow up to $50,000 on a six-month loan, and she could transfer part or all of those funds to her PayPal account whenever she needed them. "The money was instantly available to me," says Kirk. But at a price--an annual percentage rate of about 27%.
Today Kabbage offers borrowers lines of credit for as much as $100,000, with loans payable over six months. The average line of credit is $25,000, and the average borrower takes seven or eight loans a year, totaling $50,000. Since its start in 2009, the company has lent more than $750 million to small businesses, and it expects to lend $1 billion in 2015. It also expects to be profitable this year, with revenue exceeding $100 million, up some 200%.
Those numbers put Kabbage among the leaders of the increasingly crowded field of alternative lenders, says Smittipon Srethapramote, a vice president at Morgan Stanley, who researched the space prior to the initial public offering of OnDeck, a Kabbage competitor. "It's well-known that banks have pulled back from making loans to small businesses since the recession," Srethapramote says. "Kabbage and other lenders have filled the void." Not unlike Uber and Airbnb, they have created a largely unregulated industry that is making a lot of money.
The seeds of Kabbage, founded in 2008 and based in Atlanta, were sown by Rob Frohwein, an intellectual property lawyer. Now CEO, Frohwein saw how much data were becoming accessible via the cloud and that companies like eBay and PayPal were providing application programming interfaces, or APIs, that a lender could use to get real-time access to a business' customer-transaction data. Kabbage, Frohwein says, put the two concepts together.
Before starting the company, he called Kathryn Petralia, who worked for a financial services firm and was an expert in credit and payments, and Marc Gorlin, a serial entrepreneur with venture capital connections. In 2009 the three cofounders created a plan to finance Kabbage with venture capital, but a road trip to California proved fruitless. Instead, they raised $500,000 by issuing a convertible note, and after hiring employees and leasing office space, they got $1.5 million from a group of 45 angel investors. They made their first 100 small-business loans in 2010. That December Kabbage closed its first venture round and has since developed relationships with Silicon Valley Bank, Victory Park Capital and now Guggenheim Partners to provide the capital it loans out.
One reason Kabbage has been able to attract capital is its loan default rate. Even though it can assess applicants in minutes and never demands a personal guarantee, Kabbage says its loans are as likely to be repaid as those of traditional banks, which routinely take weeks to make a decision. Frohwein says Kabbage targets established businesses rather than startups, with its automated model assessing three factors: capacity to repay, character, and the consistency or stability of the business. "We believe we get to know a small business better by being connected to their data sources electronically than any loan officer can do by sitting down at a desk with the borrower," says Frohwein.
He says Kabbage incorporates nontraditional metrics, such as a company's Twitter or Facebook followers, as well as the online reviews its customers post, as a way to round out an applicant's story. "You won't get a loan because you have 7,000 likes on your Facebook page," he says. "But we might increase the cash available to you if you have an active social media following because it establishes the credibility of your business with its customers."
Before she connected with Kabbage, Jennifer Kirk went to her local bank, where she had a business checking account and a personal savings account, and where it took her several hours to fill out a loan application. She had to apply in person, she had to supply three years of tax returns--which showed she had made a profit every year--and she had to produce copies of her husband's pay stubs. When the bank ran a credit report, she says, her score topped 700. Three weeks later the bank responded: denied. "They said I was too risky," Kirk says.
But it's rarely just about risk. Brock Blake, CEO of Lendio, an online marketplace that connects small businesses with an array of lenders, says banks make more money with larger loans to larger organizations over longer periods. The result, Blake says, is a small-business funding gap--especially for amounts in the $25,000 to $55,000 range. And that's the void alternative lenders like Kabbage target. This has led to a booming industry, with new players arriving all the time, from startup peer-to-peer lenders like Prosper to spinoffs from companies like Amazon, PayPal and Square. "We like to joke that the Girl Scouts of America are about to give up on cookies to get into the small-business lending business," says Frohwein.
With all of that credit available, many businesses have gotten in over their heads because they didn't realize the full price they were agreeing to pay. The fact that the loans are for short terms can disguise how expensive they are.
Ami Kassar, CEO of MultiFunding, a loan broker based near Philadelphia who helps businesses obtain alternative loans when he thinks they represent the best option, says alternative loans typically have an annual percentage rate of 40% to 60%. Jay Goltz, an entrepreneur and small-business advocate in Chicago, was recently asked to evaluate alternative lenders on behalf of the city. He contacted several, posing hypothetical borrowing scenarios, and was shocked by what he heard. "Some of these guys make used-car salesmen look good," says Goltz, who calculated that one lender was charging as much as 150%. "I don't know how any business could grow fast enough to pay off that kind of loan."
Still, Goltz says alternative loans can work. "If you have a big opportunity, and you need to buy equipment or inventory that will help your business grow and return a positive ROI," he says, "then a loan like that can make sense." Srethapramote of Morgan Stanley says he was surprised to learn that two of the top small-business groups that turn to OnDeck are doctors and dentists. "These are professionals who would rather pay a premium for the convenience of applying for a loan online and getting funded in a day or so," he says.
Frohwein says that Kabbage prides itself on being transparent about the cost of its loans, which carry an average annual percentage rate of 40%. He said the rates range from 1.5% to about 20% for the first two months of the loan, depending on a variety of risk factors and how long the cash is kept, and then drop to 1% for each subsequent month. He adds that Kabbage doesn't charge hidden origination or maintenance fees and that customers pay interest only on the money they borrow and can pay less if they pay back their loans early.
After Jennifer Kirk was approved by Kabbage, she decided she needed about $30,000, which she took with several withdrawals. She used the money to open a pet-grooming salon to supplement her retail operation, leasing space, buying new equipment and hiring additional employees. Kabbage typically charged her 2% of the loan amount for each of the first two months, and then 1% for each of the additional four months, for what Kabbage says is an annual percentage rate of about 27%. "While APR is a consideration, most of our small-business customers are focused on the return they'll get from a loan," says Frohwein. "Also, over time we drop the rates and increase line availability for customers that demonstrate positive repayment behavior."
Kirk acknowledges that getting credit was expensive but says it was an easy decision given that no bank would lend her money to expand. In fact, she says, her revenue is up 21% so far this year--with the first month's boost in sales enough to cover the cost of her capital. "I needed money to make money," she says.
