October 14, 2020

We are posting this episode in the midst of great uncertainty about rescue lending to small businesses impacted by the COVID-19 pandemic. Congress and the White House have not yet agreed on a new round of funds for the SBA Paycheck Protection Program, or PPP, despite widespread agreement on the need for it. Meanwhile, the prior two rounds of the PPP are coming under the microscope, with early investigations suggesting both that fraud rates are high, and that fintech lenders accounted for a disproportionate share of the problem. That finding may bode ill for the sector, given that the PPP emergency was the first time that non-depository lenders were allowed into SBA loan guarantee programs, and also that they performed extremely well in reaching very small businesses — the kinds of ventures that can be a critical pathway into entrepreneurship for women and people of color.

All this makes it an opportune time to be talking with today’s guest:  Sam Graziano, the CEO of Fundation. He and I recorded this conversation several months ago, but his insights seem more timely today than ever.

In this episode, Sam tells us about Fundation’s journey, starting with his own very usual mix of skills and then the company’s launch as a direct line-of-credit lender to small businesses. He describes their epiphany, a few years back, in realizing that the technology platform they built was exactly what banks need in order to automate their own small business lending. Fundation had developed automated risk models that enable banks to say yes to business customers that, under traditional standards, would be rejected. Today, the company has a 50/50 split between direct lending and bank partnerships.

When the pandemic hit, suddenly threatening America’s small businesses with mass extinction, Fundation was positioned for action. Congress passed the emergency PPP to come to the rescue, confronting both the SBA and the banking industry with an unprecedented challenge — the need, literally overnight, to figure how to convert old, slow 20th century technology to meet this 21st century crisis. This meant quickly shifting processes into online and digital channels that could move fast, while still maintaining risk and quality controls.

In our conversation, Sam tells the PPP story from his vantage point in helping banks achieve this metamorphosis. He describes “the gauntlet” of the PPP rollout; the unavoidable uncertainties everyone faced as guidance unfolded; the widespread use of manual processes at the start; the challenges of KYC and fraud; the pattern of banks serving existing customers first; and, as he says, the “toxic” impacts of the first-come, first served sequencing in the first round.

We at AIR had the opportunity to work with Fundation on the PPP TechSprints we held last spring, working on these challenges.

Sam talks about lessons learned, and especially whether this crisis is a catalyst — an accelerant — for trends that were already underway toward transforming small business lending. He also has a vision for how bank small business services should evolve, leveraging open architecture and tech-driven unbundling of services to create really new possibilities that could change the small business lending landscape.

Sam assesses the risks ahead, including the huge dangers of synthetic identity fraud. Overall, though, you’ll be interested to hear the reasons he is optimistic for the future, and where he sees new seeds of change taking root, in places the pandemic has broken.

Meanwhile, I want to alert you to some very exciting news coming up later this week, which I will break on my upcoming podcast with Linda Lacewell, Superintendent of the New York State Department of Financial Services. Please watch for that!

More on Sam

Sam Graziano cofounded Fundation and has served as its Chief Executive Officer since 2011. He is also an advisory board member for the Coalition for Responsible Business Finance, which provides education and information to government, industry and others on how technology can help broaden access to capital to small businesses.

Prior to founding Fundation, Mr. Graziano spent more than a decade in investment banking and private equity, where he developed an expertise in strategic, financial and operational issues for banks, specialty finance companies, asset managers, broker/dealers and other institutions throughout the financial services sector. Previously, he served as Principal with Centerview Partners, where he provided strategic and financial advisory services to some of the nation’s largest and most recognizable financial services companies. Mr. Graziano’s experience includes serving as a Vice President with Keefe, Bruyette & Woods, the nation’s largest boutique investment bank focused on the financial services sector, where he executed dozens of mergers and corporate finance transactions. He cofounded the firm’s private equity practice.

BankThink PPP had its strengths. Its successor can be stronger.

PPP had its strengths. Its successor can be stronger.

For all its administrative and operational burdens, Congress should be commended for creating the Paycheck Protection Program.

In early March, there were many proposals advocating for lending programs with a government backstop. At a time when revenue evaporated for a small-business owners, they did not need a loan; they needed help staying afloat.

