Our post today is an interview with Denise Thomas, CEO and co-founder of ApplePie Capital , a peer lending platform for franchise business loans.
After launching the first online securities auction 14 years ago, Denise and co-founder Steve Pelletier started watching the recent growth in peer lending and decided that they could provide a more efficient way for small businesses to access capital.
The company presents another model in the fast-growing p2p space, one that is offering lower rates on small business loans due to lower relative risk in the franchise model and a proprietary credit model built on years of industry experience.
ApplePie Capital is one of the newest in a long list of p2p lenders. Check out the full list of best peer to peer lending sites for borrowers.
I have included my own comments in italics so as not to be confused with Denise’s.
Tell me about ApplePie Capital, about the business model and the team.
Denise: Sure, basically, we were looking at the changes that were happening in the regulatory environment with the changes in general solicitation. My partner and I were the first to do an online securities auction 14 years ago so we had some experience in financial platforms. When we looked at the changes coming out this year and last we said, “There has to be a more efficient way for small businesses to access capital.”
So we begun looking at small businesses and one of the key problems in peer-to-peer lending, at least from an institutional investor perceptive, has been originating enough volume. It’s been a problem in p2p consumer lending but even more so in small business lending because of the higher risk. In franchise business loans though, you have a performance history that you can actually look at in terms of units opened and closed.
We liked that relative certainty, so we begun to investigate and research the industry and I found that there was a real need, particularly since 2008 with the changes in the banking industry, all the new regulations that tightened credit for small business. There was a particular sweet spot under a million dollars in financing.
With new regulations, a loan of under $1 million was just as expensive to make as larger ones so the banks began moving up market. That left small business scrambling for their capital needs. The industry has an annual capital demand of $42 billion and grows approximately 5% a year. In spite of the issues in 2008 the industry continues to grow, but it has been difficult without the needed capital.
As we looked further into it, we felt that an online, systematic approach or finance in a box, could be the answer for franchise business loans. The franchise focus also addressed the cost of origination. With our two layer diligence process starting with the brand first, we are able to develop a curated pipeline at a relatively low cost compared to other platforms. After vetting the franchise brand, we look at the individual candidates. Investors like it because it is a lower risk profile and ApplePie Capital has a natural origination slope coming from the brand.
Denise hits on one of the key drivers to peer lending over the last few years and something that is likely to accelerate over the next couple of years. Just half of the banking rules under Dodd-Frank have been written and we’re already seeing weakness in bank lending. If that were not enough, rules under Basel III are driving capital requirements higher by 4% and putting other restrictions on funds available for loans.
The restrictions have gotten so bad that many banks are now choosing to invest their money on peer lending platforms like Prosper Marketplace rather than make loans. I detailed the problem recently and wondered if 2015 would bring the end of traditional bank lending.
The franchise industry accounts for 3.5% of the total U.S. GDP with double-digit growth since 2010 and a strong market for franchise business loans.
Can you talk a little bit about the some of data you referred to on franchise risk, because I think that sets it apart from other small business lending, even peer lending?
In franchising there are three things that are really important. Every brand needs to pay attention to them.
1) Location Selection
Location is always important because you have to be in the right market with a strong customer base and enough competition that might keep new threats out but won’t choke off margins. Brands already place great emphasis on location selection which lowers risk. We look at potential traffic as well as the potential for outward growth of the brands’ footprint in successive years.
2) Management Selection
It’s counter-intuitive, but a lot of brands would rather have someone outside the industry rather than directly from the existing industry. For example a pizza delivery company versus an in-room dining pizza restaurant requires different management skills so just having a background in pizza-making is not necessarily the most important dimension.
They would rather have someone from the delivery business rather than hire someone from another pizza chain, if it was a take out restaurant, because the operations are optimized differently. They’re looking for someone who knows how to keep trains running on time in a very different way from the traditional delivery model. Likewise, sometimes franchises prefer not to have someone with a background in the field that they are bringing people into because they are businesses in a box, they want to do it their way and they have perfected their model through standardization.
