What I’ve Learned (So Far) From Building the SoFi Business

When we started SoFi back in 2011, my co-founders and I felt we were on to something special.  We knew there was a problem with financial services, and we wanted to fix it.  Two-plus years and 5,000 members later, our original vision is coming to fruition.  The $80 million round we closed in April will help solidify our position as something much more than a student loan business.  We are on a path to deliver a better model for consumer finance.

The financial services industry is broken.  If you have money, you send it to an advisor, who charges fees.  Advisors allocate to investment managers, who charge fees.  Managers buy securities from dealers, who charge fees.  Dealers get their securities from banks, which charge fees.  Banks lend, and charge fees.  That’s a lot of fees.  Everyone does great in this system – except for the investor and the borrower.  They end up with high loan rates and low returns.

SoFi initially challenged this model with student loan refinancing.  We connect alumni and institutional capital directly with alumni borrowers.  In doing so, we are able to deliver lower loan rates to borrowers and attractive returns to investors, collecting a small spread to run and grow our business.  Our members (borrowers and investors) love the mission and the externalities such as job assistance and our entrepreneur program.  And now they are benefiting from a new set of SoFi products, including mortgages designed specifically for our members.

Despite the glaring need for SoFi and our matching conviction, building SoFi has not been easy.  Every day I’m humbled by what I didn’t know, took for granted or misunderstood.  Some big lessons we’ve learned along the way include:

People need to know who you are, especially when they are borrowing money from you.
When we launched SoFi at the Stanford Graduate School of Business back in 2011, we anticipated 100% market capture.  We had a lower rate than government and private lenders, so what wasn’t to love?  But as we watched people in our cohort take higher cost PLUS loans, we were befuddled.  We finally accosted some poor borrowers outside of the financial aid office.  “Why aren’t you taking our loan?” we asked, to which they replied  “Because we don’t know SoFi.  You could disappear in a year.” Huh?  Why would you care if you don’t know your lender?

What hit us is that brand, trust and ultimately credibility matter – a lot.  People want to save money, but no one wants to be harassed by a loan shark at dinner just to get a better rate. Our business is about more than just a great rate, and we’re making sure our members know this.

Selling a low-yielding illiquid product with the opportunity for higher yield and liquidity in the future is really hard.
In late 2012, we embarked on an aggressive campaign to raise capital.  We set up a broker-dealer, hired a sales force of brokers and set out to get it done.  Only, it didn’t really work.  The crux of our sale was that we would ultimately securitize our loans, and the investors would convert from a limited partnership (LP) in a fund to equity in the securitization, moving from a 4.5% yield to a low double-digit number.  Without securitization, the investor had an illiquid LP interest in a pool of assets that were being cited as the next bubble to crash, with an unknown final maturity, yielding 4.5% assuming little to no defaults and delivering a K-1 each year.  We were too hasty coming to market – with investors still smarting from 2008, this proved to be a nearly impossible sale.

So after we executed successfully on our first securitization in December 2013, we started working on a structure of a five-year note tied to school repayment rates with a conversion option into future securitizations.  We intend to offer better liquidity, finite maturity, demonstrated securitization success and a 1099 for taxes, making this a much more attractive investment vehicle.

Never underestimate the power of an easy application process.
In May of 2013, we unlocked a huge amount of capital.  We had stopped issuing new loans in late 2012, waiting for clarity on our capital position.  Over that time, we accumulated a $300 million waitlist of individuals who wanted to refinance with us.  Like the mistake of a previous president, when we unlocked the capital I announced, “mission accomplished”.  Only the loans didn’t show up.  We had managed to build the most convoluted origination system that actually made banks look cutting edge.

So what did we do?  We went above and beyond to fix this and now boast one of the easiest application experiences – not to mention the only mobile app – in the business.  This showed me that even when you’re helping people save money, you still have to make it easy for them or they’ll take their business elsewhere.

These are just a few examples of what we’ve learned, and no doubt we’ll continue learning as we build SoFi.  We’re grateful for the support of our members, and look forward to this recent capital raise driving our expansion into a broader set of products, including home loans, asset allocation and insurance – all tied to your affinity community.

Thanks,

Mike Cagney