The PPP may have been overly prescriptive on allowable use of proceeds, but it offered millions of business owners the lifeline they desperately needed in the form of a forgivable loan, not another fixed obligation. On that front, Congress had the right idea.

The next phase of the PPP appears headed toward a construct that will further limit those that will benefit — a clear signal that the small business bailout is not a bottomless pit. The time is soon approaching when the banking community and nonbank lenders will need to restart the engines of lending to small businesses in earnest.

A large swath of the nonbank lending community has been seriously injured by this unprecedented pandemic, placing the banking community in an even more critical role to meet the liquidity and capital needs of small businesses that have survived.

But the broad-based economic impact of the pandemic has, at minimum, impaired the ability of banks and nonbank lenders to apply legacy underwriting models to the small business market. Without further government support, banks and nonbank lenders will likely require a prolonged period to return gradually to “normal” lending levels.

There is a natural inclination to lean heavily on the Small Business Administration, as was done in the PPP. There is no doubt that the SBA will play a more pronounced role going forward, especially if guarantee rates are increased.

However, the sheer enormity of the future need for capital calls for a broader approach to serve a market that need not continue to rely on upsizing the SBA 7(a) program, nor imposing the administrative burdens of that program on borrowers and lenders. More so, most SBA-sponsored programs are term loan products.

Time and again, however, small businesses indicate that cash flow imbalances are the leading challenge they face. A sensible and impactful program should offer small businesses with revolving lines of credit to support it through a long-term recovery.

Fortunately, over the last several years, the banking system has been modernizing its credit delivery platforms for conventional credit products. As a result of innovation in the small-business lending space, the lending infrastructure is now in place for small businesses to easily access conventional credit products through bank websites, branches, bankers, and online and mobile banking portals.

This is generally not true (at the same scale) of SBA and other non-conventional products. The systems, technology, processes and capital are available through bank and nonbank lenders to have an immediate and enormous impact on providing liquidity and capital to the small business market. This goes over and above the PPP, simply by leveraging the conventional credit programs that already exist.

Banks and nonbanks need a risk-sharing arrangement in place with the U.S. government that aligns economic interests of all involved.

Over the last few months, there has been a push for a framework program that would do just that with key policymakers in Washington, targeted at Main Street small businesses. Despite its name, the Main Street Lending Facility has a minimum loan size of $250,000.

According to the Federal Reserve’s latest survey on small business finances, 81% of small businesses hold debt of $250,000 or less, and 68% have debt of $100,000 or less. This program is not tailored to small businesses.

The other proposed framework is simple. Use conventional bank lending programs, cap loans and lines at $250,000, and target businesses owned by individuals (not by other companies).

Banks would pay a monthly guarantee fee to the Federal Reserve based on the outstanding balance of credit lines and loans in exchange for a limited guarantee. Banks could offer committed lines of credit that are renewed each year with notice to the customer and a guarantee level that declines over time, eventually to zero.

Small businesses get great products that are easy to access immediately, banks get downside protection, and taxpayers get alignment of interests with the private market through motivating banks to make prudent lending decisions.

While the next stimulus bill will likely extend PPP, more can be done to support the small-business community. Fortunately, the pieces are in place to provide capital to this vital segment of the economy immediately, and at scale, through a program that aligns the economic interests of all stakeholders involved.


Lend Academy Podcast : Sam Graziano of Fundation

The CEO and co-founder of Fundation talks small business lending, bank partnerships, big tech, verticalization and what's next

While there are several online lending platforms that have reached scale in the small business space, banks still do the vast majority of small business loans. But many banks don’t have the capability to provide a modern, digital and user friendly experience. The good news is that banks now recognize this and are more open to partnering with fintech companies than ever before.

Our next guest on the Lend Academy Podcast is Sam Graziano, the CEO and co-founder of Fundation. His company is increasingly partnering with large banks to help digitize and streamline their small business lending operation (their latest bank partner was announced just this week).