It’s counter-intuitive but it makes sense if you dig in and look at their track record. If that company had zero closure in ten years and they opened 300 stores, you have to believe that their formula is working. So we don’t second guess their selection of people but we do investigate how they do it to ensure that it is a very rigorous screening process.
The third part of the puzzle is really the support that the brand gives to the individual units. This comes in the form of marketing:
How they allocate to do local marketing for the individual stores?
How they support them in the store opening, store build out, and all the infrastructure required to operate a unit,
And then how they stay engaged to help that franchisee maximize their potential and to grow the businesse
We have a proprietary data model and a credit policy that estabilshes the risk profile and therefore the interest rate for the loan. If it meets our criteria, then we are able to fund the specific loan. There are a couple of unique things about our funding. We raise capital from investors that can be deployed in these loans but we also offer the option that an individual can raise money through their own network. So if they bring investors to the platform, we’re happy to charge a 3% origination fee versus a 5% fee on the funds from their investors.
It brings more investors to the platform. And it’s also a testimony to that individual’s backability.
I see your operating in the accredited investors’ side. Any plans to expand that to retail investors? Or would that be dependent on Title III of the Job Act?
It would either be Title III or we would have to do a public registration of funds and I think on a certain scale that would make sense.
This is the one of the biggest distinctions I’ve seen across the existing platforms. Prosper and Lending Club are the only platforms currently open to un-accredited investors while others have staked out share on the accredited investor and institutional side. With competition building in the space, I think 2015 will bring at least one other peer lending platform offering loans to non-accredited investors. We will likely see movement on passage of Title III as well, though probably not until the second half of the year, which would open a lot of the platforms to a larger investor market.
Looking to invest but not sure about peer lending? Check out these other investing resources and reviews.
I see it looks like your supporting 5 or 6 franchise brands. Is that as many as you plan on adding?
No, we actually have more than that but you always have trailing content for the website. We’re waiting for content for others, but we have more than that now. We have a pipeline that’s quite large. We’ve actually been open for only 30 days and we have an overwhelming number of franchises in process.
Any idea on what the average rate and maturity of loans will be?
We’ll fund loans between 3 and 7 years depending on the business, how much money is borrowed and what the debt coverage ratio needs to be. Loan rates will likely be between 8% to 12%, the stronger the brand the lower the interest rate.
I know you talked about the 5% fee on the borrower’s side going down to 3% for their own social loans and I saw on the website that the investor fee would be 1% of assets, is that right?
That’s right. The servicing fee is 1% for the investors.
What three things should borrowers —someone looking for a franchise business loan
— be thinking about before starting their franchise and before looking for lenders for their franchise.
A few things, first is that selecting the right brand and business model to fit their interest. Next, location is very important in franchising. Because you really need to lock in a good location, speed to money is incredibly important. If they have to go through a Small Business Administration loan process they can lose their location while their applying for the loan because it takes up to four months. They might have to put up money before they even know if they got their loan. So it really mitigates a lot of risk having a process that can potentially get the loan approved in under 10 days and naturally our target is to fund these loans quickly once they qualify.
The second is particularly important because more and more franchise businesses are looking to have their existing operators open additional units in neighboring towns. So if you’re one of those borrowers you have to think about how you are going to plan your financial futures to support multiple store openings over multiple years.
One of the things that happens today is people use all their equity to open their first store and don’t have the required 20% to 30% for the next unit. What we do is help them develop a plan for equity, 20% to 30% in each unit and financing the balance. We don’t see others doing that level of financial planning service for the borrower.
I was just going to ask that. So ApplePie Capital can help with that financial planning and the budgeting, is that correct?
We want to be a partner for the life of that individual’s needs. We also really work with them on what are the true cash flows. When you’re going to open 2 – 3 units, you shouldn’t focus on interest rates as much as you should focus on what kind of debt service you can afford. It’s sort of like when you buy a house, you look at several factors in the loan including fixed or variable term, and the cash flows needed for other expenses.
