Cutting Corners

Don't cut corners when performing due diligence.

If cutting corners in business is bad, cutting corners when your business is selling sketchy loans means disaster as Lending Club CEO Renaud Laplanche just found out.  The stock is down huge today and the CEO resigned in light of news that Lending Club didn’t deliver what it had promised to one of its clients.  This was one of my fears when we were pitched several different peer-to-peer lending schemes.

Lending Club bundled together loans and sold them to investors.  Investors had very little ability to do true due diligence on the bundles and it looks like it tempted LC to stretch the truth on what it was peddling in one case.

This example ticks several due diligence boxes for me.  We like to see 3-5 years of live performance for a reason.  Brand new companies or management teams need time to understand the reality of their investment environment, regardless of what their backtested data tells them.  This environment isn’t just sourcing, securitizing, and selling loans, but logistics and compliance as well.  This is a big problem in the hedge fund world.  Many funds fail not because their strategy sucked, but because they didn’t know how to run the business side of the hedge fund (making payroll, keeping the lights on, leasing office space, etc).  This is incredibly difficult to do due diligence on for investors.  In most cases, it doesn’t make sense to allocate time and resources to do the research when there are more transparent means of obtaining exposure to a similar asset class.

This is another reminder not to blindly dive into aspirational investments – investments that signal an investor’s wealth rather than build it.  In less than six months, peer-to-peer lending went from something to humble-brag about at the country club to an unfortunate mistake not to be mentioned in public.