In this podcast you will learn:

  • The Fundation origin story.
  • Why he quickly realized that they needed to be focused on institutional capital.
  • The two pivots they have made since starting the business.
  •  The type of channel partners they work with for referrals.
  • How they built their platform for different kinds of partners.
  • The typical terms of their small business loans and lines of credit.
  • How their white label small business lending products work for banks.
  • The type of banks they are focused on with that product.
  • Why it is easier to talk with banks today than it was a few years ago.
  • How incumbent banks are becoming more like fintechs.
  • Sam’s thoughts on big tech entering the small business lending space.
  • Why we are seeing a verticalization in small business software.
  • The paradigm shirt he sees in the future for banks.
  • What’s on the horizon for Fundation next year.

Defining, Adopting and Executing on FinTech – Part 2

BAI Banking Strategies published this article.

By Sam Graziano, CEO, Fundation

 Be the Manufacturer or the General Contractor

Banks are in a strong position to win the FinTech revolution—but what remains are the complex questions about how to execute. There are a few basic strategies: (1) do nothing; (2) “manufacture” your own capabilities; (3) operate as the “general contractor,” aligning your institution with third parties that can do the manufacturing; or (4) some combination of manufacturing and general contracting.

For banks that are predominantly or entirely in relationship-driven lines of business rather than transactional lines of business, option (1) is viable for now. The pressures on your business are not as severe, and a wait-and-see approach may enable you to make more informed decisions when the time is right.

For others, option (1) is fraught with peril. Assuming that you choose (2), (3) or (4), the technology implementation process will be hard, but what may be harder is the related change in organizational psychology necessary to execute on those decisions. Resistance to change is natural, and some employees may view FinTech initiatives as posing potential career risk or challenging the beloved status quo, whereas these initiatives are more likely to present opportunity.

That is why FinTech initiatives should be driven top-down. Executive leadership should command these initiatives and set the vision. More important, executive leaders should explain why the institution is pursuing a FinTech initiative and why it has decided to build, partner or outsource. Explaining why can reduce the natural resistance to, and fear of, change.

Building FinTech initiatives in-house is hard work but has advantages. It provides maximum control over the project and limits counterparty risk (vendor management). The downside is that the skill sets required to execute are wide-ranging: from project management, product management, software development and quality assurance to managing hardware. That said, building in-house doesn’t mean that everything needs to be proprietary technology. After all, most FinTech platforms are a combination of proprietary technology along with third-party components that are configured and customized. Should you elect to build off of third-party software, you must ensure that the platform is highly configurable and customizable. If you don’t have control (or significant influence) over customization, you will lose the opportunity to continuously reengineer the processes necessary to rapidly innovate and evolve.

The lack of flexibility to configure and customize is the single biggest criticism we have of many of the legacy technology providers to the banking system and even some of the new software vendors to the banking industry that built their platforms on flexible technology. While materially better than older solutions, most of these new firms sell pre-packaged solutions (or “managed solutions”) that place limitations on a bank’s ability to customize the way they want to do business. Does buying the same pre-packaged solution as your competitors give you a long-term sustainable competitive edge, or does it simply provide a long overdue upgrade?

Being the general contractor isn’t easy, either, but banks are very adept at it. You could make the argument that most banks are just an amalgamation of mono-line companies (mortgage, auto, credit card, commercial, corporate, payments, wealth management). Within each of these business lines, they employ different systems (mostly third-party systems) and are therefore already operating as general contractors. The business line leaders we have come to know have significant experience managing critical third-party vendors and therefore have the skill set and knowledge to manage even the most innovative financial technology partners. What’s more, they often know what they would want their operating platforms to do, as opposed to what they are built to do today.

Should your institution decide to partner or outsource services to a FinTech, it is paramount to align interests. Both parties must establish shared objectives and measurements of success, identify and discuss potential areas where interests may not be aligned, and focus on driving results that will not happen overnight. Banks should embrace their FinTech partner as just that: a partner, not simply a vendor. Welcome the flexibility that they offer, and allow them to empower your institution to innovate and evolve.

