How To Start A Lending Company 101 — 10 Questions I Frequently Get Asked, Answered

I often get my ‘brain picked’ on how to start a lending company. Lending can be a very profitable business and buy-now-pay-later is very hot now; so I get it. Sometimes, people ask me about how to start and run a lending company because they want to start the business, sometimes they are just curious. In this write up, I will try to answer in sufficient details 10 questions I get asked often.

How do you get money to lend?

Well there are a number of places you can get money to lend; HNIs, commercial banks, loan houses, family offices, micro finance banks, wealth managers, insurance companies, pension houses, businesses with heavy cash flow, crypto companies and DAOs, betting companies, just think up anyone who might have spare change; they are a good enough candidate.

Raising debt is almost like raising equity. Sometimes a virtual call and shaking hands over some drinks will make it work. Other times, months of back and forth, ghosting, data rooms, stringing along, pitching and due diligence will get you what you want and there are those that lie in between.

It’s also important to know that your company’s activities, traction and size will determine how much you can raise and who you can raise from. I’ll always advise that you first go after HNIs, the way you might first go after Angel investors. You might not get as much money, but time to close is shorter and you’ll be able to build traction while raising from other institutional sources.

There are also different types of contracts you could get — onlending, credit lines, termed loans and venture debt. Whatever you do, try to; avoid paying interest on money you wouldn’t lend, optimize for flexibility and get a good per annum or annualized interest.

Who bears the risk of default?

It depends. You can choose a model where you are ‘buying and selling loans’ or you can choose a model where you are ‘buying and selling users’. In the former, you broker loans from financiers to fit your customer demography. You disburse it at your discretion and bear the risk. The upside is you can make a lot of money and you can build your product your way. In the later, you build a pipeline of customers within the bounds of what your financiers have stated and then upsell them to these financiers. They do a second rating and disburse at their discretion. you can provide support in recovery but are not responsible for loss. You make a slice of the pie. The downside is that you are not as flexible with product offering and your financiers can prove to be unnecessarily difficult; say for instance, disbursing after 3 months of approval. Like my mum will say “suffer plenty, na select them they select am”. Whatever you choose, it has its headaches; choose your headache.

How do you know someone will pay back?

Well this is the reason why eligibility criteria, underwriting and credit scores exist. If your friend came to ask you to borrow them some money, what do you consider before you agree or not to lend them? I’ll bet that you’ll try to size how much they currently earn , consider their current financial state, their potential for future income, how they acted when their brother lent them some money, if they are currently owing anyone else money, their financial responsibilities, if you’ve lent them money before and how long it took to pay back, and many other factors. You will think of these things unconsciously or at the least, you’ll remember the reasons why they might not be able to pay. This is basically the same way it works at scale but with a lot more sophistication and more aim at accuracy.

My best advice is that you should have a few lending thesis. Have multiple thesis and prove them, if they hold true, scale; if they are insignificant or wrong, retract.

How do you determine interest rates?

Determining interest rate is mathematics really.

Cost of capital + estimated NPL rate + inflation buffer (not rate) + profit.

These are good things to consider in what your interest rate should be. You can add other factors that will affect you running into a loss or not. The best part about a lending business is you don’t have to lose money if you do it right.

Do you raise debt in dollar?

For a country like Nigeria where we are never really sure of the stability of fx supply and rates, it can be tricky to want to get debt in dollars. However, dollar debts typically have way lesser interest rates, much higher amounts and much more longer periods of time. If you figure a way around managing fx, then you should get debt in dollars.

What happens if the beneficiary doesn’t pay back?

You should think about this before giving them money, not after. Setting measures in place for recovery is essential and shouldn’t involve printing obituaries. Haha. Collaterals are the typical first thoughts however collaterals are not that easy to liquidate. Guarantors can be co-conspirators. Shame tactics don’t work. Courts are expensive, don’t have power over individual’s finances, take a lot of time and is not a scalable measure. ‘Trust’ in financial services is not a thing.

The truth is that it is important for you to realize that he who has cash, is king. People will beg and grovel when they need money from you, but will turn to beasts once they have the money — you are now at the mercy of their good judgement. For this reason, it is important to arm yourself with sufficient leverage to use if things go south. It is also important to know you’ll lose some and to learn lessons when you do.

Has Open Banking not made everything easy?

Like many things, it depends on what you are talking about. Has open banking made it easier to access customer financial data with their consent? Yes. Has open banking made it easier to lend and recover? No. What open banking has done is to reduce the friction in getting the data that you’ll use to make those decisions. Without open banking infrastructure, you can still get and verify the data. Some providers claim to have gone ahead to refine the data you need; if only the APIs actually work! Some providers don’t give you sufficient data to create as many thesis as you’d like for underwriting. No open banking infrastructure provides sufficient leverage for debt recovery. As long as it gives too much power to the user, you lose the leverage you need for recovery.

Does BVN and GSI not make recovery easy?

In this case, it depends on what licenses you have. First of all BVN means Bank Verification Number, it is just a verification number for identity. A BVN doesn’t give anyone the ability to know how much is an account and debit it. It can identify who has the number and with more access; what other banks or financial services they are subscribed to but that’s about that. GSI means General Standing Instruction and when a customer consents, it gives the issuing entity the ability to recover money from all registered financial institutions linked to the customers BVN/Identity. However, GSI is currently only granted to Commercial and Micro Finance Banks by the CBN. If you don’t have the sufficient licenses, you best get more creative with recovery plans.

What licenses should I have and who regulates the space?

Disclaimer: This isn’t legal advise. Consult a good lawyer on issues of licenses.

You are regulated by whoever issues you a license. There are five different licenses you can get in order to lend; off the top of my head. What license you get is determined by your activity, model and size.

Money lenders license — you’ll have to get this in every state you are active in. It isn’t expensive and the price varies for different states and different lawyers. You might or might not have to ‘wet palms.’ You’ll typically have to be creative with advertising copy as well.

Cooperative license— well, if you operate like a cooperative, you can get a cooperative license that covers lending. You can get a state or national license depending on your activity.

Financial institution — if you aren’t involved in any activity that involves you managing or safe keeping money for others, this is a good license to get. It covers almost every other financial activity and gives you a better footing than both above.

Microfinance bank license — depending on your region of coverage, you might need to get a Unit(1 or 2), State or National MFB license. Also note that not all MFB licenses allow you receive money for managing or safekeeping. You are also better of buying an existing one than applying for one. It is long and tedious.

Commercial Bank License — this goes without saying.

How do you find customers?

Customers are everywhere.

Bonus question; Does reducing purchasing power not mean there’s a looming default crises?

The simple answer is yes. The personal answer is no. Debt is a liability and it is important that you allocate to your customers the liability they can afford. Customers have a warped sense of how much credit they can afford and sometimes credit companies make this same mistake. A person’s income will not go purely into financing debt. Consider essential expenses, other debts, emergencies and their wants, it will give you a better perspective of how much they can realistically spend on financing a loan without becoming credit dependent and at some point bankrupt.

I’m hoping that these FAQs answered can help someone make sense of starting and building a business that’s based on credit.