Trillion-Dollar Alternative Lending Industry Is A VC Gold Mine

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Editor’s Note: Christine Magee is an editor for CrunchBase.

In a recovering economy where big banks are restricted by complex regulations, startups and venture investors are gearing up for the next gold rush in the trillion-dollar marketplace lending industry. That’s trillion. With a T.

Big IPOs for Lending Club and OnDeck (valued at $9 billion and $1.3 billion, respectively) appear to have spurred a funding frenzy this year as venture investors dig for more pay dirt.

In the first two months of 2015, VCs committed $340 million in venture capital for lending tech startups, according to CrunchBase data. The 17 deals recorded in 2015 average $23 million each, compared to a $14 million average deal size in 2014.

Peer-to-peer lenders Lending Club and Prosper set the stage for the lending marketplace boom, but the latest generation of lending tech is all about verticals. Student loan marketplace SoFi‘s $200 million monster round in January, led by Third Point, is the largest round tracked to date. And DriverUp, a lending platform for automotive financing, announced a $50 million Series A last week from Emerald Development Managers and RRE Ventures.

“The reason these alternative lending platforms are coming up is that platform lending is simply more efficient for both the borrower and the lender,” says Stuart Ellman, managing partner at RRE.

“The borrower is able to find loans that they otherwise weren’t able to get — either from the banking crisis or from banks tightening up their lending process — and lenders have the ability to do their diligence, see the risk and the interest rates, and make the loans they want to on an a la carte basis,” Ellman says.

The marketplace model has been proven, and now entrepreneurs are tweaking it to fit all industries. DriverUp is the first to bring marketplace tech to the $400 billion automotive lending market, which CEO Sam Ellis says has operated in a very traditional mode for the past 30 years.

“Auto loans as an asset class — different than real estate, gold, treasuries, bonds and stocks — historically have performed well and held up well through the recession,” says Ellis. “If you’re a high net worth individual or some sort of investment fund, you want options and you want attractive risk-adjusted returns.”

The economy may have recovered, but the 2008 meltdown is still taking a toll on the lending market. Investors are more concerned than ever about where their money is going and how their investments will fare in another economic downturn.

“People are learning that post-recession, post-financial crisis, they want more data and more transparency about what they’re investing in, and the marketplace platform allows investors to do their own analysis,” says Ellis.

DriverUp is just one of the venture-backed startups to apply the marketplace model to a specific vertical. Companies like RealtyMogul in the $2 trillion real estate industry and Noesis in the $18 billion commercial energy equipment market have seen rapid growth despite a narrow focus.

“Unlike some industries, where if you’re starting to go after certain verticals maybe you’re a little too niche, in this industry, you’re talking about massive markets that are still able to be disrupted,” says Dan Ciporin, partner at Canaan Partners and Lending Club board member.

As alternative lending becomes more popular, shifting capital to lending marketplaces gets especially tricky for institutional investors. Many firms have come to rely on enabling technologies to expedite the process.

“As soon as you start talking to operations or accounting teams, you realize that the thought of trying to track $100 million worth of $8,000 loans is just terrifying — none of their systems are set up to deal with loans that small,” explains Matt Burton, founder of Orchard.

Orchard, a Canaan portfolio company, launched last year to simplify online direct lending at scale, and currently powers seven investment platforms, including Lending Club, Prosper, and OnDeck. Burton says there are 450 more currently on their wait list.

“This is an area that’s going to continue to see a lot of innovation and disruption for the next few years minimum, if not the next 20 years,” says Ciporin. “You’ll see things start to happen around the ecosystem that’s being created, and that’s what I think is really exciting — that there is an ecosystem now and it’s getting to be very large.”

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