After my initial elation at being admitted to business school in December 2013, I had to think through how I was going to finance the MBA. I was surprised at the expensiveness of traditional student loan options.\u00a0 Fixed-rate federal Plus loans were priced at ~8% and offered the same terms for all graduate students.\u00a0 Bank loan rates were similarly expensive and were based primarily on my past credit history than my future earnings potential.\u00a0 They were minimally adjusted for type of degree, quality of school, or career prospects.\u00a0 In other words, the student loan market was incredibly inefficient.\u00a0 My solution was to turn to my parents, who offered me a better rate than the government or a bank because they had greater trust in my creditworthiness.\u00a0 However, if everything I was told about the value of a 性视界 MBA was true, I should have been able to convince others of my low credit risk the same way I convinced my parents.\u00a0 Social Finance Inc, or SoFi, is institutionalizing this concept via crowdfunding.<\/p>\n
Value Creation and Capture<\/u><\/p>\n
SoFi runs online lending marketplaces that match lenders with student borrowers. Piloted at Stanford\u2019s GSB in 2011, SoFi\u2019s first fund raised $2 million from 40 Stanford alumni to offer loans to 85 Stanford MBA students (http:\/\/business.time.com\/2012\/04\/02\/student-loans-for-a-great-deal-borrow-from-alumni\/<\/a>). \u00a0Soon thereafter, the company raised similar funds dedicated to pairing alumni lenders with students at other top business schools such as HBS, Wharton, MIT, and Kellogg (http:\/\/bucks.blogs.nytimes.com\/2012\/04\/03\/sofi-tapping-alumni-to-help-with-student-loans\/?_r=0<\/a>).<\/p>\n There are 3 reasons why SoFi\u2019s model makes sense and why students and alumni sign up:<\/p>\n (1) Like many peer-to-peer lenders, SoFi is a lower-friction intermediary than banks. Its use of online crowdfunding to raise funds eliminates much of the administrative\/overhead costs that banks are burdened with.\u00a0 This allows it not only to generate cost savings (that are shared by borrowers, lenders, and SoFi), but to simplify the user experience for borrowers and lenders.\u00a0 In fact, SoFi claims to make a rate offer in 2 minutes (https:\/\/www.sofi.com\/b\/registration<\/a>).<\/p>\n (2) In addition to reducing admin\/overhead costs, SoFi\u2019s use of crowdfunding actually improves risk-scoring in the underwriting of student loans. The basic premise is that alumni from top schools better understand the value of an education from their school than existing lenders.\u00a0 Therefore, they should view students\/alumni from their alma maters as lower-risk than traditional lenders and should offer them lower-than-market rates.\u00a0 The practical impact is that SoFi enables students to receive more affordable financing and alumni to receive what they perceive to be better risk-adjusted investment returns.<\/p>\n (3) SoFi has leveraged the affinity that alumni have for their schools to create communities that offer mentorship and career advice. The benefit to students is obvious \u2013 an opportunity to leverage the powerful networks of alumni and their peers.\u00a0 For alumni, the program offers an alternative opportunity to \u201cgive back\u201d to the school while also securing their investment.\u00a0 After all, they\u2019re less likely to lose money on the pool of students they\u2019ve invested in if they help those in transition find jobs.<\/p>\n The hypothesis behind SoFi\u2019s creation has been borne out empirically. To students, the marketplaces offer loan rates that are 200-400 bps cheaper than traditional alternatives \u2013 indeed, SoFi offers MBA students fixed-rate loans starting at ~6% (https:\/\/www.sofi.com\/mba-loan\/<\/a>).\u00a0 To alumni, the marketplaces has offered low-risk returns \u2013 SoFi claims it has had a default rate of close to 0% while the figure hovers at ~14% for federal student loan borrowers within 3 years of beginning repayment (http:\/\/www.forbes.com\/sites\/maggiemcgrath\/2014\/12\/10\/student-debt-as-an-asset-class-a-1-trillion-opportunity\/<\/a>).\u00a0 Simply put, by giving alumni investors mid single-digit rates of return with minimal risk, SoFi offers \u201chigh-yield returns\u201d for \u201cinvestment grade risk.\u201d<\/p>\n Given that its organizational structure is comprised of investment funds (albeit funds raised online), SoFi captures a portion of the value it creates as a money manager would \u2013 by charging asset management fees (its founder was previously a hedge fund manager). The company typically charges a management fee of 0.75% and a service fee of 0.5% (http:\/\/venturebeat.com\/2012\/09\/18\/sofi-student-loan\/<\/a>).\u00a0 From an investor\u2019s perspective, this is quite reasonable for an alternative asset class.<\/p>\n Initial Growth Challenges and Evolution<\/u><\/p>\n Although SoFi\u2019s initial business model made a lot of sense, its scalability was limited. After all, there are relatively few \u201ctop\u201d schools where alumni are sufficiently confident in the school\u2019s value and screening process to invest in the students.\u00a0 Hence, the risk-based value proposition to alumni begins to decrease as the model is extended to ostensibly lower-quality schools.<\/p>\n Additionally, although there is $1.3 trillion of outstanding student debt in the US (http:\/\/www.inc.com\/zoe-henry\/5-things-to-know-about-student-loan-refinancing.html<\/a>), new originations each year are a fraction of that figure.\u00a0 As such, in order to build a large business solely through new originations, SoFi would have had to capture a particularly outsized share vs. the federal government and bank programs that are much better-known and marketed.\u00a0 However, to achieve the same degree of awareness and distribution could have introduced the very administrative\/overhead costs that SoFi seeks to avoid.<\/p>\n Furthermore, SoFi could have been constrained by the supply-side. Very simply, it would require a huge \u201ccrowd\u201d to raise hundreds of millions (or billions) of dollars from individuals online.\u00a0 Similarly, the community-based mentorship\/career guidance element could limit growth because it\u2019s difficult to find alumni who will volunteer their time in addition to their money.<\/p>\n SoFi\u2019s business model has evolved in response to these growth challenges. To address demand-side scalability, the company very quickly extended its offerings to undergrads and graduate programs beyond business school.\u00a0 Importantly, it added student loan refinancings to its repertoire (https:\/\/www.sofi.com\/refinance-student-loan\/<\/a>). This allows it to address the much larger pool of outstanding student debt in addition to new loan originations.\u00a0 It also allowed SoFi to supplement its risk-scoring framework with career\/salary data in addition to quality of school\/program.\u00a0 Additionally, SoFi began targeting the ancillary market of loans for parents who fund their children\u2019s education (https:\/\/www.sofi.com\/parent-loan\/<\/a>).<\/p>\n On the supply-side, SoFi has grown beyond its original single-school funds, enabling investors to access pools of students at various schools. It has also supplemented crowdsourced funds with institutional investments.\u00a0 This includes equity capital of its own \u2013 the company has raised $1.4 billion from blue-chip investors such as SoftBank and IVP and plans to go public in the next year (http:\/\/techcrunch.com\/2015\/09\/30\/online-lender-sofi-seems-to-push-back-ipo-plans-raising-1-billion-instead\/<\/a>).\u00a0 Additionally, it led some of the first securitizations of student loans in the industry \u2013 as was famously done with mortgages, the company\/equity investors capture a spread between the cost of an individual loan and a pool of loans (http:\/\/www.lendacademy.com\/sofi-adding-leverage-for-their-alumni-investors\/<\/a>).<\/p>\n Today, only ~20% of SoFi\u2019s loan money comes from its crowdsourced sources. SoFi has also supplemented its crowdsourced mentorship \/ career development with hired professionals.<\/p>\n Challenges to Future Growth<\/u><\/p>\n