Portrait of a Marketplace Lending Investor

Alternative lending start-ups have entered mainstream consumer and SMB lending, but have yet to establish themselves as additions to traditional fixed income portfolios for investors. Marketplace lenders started out as peer-to-peer lenders, but institutional capital and accredited investors are now accounting for the lion’s share of lending capital on such platforms. Direct Lending Investments, LLC (DLI), a growing and active participant in this developing world of private credit, focuses on buying loans and extending loans to alternative lending platforms and other business partners. In particular, the firm provides credit to the growing sectors of the market that are no longer served by traditional bank lending and, more importantly, structures its funding in a way so that the originator takes on default risk.

Inspiration and founding

Brendan Ross, the founder and CEO of DLI, first began investing in marketplace lending personally and on behalf of his clients through Lending Club (LC) and Prosper loans. In 2012, he launched DLI to expand his investment horizon beyond peer-to-peer lending, which he has since moved away from altogether. The firm’s inaugural deal in November of 2012 was with IOU Financial, a SMB loan originator. Since then, the firm has expanded to include receivables as well as real estate and consumer loans in its portfolios, and has grown to over $900 million in assets under management.

Regulatory premium

DLI targets segments, such as small business lending, which are not well served by traditional banks for their capital needs. These areas have what Mr. Ross calls a “regulatory premium” where legislation or regulation has disrupted historical financing methods. This premium allows these lenders to earn higher returns as they do not have to compete with banks, which previously served this market segment. Areas that DLI has identified with regulatory premiums include small business lending, receivables, consumer lending, and real estate.

Customer acquisition

Direct Lending strives to work with lenders that acquire borrowers in a unique way, instead of going down the overcrowded, undifferentiated path of acquiring borrowers through direct mail or from brokers. By emphasizing disintermediation and proprietary customer acquisition, the firm identifies business partners with competitive advantages in their industry. Being able to bring down customer acquisition costs is an important differentiator for a platform, and often, it is a boon to the credit worthiness of the platform.

Shift in investment structure

Over time, DLI has shifted its emphasis from buying loans directly to extending credit facilities to single purpose entities that loans and other financial assets originated by the originator. The assets serve as collateral, and the risk of individual defaults lies with the originator. This structure is designed to provide DLI’s capital with a strong first position with regard to the originator’s assets and align incentives between DLI and its business partners. In addition, various credit enhancements, such as corporate guarantees, may be utilized in each agreement. This is a markedly different approach than acquiring loans directly from originators, which do not share any of the credit risk once the loan is off their books.

Carving its own niche

DLI seeks to capitalize on inefficiencies in the lending market for its investors. The strategy may be seen by investors as a form of diversification from high yield debt, emerging market debt, and business development companies. In the niche area of private debt, there are many large companies with massive AUMs like KKR, BlackRock, Fortress, Ares and Apollo, but the company believes in quality rather than quantity and feels that performance and agility within the space is more important than contending with the largest private debt managers.

DLI over banks

Although bank capital, or a securitization, can be a cheaper source of financing for originators, it involves rigid formalities. What gives DLI the upper hand is it provides a higher loan-to-value ratio as compared to banks, and is more flexible in structuring relationships. Bankers are not typically comfortable with any tweak in their borrowers’ business models, whereas DLI understands that it is important to be nimble. This additional maneuverability has proven extremely dear to Silicon Valley start-ups and gives DLI a leg up against its banking counterparts.

Edge over its rivals

Direct Lending Investments, unlike some competitors, does not insist upon warrants or any equity stakes in its business partners; instead, it is focused on earning a high ROI and, in the process, providing lenders with unprecedented flexibility to utilize their own equity.

Founder and legal team

Brendan Ross, Founder and CEO, has been a C-level executive prior to launching DLI. He has been responsible for nurturing and turning around many businesses, including Reserve America, Fanfare Media Works, and Razorgator. He started his career at Mercer Management Consulting (now Oliver Wyman) and later started investing in consumer loans through Lending Club and Prosper in 2011.

DLI has an in-house legal team, which allows it to examine loan deals faster and more thoroughly. Research is headed by Dr. Bryce Mason, who is well known for his elaborate analysis of Lending Club loan history and was also the founder of P2P Picks. The team roster is expected to increase from 24 to 40 within the year. DLI’s ability to identify best in class originators with proprietary customer flow, coupled with a structure focused on strong capital protection without taking any originator equity is a win-win for both the originators and the limited partners.

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