In San Francisco (CA), we meet Co-Founder & VP of Community of SoFi, Dan Macklin. Dan talks about his story how he came up with the idea and founded SoFi, how the current business model works, as well as he provides some advice for young entrepreneurs.

INTRODUCTION

Martin: Hi, today we are in San Francisco in the SoFi office. Hi Dan. Who are you and what do you do?

Dan: My name is Dan Macklin and I’m one of the co-foundersof SoFi. We are a consumer finance company. We lend money to people across a variety of sources and ways.

Martin: Tell us about your background. So what did you do before you started SoFi and how did you come up with the business idea?

Dan: So I’m originally from the UK and I was educated there, and I worked for a British bank called Standard Charter Bank for about 12 years, across a variety of functions but also countries as well. So I spent a years in Singapore working on risk function. Back in London I worked directly for the group chief executive, kind of in a chief of staff role which was really a great way to see how a big 70,000 person company operates. Then I spent nearly three years in China running a smaller or medium enterprise business with a large team across the country. And then came to the U.S. to go to business school and it was a special program; a one year full time program at the Stanford business school, the GSB there, and that was back in 2010. And then went through that year, fell in love with Silicon Valley and the idea of entrepreneurship. And although I probably expected to go back to my previous company because I was sponsored by them. We the co-founders of SoFi were classmates and we were discussing ideas for businesses and one thing led to another and SoFi was born out of those conversations.

Martin: Great. What types of business models did you discuss with because I guess you had a long list of ideas, and then shortened it and said, ‘Okay, let’s start something in the consumer finance sphere’.

Dan: We did, and we had a few different ideas that went around. One of them was more in the tech space. We were trying to make a kind of eBay for video services. So if you wanted to buy someone’s time, but you didn’t want to have to drive to where they were, then you could bid $20 for a half an hour of their time and they could give you a tutorial over the internet. We quickly changed that for various reasons and we focused on finance because that was where most of us had come from. And I think that was the industry that we wanted to come up with something to solve.

So we had some broad ideas about connecting people with money who could invest. And people that needed money who could borrow and connecting them more directly without all the intermediaries that tend to exist. So that was the genesis really for SoFi and our first product was in the student loan area. So it was individuals investing money through SoFi and we then passed it on to borrowers who could borrow at a lower rate than they otherwise would.

BUSINESS MODEL OF SOFI

Martin: And how did you start about entering the market in terms of, when did you build the platform and where did you first acquire the customers? Did you focus, at first, mainly only on the Stanford University because it was easier, you had some access to students?

Dan: We did. We developed our idea in the last five months of our time at Stanford. So really from January to May of 2011, we were testing out the idea and researching and interviewing people, and getting feedback, and looking into the viability of it. By about April I think we were fairly convinced that we were going to start a business and we were going to try to make this work. So really as soon as we graduated we started the company. So it was literally, we graduated on a Saturday and two days later on the Monday we were coming in and starting work formally.

So we went back for our first customers to Stanford. So many of the MBA students there, the second years had been exposed to us in some way the previous academic year. And obviously, we knew some people and that was a great way to test the market. And we launched a pilot fund at Stanford, really, where we raised money from Stanford alumni and then lent back to Stanford students. But, yes, that was the first one.

Martin: And how much traction did you generate over the last three months or so in terms of how many students did you fund, what volume?

Dan: Yes, we raised money from 40 people. We raised about $50,000 each on average. Made a two million dollar pool of money that we then lent to about 100 students, so they were borrowing roughly a thousand dollars each. So within three months we had actually lent money. It wasn’t just an idea or a project, we were actually a lending company by that time. And obviously, since then we’ve expanded and lent to many more people since then.

Martin: And then, when you validated your business idea, why do you think the business opportunity existed? Because student loans is not a super new market, per se. It’s a big market, but why do you think there was a business opportunity that you could attack?

Dan: It was a little bit strange because we didn’t really understand why no one had gone in there in a big way until we did. So just to give a bit of context, there’s more than a trillion dollars of student debt in the U.S. today which makes it the second largest amount of debt, second only to mortgages. So it’s more than credit card debt, more than auto loan debt. But despite the size of the market, there are very few options for consumers. And about 90 percent of the loans are made by the government at very standard rates. And depending on when you go to school, which years you went to school and depending on whether you are an undergraduate or a graduate, those loans can be very expensive. So we were surrounded at Stanford by people paying seven and eight percent for their loans. And these were credit worthy people that we knew would be getting jobs and were very confident they would pay those loans back. So that’s the market we chose to go after.

