What Investors Should Consider When Buying Fractional Small Business Loans

Funding Circle launched a fractional loan marketplace, that is to say investors can now buy fractional pieces of secured small business loans ranging in size from $25,000 to $500,000 and in term from one to five years, with coupon rates of 5.99-20.99%.

According to the press release,

Investors can access Funding Circle's Fractional Loan Marketplace with a minimum opening balance of $50,000 and a minimum investment per borrower-payment dependent note (BDN) of $1,000. Investors receive access to data from across the full Funding Circle loan book, and can either browse the marketplace and select individual investments or set criteria and invest automatically through an auto-bid function.

Is buying fractional business loans a good thing for any investor? I would say there are two variables that any investor must keep in mind:

First, how good is the underwriting, ie, do you trust their underwriting team. Most marketplaces use fairly traditional underwriting models that are based primarily on the borrower's credit history and ability to repay. These models are bolstered by proprietary data and algorithms. According to Funding Circle, every loan on the marketplace is underwritten by Funding Circle's experienced underwriting team and assigned a risk score ranging from A+ to C.

Second, who handles the administration of passing pieces of an asset – ie, who is the Custodian? Servicing these loans is valuable and you need a trusted agent. Funding Circle has found a model that works for their Fractional Loan Marketplace. The key question – is the model tested? And what I mean by tested is that when there is a failure, how does a bankruptcy court view this.

As I said before, no investor likes to lose money. None. And in the world of business credit, transactions are PRIVATE. Information is public with retail credit, and all you need to make a credit decision is someone’s identifier like their SIN#, or Social Security # or some health identifier to retrieve lots of credit data. The equivalent is very hard in the commercial world, where data is not always available, or may be outdated, or even incorrect.

I applaud Funding Circle’s innovation.   It’s another option that helps provide liquidity. But as always, caveat emptor.

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