Startup Snapshot: The Difficulties of Breaking Into a Highly Regulated Industry

Randall Smith reported in today’s New York Times that, “On a warm morning early last year, a start-up founder named Matt Burton addressed a group of 175 investors and executives at the sleek glass IAC building in Chelsea.

“Mr. Burton described how his company, Orchard Platform, already a provider of loan data to financial institutions, would soon unveil its own trading platform for loans.

It had all the earmarks of a successful plan. Mr. Burton and the other Orchard founders had worked at an online ad exchange called Admeld, sold to Google for $400 million. Venture capital firms and Wall Street heavyweights including John Mack and Vikram Pandit had invested in Orchard. And Lending Club, the leading start-up offering online loans, had not yet been engulfed in scandal.”

The Times article noted that, “More than a year after Mr. Burton revealed his big plans, Orchard has completed just a scattering of transactions. Over that time, it burned through more than $5 million in legal fees and other expenses. A regulatory snarl over whether the loans would be treated as securities caused delays. Major lending platforms were reluctant to participate. And the market for loans was thrust into upheaval by a wave of defaults and a scandal that broke last May at Lending Club.

“Next month, hoping to add momentum, Orchard plans to unveil a scaled-back version of the platform, eight months later than first planned.

“But regardless of the company’s fate, its struggles thus far reveal just how hard it can be for a new entrant — even one with successful founders, a promising service and big-name investors — to break into a highly regulated industry.”

Mr. Smith pointed out that, “When Orchard was founded in 2013, marketplace lending was just taking off. Unlike banks — which take deposits, make loans and hold capital to absorb loan losses — marketplace lenders match investors and borrowers directly, with the investors taking the risk of losses in exchange for higher interest rates.

Orchard began by offering institutional investors an automated service to analyze the loans and buy them from different online lenders. But its long-term plan always included creation of what Mr. Burton calls a ‘many-to-many’ trading platform.”

Today’s article stated that, “But building an auction-style exchange for loans proved to be significantly more complex than building a marketplace for online ads.

“As Matt Harris, a start-up investor at Bain Capital Ventures, put it, ‘Building a trading venue and attracting liquidity is somewhere between difficult and impossible.’ He still believes Orchard can get there eventually.”

Mr. Smith added that, “Standardizing data was daunting because each loan platform had its own legal and data formats, such as different definitions of debt-to-income, said Ram Ahluwalia, chief executive of PeerIQ, which tracks alternative lending…[and]…in July, S.E.C. officials told Orchard that they would consider loans being traded as securities, potentially imposing a tougher level of oversight. That made some lenders nervous about participating. Some lenders were also concerned about exposing investors they had cultivated to loans from competitors.”

“As it moves forward, Orchard has played down the regulatory issue, proceeding without an explicit formal S.E.C. ruling on whether the loans are securities. It is a potentially risky move, but one the company believes will work in part because it has dropped its goal of legal standardization, cutting the need for lending platforms to agree on regulation issues. The S.E.C. declined to comment,” the Times article said.

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