Don’t Squander the “Trust Asset”

In a world where Amazon, Google and Apple dominate the digital landscape, deliver ideal customer experiences, and may possess a “trust asset” of their own, the status quo is not an option, no matter how painful change can be. If your financial institution intends to compete over the long term, executing on a FinTech road map is vital. While there are potential transformational technologies on the horizon, they are unlikely to threaten the majority of financial services providers that facilitate payments, extend or facilitate the delivery of credit, or assist consumers and institutions with managing savings and wealth. As a result, the near-term decisions that need to be made will have consequences, but those consequences are not as dramatic so long as financial services companies are moving toward infrastructures with a foundation of flexibility. Over the next decade, flexibility will allow financial services companies to compete more effectively by delivering the products, services and experiences that customers will demand; flexibility is what will allow your institution to maintain its competitive position over the long term.



Sam Graziano, CEO of Fundation Group LLC

Sam Graziano is a seasoned financial services executive and entrepreneur. He co-founded Fundation in 2011 and is directly responsible for the strategic direction and growth of the company. Prior to founding Fundation, Mr. Graziano spent more than a decade in investment banking and private equity, where he developed an expertise in strategic, financial and operational issues for banks, specialty finance companies, asset managers, broker/dealers and other institutions throughout the financial services sector.


Disclaimer: The views and opinions expressed in this article are those of the author and do not reflect the views of Fundation Group LLC or partner institutions.

Fundation CEO says marketplace lenders moving to balance sheet funding in 2017 Exclusive

Fundation CEO says marketplace lenders moving to balance sheet funding in 2017 Exclusive

Thursday, 30 March 2017 10:53 AM ET

By Kate Garber

➤ Balance sheet funding model likely to win out among marketplace lenders, and they need permanent, diverse capital sources to weather credit cycles.

➤ OCC fintech charter applicants should expect significant oversight from regulators.

Digital small-business lender Fundation Group LLC CEO Sam Graziano spoke with S&P Global Market Intelligence about the company's balance sheet funding model and expectations for the OCC's proposed fintech charter. Graziano also shared his take on the broader digital lending industry. He pointed out that the word "profitability" was floated more at a recent industry conference and suggested that there is "an acute awareness" among digital lenders that they must prove they are sustainable by making money.

The following is a version of that conversation which was edited for clarity.

S&P Global Market Intelligence: Last time we spoke, which was in December 2016, we talked about your new partnership with Citizens Financial Group Inc. We also touched on bank partnerships and the merits of the OCC's proposed charter. What's new at Fundation since then?

Sam Graziano: We're just continuing to execute our strategy, which we're even more confident in. We do see the competitive environment within small business to be softening a bit, which is good for our long-term prospects as well as the other well-capitalized institutions in the market. We have nothing new yet to announce on other bank partnerships, but our pipeline is very strong.

Fundation announced March 21 that it secured an asset backed credit facility from MidCap Financial Services LLC. Graziano said the deal is another example of how the company is optimizing its balance sheet structure and gathering the capital and flexibility it needs to lend to more small businesses.

It adds leverage to our portfolio. We are a balance-sheet driven business predominantly. We put our balance sheet at risk. We do believe adamantly that that is the right model for the broader marketplace lending industry.

In fact, I think most marketplace lenders will end up with some form of balance sheet funding, probably by the end of the year. I think almost every firm in the space is taking that viewpoint which is that developing businesses that make money in lending is hard to do if you don't have a balance sheet.

Do you feel confident in Fundation's ability to shore up funding in the event of something like a turn in the credit cycle?

It's always harder in the midst of a credit cycle to secure funding. The magic is to be able to develop as permanent and diverse sources of capital as you can with very strong institutions ahead of a cycle, so that when you go into a market cycle you can take advantage of market dislocation. I think that's really what we're trying to do.

None of the arrangements that we will end up with from a capital supplier perspective will be like a marketplace model where it's: "hey, you can buy loans today, but if you don't feel like it tomorrow you can stop." That's not sticky, defensible capital. We're looking to develop more permanent, more long-term relationships with our capital suppliers that can support our balance sheet across cycles.

More details have come out on the OCC charter and more broadly there is the sense that financial institutions will benefit from regulatory roll-back. What's your take on how the new environment in Washington could affect digital lenders?

There are still more details to come, but I thought the OCC bulletin on the initial framework was extremely interesting. I thought it actually did give a pretty good amount of details. It does feel like there's a lot of momentum in that direction, to allow the industry to basically operate under a national framework, which I think ultimately would be beneficial to both consumers and small businesses.

