I Just Got an Ad for a Million Dollar Loan on Instagram. What’s that about?

6.05.20

If Michele Romanow’s resume doesn’t give you an inferiority complex, nothing else will. A serial entrepreneur, TV personality, and venture capitalist, Michele Romanow may be Canada’s favorite public figure following a shirtless Justin Trudeau.

Founding businesses is a light hobby Ms. Romanow picked up in between study breaks from civil engineering. She started her first business — a zero-consumer-waste coffee shop — at the age of twenty. Since then, Michele founded five more companies, including a caviar fishery, an online shopping platform, and, in her most ambitious iteration to date, an online merchant lender, Clearbanc.

Clearbanc ads will offer you the world. A term sheet in 20 minutes. Up to $10M delivered to your bank account in 24 hours. Funding for your company without giving up equity or your home.

Merchants have responded with a mix of incredulity, skepticism, and praise. How much is real? Is this truly a new financial vehicle democratizing capital, or is it just a dressed-up version of payday loans?

Startups Facing 40-Year Decline

It’s important to note that Clearbanc arrived at the tail-end of a 40-year decline in startup rates. In the 1970s, it was still within the realm of possibility to wear thigh-high whitey-tighties, flaunt a horseshoe mustache, and start a small business. In 2020? Not so much.

In contrast to a lot of popular perception, startups have been losing ground for over four decades. The startup rate — defined as the number of startups compared to the number of overall firms — fell from nearly 17% in 1977 to approximately 8% today. The sharpest decline in entrepreneurs is seen among young people. It’s easy to dismiss Millennials as just a bunch of snowflakes too busy making TikTok videos to start a new business. That might be one factor, but research points to more systemic problems that undermine the success rate of entrepreneurs.

One of the largest issues at hand is outdated capital infrastructures that cannot reach the vast majority of aspiring entrepreneurs. Despite accounting for 99.9% of US businesses and 47.3% of private sector employees, small businesses are the most in need of capital. They face far more hurdles to funding than larger firms, including higher interest rates, shorter maturities, and more stringent collateral requirements.

Where’s the Money, Honey?

The vast majority of entrepreneurs could use a fairy godmother, rich uncle, and/or generous bank loan. Sadly, not many of us have parents like Mike and Jackie Bezos who are willing to throw $300,000 at an internet startup. Even before COVID-19 hit, startups listed lack of cash flow as their number one concern in 2020. At time of startup, 83% of entrepreneurs did not have access to private institutional capital. Instead, nearly 65% use their own savings (or their families’) to fund their dream baby. Another 9% throw it onto their Amex balance and pray they make the monthly minimums.

Why is capital so difficult to come by? It depends. Below, we list the most common sources of capital (and their accompanying risks) for entrepreneurs.

1. Personal or family savings of the entrepreneur (64.4%)

If the possibility of going broke, losing your good credit score, or starting a public slugfest with your father-in-law doesn’t sound very appealing to you, you might want to rethink starting your own business. Considering that 50% of small businesses get shuttered within five years, entrepreneurs shoulder a huge amount of risk when they use personal funding to finance their new business. They not only face the possibility of a ruined credit profile and seized personal assets, but there’s also the reputational fallout with family and friends to consider. Nonetheless, self-financing remains the most popular funding method for entrepreneurs simply because no one else wants to fund them.

2. Bank Loans (16.5%)

Commercial banking grew up alongside the titans of American industrialization: steel, coal, and oil. Bank loans were originally designed for manufacturing companies that could offer valuable physical assets for collateral.

Most entrepreneurs today aren’t laying down tracks for the Transcontinental Railroad. They’re pitching glorified spreadsheets or designing companion robots for lonely millennials. When 86% of businesses are service-oriented, there’s not much to offer for collateral.

Another problem is that community banks — once a vital lender to small businesses — are vanishing. In the mid-1980s, there were 14,000 community banks. That number has fallen to under 5,000 today.

3. Credit Cards (9.1%)

Besides the chance of ruining your FICO score, credit cards also distinguish themselves as one of the most expensive types of capital. In 2018, the average APR (annual percentage rate) for a general-purpose consumer credit card was 20.3%. In the worst-case scenario, if you put 10,000 USD (the average small business loan) on your credit card, only to watch your business to tank, that balance would cost you 2,229.94 USD in just one year.

4. Venture Capital (0.5%)

Venture capital is the most famous form of financing thanks to its outsized media presence and VC’s tendency to build their own megaphones. Ironically, VC funds are used by a mere 0.5 percent of entrepreneurs.

