Last week, Accel and Greylock led one of the largest Private Equity deals in Europe this year - the funding of Wonga to the tune of $22.5M. Wonga is an online short-term lender in the UK, offering quick cash to customers who need it. There was a major uproar on the net centering around an article written by Umair Haque at the Harvard Business "Edge Economy" blog. The article led to several comments on the page itself, as well as this response from Lawrence Meyers at the Blogger News Network, which led to this response from Umair.
This is an interesting debate, as it highlights some misconceptions about VC and the definition of innovation today. The issue is interesting to me as well, simply because I was part of the Greylock team that ran due diligence on the company and encouraged the investment first-hand.
Firstly, without completely rewriting the arguments and counter-arguments of the folks above, the main question debated was whether Short-term Lending, a business that has existed since the creation of money, is worthy of VC investment to begin with, and whether sufficient innovation has been created in this case to justify investment.
Merits of Short-Term Lending
As to the merits of Short-term Lending, there are a handful of arguments given for its lack of moral fiber, namely:
- High Interest Rates - often in the 1000x APR, above rates published by banks and credit card firms
- Tendency to have hidden fee structures - transparency is not generally something these firms strive for
- Encouragement of rolling balances - accept many customers, then keep them in debt longer, paying ever more compounding interest
- Association with loan sharks, shady organizations and businesses - pawn shops and collection agencies are not associated with 'clean practices' by most
These issues are all real, and part of the Short-term lending business. In our due diligence, we found many lenders who fit this MO quite nicely. However, while practices in the industry are not always just or particularly nice, there is a market for this kind of service and there is plenty of room to create a more just and more customer-friendly system to better serve the population that depends on these products. Wonga, to the best of my knowledge, thinks different about the space, and has changed the customer experience for the better.
Now, one could argue that the customer base who needs a Wonga-like product should be forbidden to have this loan choice - that they should rely on their local bank's overdraft protection or last-resort secure loans, like pawn shops. In the US, many states made just this decision, banning the practice of Payday Lending outright or capping the interest rates available. However, one could also argue that both these options have caused harm to the consumer who is not presented with lending choice, resulting in them not having access to funds at all, or severely limiting competition to whatever banks choose to charge for overdraft. Surprisingly, if overdraft fees were put in terms of APR, one would find a hefty # that, in some cases, surpasses that of payday lenders. In the end, there is merit to both the pro and con arguments.
Personally, I believe in customer choice, and assuming some level of transparency, I am comfortable with the offering of these products. I don't think the product is inherently evil or "the worst business proposition in the world" - this product can be harmful, but can also be helpful, depending the level of responsibility taken by the borrower, and the purposes of the loan. There are numerous businesses that are just plain harmful, like cigarettes, liquor, and transfat-based foods, which are much more problematic, at least in my eyes.
Merits of VC Investment
VCs have the responsibility to make money for their investors, by directly investing in high-risk-high return early-stage private companies. Successful VCs have traditionally developed a market thesis, and attempted to invest accordingly. The model is oriented towards industries and markets in need of innovation. Every fund has identified its own industry priorities, based on the Partner's expertise and their thoughts on the marketplace.
To me, today's areas for significant innovation include:
- Energy and Clean technology
- Internet-based applications (including SaaS)
- Advanced Storage, Semis, Networking, etc.
- Medical devices and pharma
- Financial Services
The recent crisis, coupled with other macro trends, particularly the evolution of the internet, have created a need for financial services to be completely rethought. The creation of new payment methods, marketplaces, content delivery, and information transfer have resulted in the need for more sophisticated and efficient financial technologies. As a result, nearly every model the industry has used since the middle ages has been rethought by entrepreneurs, resulting in the creative destruction process.
Wonga is one such attempt - Errol and his team took the payday loan model and flipped it on its head:
- Interest rate - based entirely on loan length; most lenders require a loan to be at least 30 days, at a specific rate, even if the loan is for 5 days - Wonga is flexible for borrowers who want shorter-term loans
- Consistent cost structure, presented in a transparent manner - customers always know up-front what they'll pay
- Encouragement of on-time payment - Wonga strongly discourages late payment by rejecting most applicants based on a proprietary dynamic risk engine that is quite brilliant; Wonga also works with borrowers to ensure timely payment, and rewarding borrowers with good track records
- Wonga is building a strong consumer brand name in the UK, based on its consistent customer experience and retention efforts
I believe these elements make Wonga worthy of a 2nd look, as an innovator in an ill-associated space.