What's interesting though is they also do make it clear that regulation of those that adopt the special charter will be substantial. It's not as if it's going to be a free pass. It's not as if it's going to be much more lax than [what] the banks operate under. That said, I imagine, where warranted, it would be a little bit more lax because at the end of the day, these are not deposit-taking institutions. Most of the companies I imagine will pursue the charter are lending institutions, none of which present any type of systemic risk to the financial services industry or to the economy at large.

One of the things that came to mind as I was looking at it was, given all the things that these institutions would need to do to be able to operate under the special charter framework, I could see some institutions saying "heck, if we're going to go this far, we might as well go all the way and basically apply for a banking license to be deposit-taking institutions."

Are you all more or less interested in applying for a charter after all of these details have come out?

I'd say we're more intrigued for sure. But we're still a ways off from making any decision. For us, it doesn't necessarily scare us off from what we've read because they make it very clear in terms of the types of products that they're going to be able to allow to have this charter.

We feel like we as a company are already in a pretty good place and potentially the level of investment we would have to make relative to others perhaps wouldn't be as large.

Q&A Break with Sam Graziano, CEO of Fundation

This is a reposting of the piece "Q&A Break with Sam Graziano, CEO of Fundation," published by Politico Pro / Politico LLC.

Fundation is one of a growing number of online small-business lenders that have popped up in the last several years. Company CEO Sam Graziano took a few minutes out of the fintech conference to chat about the company’s hopes and concerns on government policy toward small-business lending.

This transcript has been edited for length and clarity.


You’ve mentioned your concerns about regulating small-business loans like consumer loans.

My main concern would just be if there ends up with state-by-state rulemaking that is too prescriptive. An example would be, there are some people that feel different ways about ability to repay, the concept of ability to repay [in small business lending]. And while on the surface that seems like, "yeah, the customer should be able to pay," when you sort of peel the onion back a layer and sort of look at that issue it would actually be very dangerous.

The businesses that need capital the most tend to be younger, higher growth businesses. And those tend to be the businesses where expenses come before revenue. So you can look at that on the surface and say that business doesn’t have the ability to repay, but in reality they are a business that needs capital the most and is in a position to sort of do the most for society.

And so while I think some rules and regulations could be well-intentioned, I am worried that they could end up having the wrong effect. So that would be my concern if we end up with a state-by-state regulatory regime that could be too prescriptive, more onerous for small business finance companies.

So shifting that to the OCC fintech charter, what was your reaction to that proposal, and moving forward what are things you’re looking at in terms of your decision as to whether to go for a charter?

I think we need to see it play out a little more, to see a little bit more of the substance behind what does it actually mean to have the charter. What areas that exist within bank regulation today are going to be applicable to a company that has this sort of special charter?

So something like capital standards.

A perfect example? Should capital standards apply to a business like ours and what is the risk to the economy at large if a business like ours goes down? Our whole industry is still tiny in the grand scheme of the capital markets, so it’s those types of things in particular.

The Community Reinvestment Act is another thing. For us, the CRA’s probably not an issue at all, the vast majority of our loans are less than a million dollars for companies with less than a million dollars in sales, and we’re like the poster child for CRA-style lending.

Nonetheless, there are things that just need to be a little bit clearer. I think the benefits are certainly allowing institutions like ours a safe harbor, if you will, out there. If you have this charter and you operate a certain way, you can do your business without having to worry about any type of state-by-state law or type of regime.

What’s your policy wish list for this administration?

I think further fleshing out the OCC charter is certainly a big one. Another that comes to mind, the different regulators that supervise the banking industry in essentially similar ways, but they all have their own take—the Fed, the OCC, the FDIC—you’re talking about a number of different regulatory bodies that are all essentially regulating the same things, I think jointly having very clear guidance of, when is it ok for you, Mr. Bank, to partner with a fintech, and what exactly needs to be in place for that to happen? What exactly does that fintech need to be doing to make that OK?

Third-party vendor guidance.