We didn’t really understand why no one had tried it before. I mean it is a government dominated industry, so there are some barriers there, perhaps. It was a little bit difficult for the banks to play in that space for a variety of reasons but it was a little bit strange that no one had done it before so it was almost too good to be true. But we saw no reason why we shouldn’t do it, and that’s why we went for it.

Martin: And why did the banks not go in there and offer other risk adjusted interest rates?

Dan: It’s a little bit confusing because many of banks in the past had worked for the government. So the banks would make loans, but they’d be backed by the government, so there was an implicit guarantee there. And that, and a few other things, kind of muddied the water and just meant that they were an industry that they had retracted from. So post financial crisis 2008, there were some banks that were in this space, but they came back from it. And they attracted.

So maybe we were a little bit lucky or fortunate. I don’t know if those are the right words. But certainly, in terms of the timing, the banks weren’t seeking, really, to go into new lines of business. They were pulling back and concentrating on compliance and regulatory issues that were their main concern at that time. So I think they created that gap for us.

Martin: Great. So after you have generated this kind of two million of credit transactions, what was the next step? Did you directly, after this kind of traction raise money in order to scale?

Dan: Yes.

Martin: Or did you just try to bootstrap?

Dan: No, we raised money for the company after that. So through that process of lending to those students, and raising money on the other side, we showed two things- one we showed that we could lend money. We had to get a lending license, and we had to set up a website, and we had to have arrangements with a servicer. You know, all those mechanics that go into that. So we proved that, albeit at a small level, but we proved that we could do it. And on the other side, we proved that we could convince people that this was a worthy investment. And they would trust two things- us as a company to handle their money, but secondly the quality of the loans they were funding, the quality of the people they were lending their money to. So both of those things we proved out, again, at a very early stage. So on the back of that we raised money for the company.

So this would be, really, five months into the company’s existence. We raised a seed round / an A round, I never quite know where the distinction is, but it was a four million dollar round. And that then gave us the ability to go and start hiring people and start being a bit more aggressive in our growth and our growth ambitions.

Martin: Dan, today you have a product portfolio. Can you elaborate a little bit on that and what kind of customers you’re targeting with it?

Dan: Sure. So since those early days, we expanded the schools in which we would lend to. And we then expanded to lend to people who had graduated from school. They maybe two or three years out, but they want to refinance their student debt. So that was the bulk of our business for the first three years of our existence. And then we expanded, as you say, to other products.

So we then started to offer mortgage products. But mortgage products that are different to what the market is offering. So many things, but one of them is we that we only require a 10 percent down payment with no mortgage insurance. So something that is very different in the market.

Also personal loans so many of people are using these for one off purchases or maybe to refinance very expensive credit card debt.

And we’re seeing great take home from both of those new products, as well as our existing student loan business. So now, three or four and a half years into the company, we have three very large loan products and we’re seeking to go beyond that as well, beyond just making loans and seeking to help people in other areas of their financial lives.

Martin: Dan, so before you started you had no debt on the books and because you have this marketplace between investors and people who are looking for some kind of financial product. As you expand your product portfolio is this still the case, or are you looking to take mortgages or taking other debt on your books?

Dan: We have a bit of a complex model. It’s like a hybrid model. We actually make all other loans from our own balance sheet and then typically one or two months into that loan, the loans would be bought by an investor. So that doesn’t change the relationship between Sofi and the borrower. Their relationship is still with us. They still owe us the money. If they have a question about how much do I owe this month, they call us. But the economics to that loan are owned by another party. And that’s really a way for us to scale more quickly If we were just using our own balance sheet it then becomes difficult to raise that money. And frankly we wouldn’t be able to keep up with the demand that we see for the loans that we have. So they’re on our balance sheet for a short period of time but, ultimately, the bulk of those loans are sold to other investors.

Martin: And those other investors are those mainly companies like banks, or is this a big bulk of individual investors?