The idea that most companies should raise venture capital is akin to saying that most people should date supermodels: it’s absurd. Most business models are totally inappropriate for joining a VC’s portfolio. Venture capital was developed for incredibly high-growth industries. Companies that are unsuitable for such a high-growth model may find VC debilitating or even fatal. The Founders Collective, a VC firm focused on seed stage startups, describes venture capital as a “dangerous commodity” and went so far as to create an instruction manual for unsuspecting founders.

Then there’s the problem of dilution. For each round of capital raised, founders own less and less of their own company. For years, founders were increasingly told, “Dilution is the solution.” When Microsoft went public, Bill Gates still owned 49% of the company. Compare that to when Lyft went public in 2019, and the two founders collectively owned 7% of the company at time of IPO.

5. Other Sources of Capital (9.5%)

Other sources of capital include a hodgepodge of angel investors, government grants, business credit cards, etc. Unfortunately, government grants are available to limited kinds of businesses, and angel investors are a rare breed.

The Rise of Capital Entrepreneurs

Clearbanc entered the funding desert with much fanfare in 2015. Since then, it has deployed over $1B to 2,200 online businesses. Romanow is part of a growing cohort of capital entrepreneurs: innovators developing new vehicles for distributing capital and reducing barriers to entrepreneurs. New vehicles include revenue-based investing, online lending, crowdfunding, and blockchain. Other prominent names that fall under this category include Square, Stripe, PayPal Working Capital, and Shopify Capital.

Romanow was inspired to start Clearbanc after her experience as an investor on Dragons’ Den (the Canadian version of Shark Tank). There, she observed countless entrepreneurs misusing VC dollars on predictable costs such as marketing. “People were using the most expensive capital, which is equity, to do something that is repeatable and scalable like buy Facebook and Google ads.”

So, what should equity be traded for? “Equity makes sense when you’re taking an insane amount of risk; true 0:1 risk. Take building a vaccine. There are 200 vaccines being developed. One of them is going to work and one of them is not going to work. You’re going to need tons of data scientists to assess that. [Vaccines are] true equity level risk.”

Lack of Diversity

Michele Romanow was sick of seeing the same people, same products, and same states get the majority of funding dollars. “There’s a reason Peloton got so much venture capital funding,” said Romanov. “It was because every venture capitalist could imagine their wife buying a stationary $5,000 bike with an iPad on it.”

Clearbanc aims to remove personal bias from lending by using data, rather than intuition or pattern matching to make its investment decisions. Unlike a bank, Clearbanc requires no credit checks or personal guarantees. And unlike VC, Clearbanc requires no pitching, prolonged time-commitments, or equity.

Instead, Clearbanc uses non-traditional datasets and proprietary algorithms to make faster, more risk-insulated loans. These datasets might include payment processing transactions, ad accounts, billing accounts, Facebook accounts, etc. Anything that might predict the health of the company is up for grabs.

The plus-side of all this personal invasion is that the money is delivered quickly. As they say to companies, “We’ll give you money without you having to get out of bed.” Another advantage is wider geographic spread. 80% of VC dollars go to California, Massachusetts, New York, and Texas. Clearbanc, meanwhile, has invested capital in every state and funds 8x more women than the VC industry average.

A Price for Convenience

The price of getting 10k delivered with a side of fries is a higher effective APR. Clearbanc loans are repaid through a flat fee plus a percentage of your daily sales. This percentage ranges from 6% — 12.5%.

In a high growth scenario, you would pay back the Clearbanc revenue share of 6% upfront fee in under three months, so ~2% per month. If put in terms of an annualized rate, you would have an APR of 24% (2% x 12), which is similar to many credit cards. In theory, if you took out a small loan but had a few months of record sales, your APR rate could climb even higher.

Still, on the flip side of this, if things go south and the loan took over a year to pay back, your APR could fall well below 10%. The security in Clearbanc’s loan lies in the fact that you will never pay back more than a fixed percentage of revenue per month, no matter how your company is performing.

Alternative Lending is a New Source of “Dream Funds”

Lending to small businesses by the top five fintech companies rose by 39% from 2018 to 2019 and reached $13.5 billion dollars. PayPal Working Capital alone now lends more than $1 billion a quarter.

With the economic fallout of COVID-19, Clearbanc has seen more callers knocking at its door. “Funding options for small businesses have been taken away,” said Romanow. “If you had venture debt, we’ve seen a lot of MAC clauses be pulled which means people no longer have access to their venture debt lines. We’ve seen a lot of folks that gave small businesses capital no longer doing that, and government funding has dried up pretty quickly.”

And as the number of community banks continues to dwindle, online lenders may become entrepreneurs’ (only) lender of choice.

About Colbeck: Colbeck is a strategic lender that partners with companies during periods of transition, providing creative capital solutions to meet their evolving needs. You can reach the team at inquiries@colbeck.com.