There’s some guidance out there. The FDIC has some, the Fed has some, but I think one comprehensive document that is signed off on by each of those regulatory agencies to say we’re comfortable with fintech partnerships when they look and smell like this, I think that would be great.

Several trade associations for online lending have popped up recently, do you think there’s going to be consolidation on that front?

I think there has to be. I think, again, there’s a lot of good intentions out there. They’ve been in a little bit of … a chess match with some of these associations and coalitions of different philosophies and different things like that. Generally speaking, pretty well-aligned but it’s sort of been a messy process to get people to come together.

Whatever the subtle or not-so-subtle differences are between one group or another, I think not sorting that out is more dangerous than not having a unified voice to be able to say to government, "Look, here’s what we’re doing well for society, here’s our concerns" and to talk about what those clear issues are. But if they’re getting conflicting points of view from different groups, or different groups are saying different things, it could sort of start to muddy the waters a bit.

And for an industry that is in the grand scheme of things not that big — we look at it and feel that it’s big.

You’ve attracted a lot of attention.

We’ve attracted a lot of attention for an industry that is sort of a rounding error in the scheme of the banking system. And I think it’s because it’s an early manifestation of what digital technologies can do to the lending markets in terms of the type of experience they can offer consumers and small businesses, the number of consumers and small businesses that can be served more effectively. So it’s almost like an incubation ground for the banking industry at large so it deserves a lot of attention, but nonetheless the industry is small. We need to be careful of and mindful of that to some degree because I think there’s probably only so much attention we’re going to get from the people making decisions in Washington.

Is Alternative Lending Suffering From an Identity Crisis?

It’s been a long, windy road for the FinTech industry. Sam Graziano of Fundation explains the industry is on the cusp of yet more distinct pivots.


The growth and evolution of "alternative lending" has been a windy road. Like any so-called "disruptive" industry, the eventual successful business model (or business models) evolves through a series of "pivots" (in entrepreneur-speak). It would appear that we are on the cusp of another major pivot for the industry, or, more likely, a few distinct pivots that will be taken by a few distinct groups of businesses, furthering their evolution toward business models that are scalable, profitable and part of the long-term financial services ecosystem. Perhaps, in so doing, clarifying for the outside world whether these companies are technology-enabled financial services companies or technology companies addressing the financial services industry (true "FinTech" companies).

What’s clear is that the industry continues to suffer from an identity crisis, evidenced by the terms used to describe it. It was initially labeled as "Peer to Peer Lending," at times uses the term "Online Lending," morphed into "Marketplace Lending," and now, at least some are using a term I am proud to have coined, "Digitally Enabled Lending" (or its abbreviated version "Digital Lending"), a term more suitable to the broad array of businesses within the industry. The industry terminology never seems to quite catch up to changes in business models or draw enough clear distinctions between the various business models.

For purposes of this article, let’s use my preferred term, "Digitally Enabled Lenders", (or DELs for short). A DEL is distinctly different than the Alternative Lenders of years ago — the factors, asset-based lenders and equipment financing companies that were the original fabric of the non-bank lending ecosystem. DELs leverage the "Triple As" (aggregation, automation and analytics) to run their lending models. Aggregation, enabled by technology, is the process of a DEL capturing data from third parties in real-time. Automation, enabled by technology, in this context is the process of applying software to running business logic (credit algorithms) or redundant business processes. Analytics, enabled by technology, in this context is the process by which DELs turn that aggregated data into statistical probabilities – probability being the key word. The "Triple As" are the common denominator of the industry, an industry built to underwrite, originate and service small-balance credit to consumers and small businesses more efficiently than the traditional bank models ever have. Perhaps after another credit cycle DELs will prove to have developed better risk models as well.

Undoubtedly this tech-enabled method of lending is and will be a driving force in the evolution of small-balance lending. Yet, the "Triple As" don’t equal triple the profits. As it turns out, customers don’t just show up at your doorstep asking for the "tech-enabled loan." And, more recently, the capital markets are suggesting it might not flood every prospective industry participant with cash forever. Meanwhile, the banks still have two major competitive advantages: 1) their low cost and stable funding, and 2) a structural advantage to the customer through the deposit relationship.