We do the same type of modelling and say, “Look, if you want to get to multiple units and here’s your debt service in the first unit, it’s going to look pretty attractive as you get your 2nd and 3rd unit open.” W try to have franchisees not focus on interest rate as the leg of the stool that really ends up mattering. We just did a loan analysis yesterday and the difference between 9% and 10% for the risk profile of this loan was only $50 a month.
And so, you have to look at it because people look at interest rate and think, “Oh well, I can get an SBA loan for 6%.” You may pay a rate 2% higher but the loan is funded faster and there are no collateral requirements. That is very attractive to these businesses.
The bank may want your house and your first born child along with it, and then you can’t open another unit.
Can you take me through the qualification process? In particular, I think you referred to timing. How long do steps in the qualification process take?
Well if somebody has all of their information, we can literally process them in days. We’re trying to approve them and provide a price within 10 days of the application and that’s if we already have the brand on board. If we’ve already vetted the brand, we are getting that loan application and all associated information that we need to evaluate the risk and set the price. For the marketplace to have the opportunity to invest, we tell them to allow 30 days for the whole thing.
We put everything online so it’s very streamlined, all the signatures – it’s a paperless process for the investors, so it goes pretty quickly.
Now on the investor’s side, what should investors know about franchise lending?
I think they should know that it’s really a longer-term fixed income product that if you have retirement funds or other cash that you’re not earning good yields on, this is a lower risk steady income investment asset class. It’s a new asset class.
A lot of people think about food industry related brands when they think about franchises. We’ve taken 3,500 brands and reduced it down to 500 from the vetting process. We look across industry and across geography so we’re building a diversified portfolio and it’s not all food. In fact, more like 25% to 30% will be food related and some of that is retail and not really food service.
Denise brings up a couple of interesting points here for peer lending investors. First, through different platforms it is becoming easier to diversify your portfolio across term lengths. Whereas consumer loans on Prosper and Lending Club are being made for three to five years, ApplePie Capital extends the loan out to seven years. Longer maturities reduce your reinvestment rate risk while shorter maturities reduce the affect of rising rates on your portfolio’s value. Click through for a full review of Prosper and Lending Club in my peer lending sites review.
While credit diversification has evolved as one of the biggest factors in consumer loan investing, investing across different industries is the important factor in small business investing.
So are investors investing in a portfolio of franchise business loans or are they investing in specific loans on the platform?
The investors who have committed capital are investing across a variety of loans, so we have both options available for investors. They can chose one-by-one or they can invest a fixed amount of money across multiple loans. We’ll be putting some additional functionality on our website in the first quarter that will provide some automation for the fixed amount option across multiple loans and we can do that for investors today if they contact us.
How about growth, whether geographic or product type?
We are currently loaning into all 50 states but, as you know, franchising is global. It is more complicated to look at the regulatory environments in other countries. But eventually, we will find an approach and a way to broaden outside the US. I think that we may also have growth in other product areas through life cycle support for the business and other types of financing solutions. For example, built into every financial agreement, every 7 to 10 years franchisees have to do a brand refresh. So we’ll work on programs for a brand so they can roll out a remodel across all their units.
What about hurdles? What about challenges, whether for the peer lending industry in general or for ApplePie Capital?
I think regulatory is always something we take seriously and watch. We have a lot of comfort in the IPO of OnDeck and Lending Club. Their models have been through the regulatory scrutiny and I think they offer a halo effect for those coming behind them.
If the regulatory environment changes, it’s going to change for everybody. It’s going to be harder and harder when you’ve got public companies, and so I think we feel relatively stable in that for the foreseeable future.
I want to thank Denise and I want to thank you, the reader, for joining us. I hope you will join us for more interviews and follow the blog on Facebook and Twitter. Please consider sharing this article with your friends using the social share buttons on the left.