Is OnDeck Capital the Next Generation of Lender or Boiler Room?

Is OnDeck Capital the next generation of lender or boiler room?

Illustration by Steph Davidson

Onstage at a conference in San Francisco in May, Noah Breslow is gliding through a slide presentation on why his company, OnDeck Capital, is going to make bank loan officers as obsolete as travel agents. Dressed in jeans and a blazer, he pulls up an image comparing OnDeck to Amazon, Priceline, and Zillow. “Financial services is being disrupted—full stop,” he says. “Lending is one of the last industries to be transformed.”

Breslow shows a photo of a beaming Brooklyn wine store owner as he explains how banks aren’t lending to good small businesses. His point is that they want to borrow so little—say, $20,000 to make payroll—it’s not worth the banks’ effort to perform their expensive due diligence.

OnDeck’s software, Breslow tells the audience, gives potential borrowers an “OnDeck Score,” a proprietary assessment of creditworthiness that pulls in more and better data than banks do. The startup’s technology analyzes thousands of variables—from cash flow metrics to clues from social networks—and spits out a loan verdict in hours, not weeks. Algorithms replace loan officers, entrepreneurs get the money they need, and everyone is happy. “We set out to create a different kind of score,” Breslow says. “And a billion dollars of loans later, we think we’ve done it.”

OnDeck’s Big Data pitch has investors panting. The lender has raised $180 million in capital from elite investors, including Google Ventures and Peter Thiel. Goldman Sachs and others have given OnDeck more than $300 million to make more loans. Its New York headquarters has all the trappings of a hot startup, with weekly happy hours, a game room with foosball and Pac-Man, and team-building scavenger hunts. Now the company plans to go public; on Nov. 10 it filed a prospectus for an initial public offering. Morgan Stanley, JPMorgan Chase, and Deutsche Bank, among others, are underwriting the share sale, which could happen by the end of the year and value OnDeck at around $1.5 billion, according to a person who’s familiar with the underwriters’ internal estimate but isn’t authorized to release that information.

Despite Breslow’s talk of tech disruption, algorithms alone don’t explain OnDeck’s growth. Rather than disrupting bank lending, it’s more accurate to say that OnDeck is part of an industry known as “merchant cash advance”—essentially payday lending for businesses. It’s a high-risk market, and interest rates can exceed 500 percent a year, or 50 to 100 times higher than a bank’s. (OnDeck’s rates average 54 percent, according to a document it sent to investors in the spring.) To fuel its rapid growth, OnDeck has worked with independent brokerages, which at one point found takers for nearly 9 of every 10 dollars the startup lent. It’s the equivalent of Priceline getting old-fashioned travel agents to enter orders into its website.

If Google Ventures and Goldman Sachs represent the prestigious end of OnDeck’s dealings, then merchant cash advance brokers are at the other extreme. The field is rife with unsavory brokerages, staffed by many of the same people who pushed subprime mortgages a decade ago and worked the bottom rung of the stock market in the boiler rooms of the 1990s. One of them is Mario Figueroa, president of Chadwick Cashflow Advances, a brokerage in Saddle Brook, N.J. He got into high-interest small business loans in 2011, shortly after doing time in a Newark halfway house for stock fraud.

OnDeck hired his brokerage to market its loans a few years ago, Figueroa says. Near his office in October, over a lunch of pizza, calamari, and tequila shots, his brand-new BMW 6 Series parked outside, he describes how an OnDeck representative offered to pay thousands of dollars for every borrower he brought in. He could hardly believe it was legal to charge such high rates, until he learned that most states’ usury laws don’t apply to business loans. His salesmen, who spend their days cold-calling businesses to offer easy money, are a colorful lot. The list of Figueroa’s past and present employees includes a former hedge fund manager convicted of stock fraud and a recovering heroin addict on probation for a motel stickup gone bad. One new hire stopped coming to work after he robbed a bank. “I saw an opportunity here,” Figueroa says of working with OnDeck. “The banking world is not using the cheap money the government is giving them to fund small businesses. Thank God we exist.”

OnDeck has teamed up with brokers convicted of stock scams, insider trading, embezzlement, gambling, and dealing ecstasy, according to interviews with the brokers and court records. Brokers have brought $349 million of loans to OnDeck so far this year, already 35 percent more than 2013’s total, according to the prospectus. That represents a risk, the company acknowledges in the filing: If partners “mislead loan applicants or are engaged in disreputable behavior, our reputation may be harmed, and we may face liability.”