Small-balance lending, technology or not, is a tough business. Few, if any, DELs have delivered the level of profits that the private and public markets will require to justify the valuations they still command. As high profits still elude the DELs, they are starting to pivot, or, at least signal a pivot is in the making. The bank dis-intermediators are talking about bank partnerships, the brand builders are talking about providing platform solutions and the "marketplaces" are moving toward leveraging permanent capital vehicles. None of which is a criticism of any kind (I run a DEL after all!). If only Blockbuster had pivoted faster when Netflix launched their disruptive concept of mailing people their DVDs.

The nature of the pivots differs based on product line. To date, DELs largely exist in four markets, student lending, unsecured consumer lending, nonconforming mortgage lending and small business lending. Some DELs are pursuing new product lines to sustain their growth rates and capture more of the customer’s wallet. Others are pursuing bank partnerships. A select few are intent on becoming software companies (not lending at all), enabling digital lending for the banks and other non tech-enabled lenders. And, lastly, others who have already proven their ability to drive strong unit economics by marketing directly to a consumer (or a business) are intent on becoming a lasting brand within the U.S. financial services ecosystem.

What is rather clear is that the players in the DEL market are choosing to pivot and pursue pathways that will result in profitable and sustainable business models. My wager is that the result will bring clarity to the DEL identity crisis through the creation of multiple new business models and multiple new identities.


TSL graphic


Sam Graziano is the chief executive officer of Fundation, a New York City-based small business direct lender and solutions provider that utilizes a sophisticated software platform to streamline the lending process. Graziano is a highly experienced financial services professional and entrepreneur. Graziano graduated from Bucknell University with honors with a degree in Computer Science & Engineering.

Investing in Alternative Lending?

That Could Mean a Lot of Different Things

As CFA’s recent Alternative & P2P Lending and Investing Forum in New York proved, “alternative lending/fintech” is a topic on many minds today. It’s also still somewhat shrouded in mystery. Sam Graziano, CEO of Fundation, sheds some light on the topic, particularly about those investing in the space.


“Alternative Lender” is a term now applied to just about any lending-oriented business model without the word “bank” in it. The term has been applied to businesses that source borrowers and refer borrowers to lenders (also known as an “Aggregator”), businesses that originate and sell loans or loan participations (also known as “Marketplace Lenders”), and businesses that originate and hold loans for their own balance sheet (also known as “Direct Lenders”). From an investor’s standpoint, there are dramatic differences in how you can participate in this market and your investment rationale for doing so.

The Old Alternative Lending and the New Alternative Lending

For many of you reading this article, “alternative lending” is not a new term. In fact, your business may have been called an alternative lender, a term that historically was applied to asset-based lenders, factors and other commercial finance companies that originated leveraged loans, equipment loans, and short-term and long-term secured receivables financing. Many of these product categories are now addressed by specialized business units within the banks themselves.

The new alternative lenders are something else entirely. The markets they address, the way they underwrite and how they acquire customers is different. The ecosystem of aggregators, marketplace lenders and direct lenders provides small-balance credit instruments predominantly through the Web to consumers and small businesses, uses business process automation to deliver cost and time efficiencies into the lending process, and uses real-time (seconds) data aggregation and analytics to predict and price risk. Fundamentally, these business models are leveraging technology to deliver small-balance credit in markets where the banks do not. I humbly suggest a different term for these companies: “Digitally Enabled Lenders,” or DELs.

Why Is There So Much Interest in DELs?

After about eight years, two IPOs and perhaps $20 billion originated, the level of investor excitement over DELs has not dissipated. LendingClub, the world’s largest marketplace lender, launched its initial public offering in December 2014, followed shortly thereafter by OnDeck Capital, the largest short-term working-capital financing provider to small businesses. LendingClub, a business without much of a balance sheet , trades at nearly 200x its annualized “adjusted” EBITDA and more than 100x forecasted 2016 earnings. OnDeck Capital, predominantly a balance sheet lender, trades at more than 4x book value and more than 35x forecasted 2016 earnings.

