Banks’ Pain Is Startups’ Gain

Photograph by Lachian Currie

Is Silicon Valley becoming the new Wall Street?

As major banks grapple with layoffs, fewer bonuses and expensive legal bills from mortgages gone bad, financial startups are gaining momentum. Three announcements out of Silicon Valley today illustrate how hot this industry is.

Prosper Marketplace, a provider of personal loans, said it raised $20 million in a venture funding round led by Sequoia Capital, and recruited Stephan Vermut from Wells Fargo to be the startup’s chief executive officer. PayNearMe, which develops a payment network for people who use cash instead of credit or debit cards, raised a $10 million round led by August Capital. And a venture capitalist has set up a firm to invest specifically in these types of companies.

Micky Malka introduced Ribbit Capital today after closing its $100 million fund. The Palo Alto, California-based venture firm will target startups that specialize in financial lending, payments, personal-finance tools, and services for the accounting and insurance industries. Ribbit plans to invest in at least a dozen companies, Malka said in an interview.

Young financial companies tend to focus on untapped or under-served markets. Lenders, in particular, are gaining appeal because many of the big banks are shying away from loans, amid the uncertainty and increased regulation following the financial crisis of the last decade. That phenomenon helped BillFloat, an online provider of micro loans, raise $21 million.

“We’ve never had such a perfect storm of events happening,” Malka said. “None of us are proud of our banks.”

Regulators haven’t exclusively targeted the major financial institutions. For example, Prosper began in 2006 as a marketplace matching borrowers and lenders, operating in a legal gray area. Two years later, the Securities and Exchange Commission stepped in. After shutting the service down, the San Francisco-based company spent $4 million to retool its business and then reopened in 2009.

Now, people turn to Prosper for debt consolidation, auto-repair loans and business-inventory capital at interest rates as low as 6.6 percent. The company doles out loans of up to $25,000 each. Those loans are funded by investors — both retail and institutional — who use the service as an alternative to stocks and bonds.

Prosper’s revenue of $1.9 million in the third quarter was more than triple what it was a year earlier. But the company trails LendingClub, another online lender based in San Francisco, which recorded $9.9 million in the same period. Backed by venture capitalists including Norwest Venture Partners and Kleiner Perkins Caufield & Byers, LendingClub has issued $1.25 billion in loans since opening in 2007, more than double Prosper’s $447 million.

Vermut, Prosper’s new CEO, had led Wells Fargo’s prime-brokerage division since last year when the bank purchased the company he co-founded called Merlin Securities. The investment by the venerable Sequoia Capital is a vote of confidence for Prosper.

“This is a market and asset class that is very nascent,” Pat Grady, the Sequoia partner who led the Prosper investment, said in an interview. “If it works, both Prosper and LendingClub will be very big, very meaningful businesses. All the signs are there that it’s going to work.”

Based in Sunnyvale, California, PayNearMe is building an entirely new payment system geared toward the Americans who don’t have credit or debit cards. Since mid-2010, PayNearMe has let consumers purchase goods online, pay loans and buy bus tickets by going to their local 7-Eleven and using cash.

Along with the $10 million in financing, PayNearMe introduced a service that simplifies the sign-up process so that landlords, collection agencies, lenders, schools and insurers can accept the payment method, CEO Danny Shader said in an interview. The express service costs merchants $199 to set up, he said.

“This is for people whose only option today is cash or money orders,” Shader said. In other words, the ones being ignored by traditional banks.

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