Breslow declined to be interviewed for this article. “The reality is that brokers represent a small and diminishing percentage of our overall business,” says Jonathan Cutler, an OnDeck spokesman. The company has been weaning itself off the network in the runup to its IPO, bringing in more borrowers with ads on Google and TV. But brokers still accounted for 39 percent of the total value of loans in the third quarter, and they’ll be difficult to break up with entirely. They’re ruthlessly effective at signing up customers, and to justify its potential $1.5 billion valuation, OnDeck needs to keep growing exponentially.
OnDeck was launched in 2007 by Mitch Jacobs, a serial entrepreneur in the field of digital transactions. As a junior at Dartmouth in 1993, Jacobs started and eventually sold a company that let students pay with their IDs at local stores.

At OnDeck, his first hire was Breslow. Born in Brookline, Mass., Breslow studied computer science at MIT and worked for a Bill Gates-backed satellite broadband startup before getting his MBA at Harvard. “I met with tons and tons of people, but Noah was just a startup athlete who stood out,” Jacobs told Forbes in 2013.

In the beginning, Jacobs told investors and reporters that OnDeck wanted to undercut the sprawling, shadowy merchant cash advance industry. In a May 2008 press release, OnDeck referred reproachfully to such lenders, who “charge excessive percentage rates for short term capital.”

Small businesses like pizzerias and florists know all about merchant cash advance; they get bombarded with cold calls and spam faxes from brokers. The rates are insane, but often there’s no alternative. Cheaper loans backed by the Small Business Administration are tough to get and can take months to close. Entrepreneurs have often maxed out their credit cards and other debt, yet they’re unwilling to throw in the towel.

Although OnDeck pushed loans costing double or triple the rate of a credit card, they were still more affordable than most cash advances. When the financial crisis hit in 2008, OnDeck had barely gotten going. That was lucky. The hottest small business lender at the time, a credit card issuer called Advanta, failed in 2010 after more than half of its loans went bad. Before long, though, the credit collapse turned out to be good for OnDeck. Banks made it even harder for businesses to get loans, especially small ones, pushing them toward high-cost alternatives.

As OnDeck began to grow, Jacobs found it easier to work with the merchant cash advance industry than against it. In 2010, 88 percent of its loans came through brokerages. “We have a relatively small and focused group of entrepreneurs more successfully tackling a problem that all the resources of the U.S. government and financial system have been stumbling trying to solve,” Jacobs told Bloomberg Businessweek in September 2010.

During the recovery, with central banks around the world cutting interest rates to near zero, investing in high-interest loans made by OnDeck started to look like a sweet deal to Wall Street. By August 2011 the startup had raised $19 million in a venture round, its third; the following year, Goldman Sachs and Fortress Investment Group gave it $80 million of debt financing to extend more loans. OnDeck’s rivals were on a roll, too. The biggest, CAN Capital, founded in 1998, gained Silicon Valley cred in 2012 when Accel Partners put in $30 million.

That’s also around when Jacobs and Breslow split. Jacobs left OnDeck in early 2012 to work with nonprofit microlenders, he said at a conference that year. In an e-mailed statement, Jacobs says: “Though I am now fully engaged in my next startup, I remain a significant shareholder in OnDeck because I know OnDeck is methodically developing the technology and the credit knowledge required to serve the small commercial loan segment of the U.S. economy at scale without subsidy.”

After Breslow became CEO, OnDeck stopped bashing cash advance brokers, says Sean Murray. A former broker, Murray now runs the DailyFunder, a website tracking the merchant cash advance industry. “I really hated OnDeck because they wanted my clients on one end, and they would tell my clients on the other end that I was evil,” he says. “Once Noah came in, that whole weird dynamic ended.”

Breslow started negotiations to sell the company to, a London payday loan startup whose offices have drawn protesters holding signs calling them “Loan Sharks.” But the deal would have valued OnDeck at less than $250 million, and Breslow and his investors balked at the price, Bloomberg News reported early in 2013. He went back for $59 million in venture capital instead and added Google Ventures and Thiel to his growing roster of investors. “We invested in OnDeck because we believe in the team’s game-changing vision, strong talent, and disruptive technology,” Karim Faris, general partner at Google Ventures, said in a statement at the time. He was named an observer to the OnDeck board, whose members include James Robinson III, the former chairman of American Express.

It’s hard to square such gilded backing with the company OnDeck kept. One brokerage OnDeck teamed up with, Yellowstone Capital, sits above an Irish bar in Lower Manhattan. Yellowstone’s co-founder, David Glass, helped inspire the 2000 movie Boiler Room and later pleaded guilty to insider trading and wore a wire to avoid prison. (Glass says he stepped away from the business and is a minority shareholder. Cutler, OnDeck’s spokesman, says the company ended its relationship with Yellowstone earlier this year.)