Unquestionably, these valuations indicate an expectation of a high rate of growth for years to come. Justifying these growth rates requires investors to assume that DELs are technology disrupters that will disintermediate the banking industry and capture meaningful market share in the process. The investment narrative is
that regulatory pressure, heightened regulatory capital requirements, and antiquated and entrenched technology put banks at a competitive disadvantage versus DELs. There is a lot of merit to this investment rationale, as the level of regulatory supervision is impeding bank innovation and consumers are embracing what the web and mobile applications deliver throughout their lives.

The Other Side of the Coin

The largest DELs address the unsecured consumer loan, nonconforming mortgage, graduate student loan and small business loan markets, where digitally enabled processes permit the delivery of small amounts of credit to individual borrowers through the Web. It is easy to understand why DELs do not exist in larger-ticket, higher-touch lending categories like ABL commercial real estate and commercial loans. However, there are also no substantial DEL franchises in some of the largest consumer markets, such as credit cards, auto finance, conforming mortgages and government-guaranteed student debt. The national banks and other national brands still dominate these product categories.

Despite an operating expense advantage enabled by technology, the banks have a potentially insurmountable advantage in terms of cost of capital. They also have a structural advantage to the customer’s mind share as a result of the deposit relationships they have with customers. So the question remains as to whether DELs can compete head-to-head with banks for a customer. DELs, thus far, thrive where the banks cannot or will not participate.

Banks will often shy away product categories where all, or many, of the following characteristics are present:

  • Regulatory pressure or a deliberate risk management decision on the part of the banks to reduce exposure to a given product category
  • A lack of (or material deficiency of) collateral or government guarantees
  • Heightened regulatory capital requirements
  • The need to employ a risk-based pricing framework to manage risk effectively, with which many banks are uncomfortable.

Even when these market characteristics are present, many of the consumer-oriented products are dominated on a national scale by virtual oligopolies among the national banks. Take credit cards, for example: this market is dominated by 7 companies—Bank of America, JPMorgan Chase, Capital One, Citigroup, AMEX, Discover and US Bank. These are business lines with massive scale and are highly profitable. These firms will protect their trophy franchises at all costs.

Investing in Digitally Enabled Lending

To be an investor in Digitally Enabled Lending, you have to pick your product category and pick your investment strategy. Marketplace lenders offer investors, for the first time, the ability to purchase consumer and small business loans at scale, a proposition that can deliver exceptional risk-adjusted returns with low volatility across market cycles.

As an equity investor, you need to pick the business model that you believe in. Aggregators and Marketplace Lenders are capital-light, low-profit-margin businesses (profit as a percentage of dollars originated) and, therefore, require substantial scale to generate profits. But scale is the name of the game, as many believe that these businesses can grow unconstrained by access to capital.

Direct lenders, on the other hand, are capital-intensive businesses, but capture the entire revenue stream on a given credit instrument rather than outsourcing most of that to the loan buyer. These are traditional commercial finance companies in the way they make money, but nontraditional in how and what they originate and retain.

In today’s landscape of Digitally Enabled Lending, we find an interesting mixture of traditional financial-services equity investors, credit investors and technology-minded investors that have different points of view.

Ultimately, every DEL is exposed directly or indirectly to the cyclicality of the demand for, and performance of, credit. Time will tell if this is a new story altogether, or the same story in digital form.

Sam Graziano is the chief executive officer of Fundation, a New York City-based small business direct lender and solutions provider that utilizes a sophisticated software platform to streamline the lending process. Fundation launched its system to the public in May of 2013 and is now backed by a group of high-profile private equity firms and other investors. Graziano is a highly experienced financial services professional and entrepreneur. Prior to Fundation, he spent over a decade in investment banking and private equity where he developed an expertise on strategic, financial and operational issues for banks, specialty finance companies, asset managers, broker/dealers and other institutions throughout the financial services sector. At Centerview Partners, Graziano provided strategic and financial advisory services to some of the nation’s largest and most recognizable financial services companies. Prior to Centerview Partners, he spent six years with Keefe, Bruyette & Woods, the nation’s largest boutique investment bank focused on the financial services sector, where he executed dozens of mergers and corporate finance transactions and then co-founded the firm’s private equity practice. Graziano graduated from Bucknell University with honors with a degree in Computer Science & Engineering.