Dan: It’s a variety. There are still individuals there. We have individuals investing their own personal money. But we found, in our early days, that that was difficult to scale to keep up with the demand for loans. So we’ve complemented that money from individuals with money from institutions. And those institutionsare financial institutions primarily – small banks, regional banks, bigger banks, state level banks, along with pension funds and hedge funds, not-for-profits, a variety of places. But the common theme being that they see the value of the loans they are making and wish to invest in that return.

Martin: And how are you credit scoring the people? And making sure that you are earing some kind of a premium before you’re selling off the loans to other parties?

Dan: So we do have a different approach to assessing people’s credit than traditional banks would look at. So we’re much less reliant on your credit score, and actually it doesn’t factor into our decision – your score itself.

So we look more at whether we think that you have enough cash to pay back the loan, which sounds very obvious. But, it isn’t how a lot of the industry works. A lot of the industry is very much looking at your credit score, which may be high or low for many reasons. And we don’t think it’s a very good predictor of somebody’s ability to pay back in the future. It is a predictor, but it’s not the only one. So we look at a variety of things, but ultimately it’s do we think you have enough money at the end of the month to pay back the loan and that would depend on a variety of issues.

But we’ve made over 60,000 loans today and we’ve had only five people default on those loans. Four of them, unfortunately, passed away. We have something in the small print that says if you pass away we can wipe that debt. So it’s extremely low, the default rates, and we’re still early as a company, so we’re not claiming victory just yet but it’s an encouraging start.

Martin: And how do you acquire the students, for example, for the student loans?

Dan: So most of our loans now, in the student loan area, are refinancing student loans. So they aren’t necessarily students. They are graduates and they are now working for well-known companies and lesser known companies, big and small, around the country. So these are people who typically are a few years out of school, whether an undergraduate program or a graduate program. And we find them in a variety of ways, but word of mouth is a key thing. Around 50 percent of our customers heard about us from a friend. So I think that shows the quality of the product. You’re not going to tell your friend about something that was a bad experience. So we’ve worked very hard to make sure that the application experience and the simplicity and the customer care, etc., etc., are very good.

Then combined with the savings, our customers are saving on average $14,000 when they refinance with us. That service combined with the product itself is a very compelling mix. And that really has led to huge word of mouth that is driving a lot of our growth.

Then, obviously, we supplement that with different forms of marketing – online and offline. And then we have, also many partnerships with big and small employers around the country. So we help to offer our produces to their employees as an employee benefit. And that’s proven to be very beneficial for all parties.

Martin: At what point in time did you start to get institutional investors, and how did you convince them in the first place that your loan portfolio is worth buying?

Dan: Yes. A great question because at the very beginning of the company we would tell people what we were up and we would say: “These are the kinds of people that we are lending money to.” And many people would nod their heads and say: “Yes, they sound like a great investment.” And then you would say: “Okay, well, can we have some money please?” And they would say: “Well, why don’t you come back in a year, you know, after you’ve proven that these people can pay back their money?”

So although we’re relatively young, and it’s four and a half years, it was still a gradual process. So you would have to take small bite sized chunks at the beginning, the real early adopters, the people who were willing to maybe go on their gut instinct a little bit more. But for many of the investors, we had to wait a couple of years until we had that track history. Until we had that repayment history to say: “Okay, we now have X thousand people who have repaid their loans. Now will you invest? Now will you believe what we’re saying?”And it’s a gradual thing.

So we’re at the point now where we have securitized many thousands of our loans and those securitizations are actually rated by the rating agencies. So there’s some third party validation that they have looked at the credit quality. So every time we do that, the rating gets slightly better, the amount of money that it costs us, basically, to pay that investor goes down and we can then feed that lower cost of capital to our customers, to our borrowers, in the form of cheaper loans for them.

Martin: Did you try to find some kind of banks orinstitutional investors or equity investors, for example, in your company with the argument: “Guys, I will offer you an investment opportunity, which is an option to having with access to our strongly growing loan portfolio.”

