Los Angeles-based ZestCash is the latest in a string of short-term consumer-loan companies to win VC backing, landing $11 million in Series A equity financing from a group led by Lightspeed Venture Partners and GRP Partners, plus $8 million in debt financing.
That is on the heels of the $2.3 million that rival Pawngo raised last month from Lightbank, the investment fund of Groupon co-founders Eric Lefkofsky and Brad Keywell, and the 73 million pounds in Series C funding UK-based short-term lender Wonga got earlier this year from a group led by Oak Investment Partners.
A new crop of short-term, high-tech lenders hope to fill a niche neglected by commercial banks, extending credit — at sky-high rates — to riskier borrowers that need a quick cash infusion. With the aid of software, they figure out which would-be borrower in severe need is most likely to be able to repay the loan, typically of a few hundred dollars.
Borrowers who use such services — say, to fix a car — tend to be less financially stable compared with mainstream borrowers, said Arjan Schutte, managing partner of Core Venture Partners, which specializes in non-traditional financing.
But ZestCash and its competitors are counting on turning a profit by figuring out who is likely to be able to pay back the loan. It is a big pool: some 21 million U.S. households are underbanked, meaning they have bank accounts but also rely on alternative financial services such as payday loans or check-cashing services, according to the Federal Deposit Insurance Corporation.
That corner of finance is “one where application of technology is opening up new avenues to run business,” said Jeremy Liew, managing director of Lightspeed.
At ZestCash, where the co-founder and chief executive is former Google chief information officer Douglas Merrill, that technology includes using Google-style algorithms to find likely candidates among the pool of loan applicants.
Co-founder and chief risk officer Shawn Budde, who formerly handled the subprime credit card portfolio at Capital One, brings banking chops to the business.
To build its loan model, Zestcash applied what Merrill calls “a big-data approach,” poring through numbers from 20 million loan transactions across California. It came up with several hundred variables to use in evaluating loans, many of them used in counterintuitive ways.
For example, a bankruptcy typically counts against a customer who applies for a traditional loan. But with ZestCash, if the bankruptcy is in the last couple of years, it actually works in the customer’s favor.
“If you declared bankruptcy fairly recently, you are paying attention to your financial situation,” Merrill said, adding that focus means the customer is more likely to pay back a loan.
The loans aren’t cheap. A ZestCash customer with a typical loan — $500 for five months — would end up paying a total of $860, or $360 in fees.
But that’s much cheaper than consumers’ other options if they have poor or thin credit, said Merrill. For example, a $500 payday loan rolled over for five months would likely cost about $1,400, said Merrill, meaning the customer would pay $900 in fees.
The typical ZestCash customer uses the funds for healthcare expenses or car repairs, said Merrill. He was inspired to launch the service when his sister-in-law, a working single mother driving on icy roads in Washington state, needed money for new tires.
Merrill plans to use the new funding for purposes such as marketing and expanding beyond ZestCash’s current service area of Utah, Idaho, Missouri and South Dakota.
The company has a loanbook of “a few million dollars” and believes it will turn an operating profit early next year. Merrill said its current default rate as a percent of all loans was in the low 20s.
Additional investors included Flybridge Capital in the equity portion of the funding round and Lighthouse Capital Partners for the debt portion.
(By Sarah McBride; editing by Edwin Chan; and by Gary Hill)