Dan: So we did a bit of that. We’ve done a bit of that. We also at the very beginning, many people, when we were going after individuals, many individuals were interested in investing in the loans, but in most cases that is a single digit return. And they were more interested in the opportunity to invest in the company because they like the idea of what we were doing and thought that it could grow into a decent sized company. So we had lots of people that said: “I don’t really want to invest in the loans. I’d like to invest in the company.” So at the beginning we kind of mixed the two, and said: “Well you can’t invest in the company unless you invest in the loans.” And that was one of the ways that we got people to commit capital to the loans and enable us to start making loans. Because, obviously, equity capital on its own would not be very useful to us. So there was a bit of a trade off there that our early investors were willing to go along with, because they believed in what we were doing as a company.

Martin: And did you only try to raise equity, or did you also think about venture debt?

Dan: We just raised equity, and we discussed venture debt. But I think we preferred a kind of cleaner model. So it was equity all the way. Every round that we’ve done has been equity.

Martin: In terms of regional distribution of your customers, is it only U.S. focused or are you also international?

Dan: So as of today it’s just U.S. It’s across the whole of the U.S. It isn’t just a West Coast business, or New York, San Francisco. We have customers in every state, bar one. Because we have a license for each state.

Internationally, we have considered that and we’ve discussed that and I think at some stage in our existence that will happen. It’s not on the table today, at this point in time, just because of the opportunities in the U.S. but at some point in time I think that will happen.

Martin: Right now you are a consumer finance company. Do you think it’s easier to start a consumer finance business than, for example, a corporate finance or, let’s say, a business finance business?

Dan: I don’t know if it’s easier. We sit here in Silicon Valley in San Francisco. There is appetite and acceptance of new types of businesses. So that among the consumers here, and I think in the U.S. at large, there is a large group of people that will give new businesses a try. And I think maybe that’s a little bit different than other countries where they want to see a name that’s been around for 50 or 100 years.

So I think getting new business off the ground is possible here. And with new technology, it’s getting easier to get the word out. This person comes with that, because everybody’s doing that, and it’s so noisy so that sometimes you can’t get heard. But you can, through social media and other places, you can get the message out. And if, again, coming back to the point of people referring their friends, if you can create a product that people like, it easy for them to tell their friends now. There are review sites online. People can put things on Facebook and tell their classmates. Maybe there’s 400 people on this Facebook group and someone will say: “Hey I took out a loan with SoFi and you should check it out.” That didn’t exist before. So I think going into business is more binary. You’ve got big ticket partnerships or deals, but if they don’t happen then maybe you’re in trouble. Whereas with the consumers it’s a bit more gradual.

ADVICE TO ENTREPRENEURS FROM DAN MACKLIN

Martin: Dan, what is your advice to first time entrepreneurs?

Dan: I’ve seen a few people try to start companies out of business school, and I think the idea that you have has to be fundamentally different from what’s there today in the market. Because if it’s only a few percent better than what’s out there today, the chances are you’ll hit an obstacle that will be big enough that you may not get over it. I think to be able to get over those obstacles you have to have an idea that’s almost ten times as good as what the market currently has. Because inevitably you’ll hit those obstacles and you need something that’s big enough that people will think: “It’s worth going for. It’s worth jumping over that wall to get to.” To get financing people need to see something that is very different that what’s out there today, not just something that’s a subtle shift. So I think, having a big idea, and making sure that idea is significantly different from what’s out there today. I mean, that’s easier said than done, butI think that’s the best advice I can give.

Martin: What other type of advice can you share? Some of the learnings, maybe, over the years?

Dan: I think it’s tough in the beginning to get everything right, so you shouldn’t expect to build the perfect product. Or you shouldn’t expect to have the perfect customer experience straight away. Now, of course, you want to get there as quickly as you can. But I think in most businesses, if you wait too long you may have missed your moment or you may run out of money. By trying things, and sometimes not succeeding, you learn. Now, you don’t want to do that all the time, but you can’t wait for it to be perfect.

I think that’s something that I’ve learned since I’ve been here in Silicon Valley, and in the U.S. in general. It’s try lots of stuff and sometimes it will work, and sometimes it won’t, but don’t be afraid to fail. If you can fail small along the way, and learn from that, I think that you can refine and improve your product into something that people really do want.

Martin: Good. Dan, thank you so much for sharing your knowledge.

Dan: Martin, thank you.

Martin: And good luck with SoFi.

Dan: Thank you. Good luck to you.

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