The vibe at the company holiday party last December recalled scenes from a more recent film, The Wolf of Wall Street. In a YouTube video that has recently been taken down, a representative from OnDeck, introduced as Noel, struggles to be heard over the drunken brokers jammed around a pool table. He’s trying to pump up the crowd to sell more loans to small businesses. “All I gotta say is, right now, everybody in this room has the opportunity to make more money than they ever did,” Noel says. “We love all you bastards!”
The ideal OnDeck customer is someone like Jack Metcalf, who owns a ceiling-fan store in Apple Valley, Minn. Metcalf is on his sixth loan from OnDeck. They get him through the winter months when people tend not to buy fans. He says banks wouldn’t give a bridge loan like that to a relatively new business, even one that’s doing well. “The rates, they’re high, no doubt about it,” Metcalf says. “But at the same time, banks really weren’t a very good option.”

OnDeck pays a commission to brokers who bring borrowers to their platform. That generally isn’t disclosed to borrowers; instead, brokers say, OnDeck approves a borrower for one rate, then allows the broker to charge another, higher rate and keep the difference. OnDeck limits how much its partners can charge to 12 percent. On a $50,000 loan, that’s $6,000. Some salesmen tack on extra fees, brokers say, despite an OnDeck policy against the practice. (OnDeck says it will cut ties with any broker it discovers doing this.) The whole business is so murky that borrowers sometimes can’t tell whom they’re borrowing from, or what they’ll end up paying.

Jessica Prinz owned a delivery service with five drivers in Glendale, Ariz. In June 2013, desperate to make the next lease payments on her trucks, she called the number on an unsolicited fax she’d received, offering fast money. “There’s nowhere else to turn,” Prinz, 33, says. “They’re sketchy, but that’s all you have.”

Prinz doesn’t remember many details—not the name of the broker or the name of the lender or even how many loans she took. She signed up for at least two. The first, dated June 12, 2013, was a two-and-a-half-month $10,000 loan from Yellowstone that carried an effective annualized interest rate of more than 500 percent. Two days later, she took out $30,000 from OnDeck to be paid back over six months. That loan had an effective rate—including interest, a $2,520 guarantee fee, a $750 origination fee, a $500 OnDeck platform fee, and a $387 servicing fee—of around 110 percent. A month and a half later, Prinz sought bankruptcy protection. “It’s the worst possible decision you can ever make, because they own you,” she says. “It’s crack for a business. You can’t get off of it.”

Ken Larivee was behind on the bills at his paint and decorating business in Pinellas Park, Fla., started by his father in 1976, when an account executive with A First Funding stopped by unannounced one day last year. The broker told Larivee he could get cash by the end of the week at an interest rate of less than 20 percent.

The loan the broker actually got him, for $55,000, came from OnDeck, according to a loan agreement Larivee provided, one that lists a total repayment amount of $75,350 in 252 daily installments. Larivee says the broker led him to believe that he could renegotiate the interest rate once he’d paid back half the loan. He never heard from the guy again. The weight of the payments drove Larivee to file for bankruptcy in May, after he’d repaid about $26,000. “It sounded like it was too good to be true—and it was,” Larivee says.

“Business owners recognize that brokers are compensated for their value-added services by lenders in the same way that brokers are compensated for other products small-business owners purchase, such as small-business insurance or health care,” says Cutler. As for vetting brokers, OnDeck says it uses background checks, telephone screening, and other methods. But brokers with alarming backgrounds have still found ways to work with the company. Bryan Herman, who was convicted of securities fraud—and was a protégé of Jordan Belfort, the actual Wolf of Wall Street—is now a salesman at a brokerage in Midtown Manhattan that works with OnDeck. Another broker, Joe Ferragamo, appeared on the reality show Mob Wives after he went to prison for his role in a mafia-tied stock scam. “I’m recently off parole, so I’m able to take a more active role in trying to bring this company into the forefront,” says Ferragamo, who’s a managing director at a Staten Island loan shop that says it originates hundreds of thousands of dollars a month in deals for OnDeck.

Ron Ferlisi, who was sentenced to 33 months in prison in 2001 for selling fake stocks, runs a brokerage called Merchant Advance Express that sells loans for OnDeck and others. He says Breslow’s company has become easier to work with and is approving more businesses for loans. “They’re getting very aggressive to get money on the street,” Ferlisi says from his office in Uniondale, N.Y., over the rumble of dozens of brokers. “I have a great relationship with them.”

He got into business lending after prosecutors had him barred from real estate in 2007. “He paid his debt to society,” says Ferlisi’s lawyer, Lindsey Rohan. “You couldn’t expect all the people who were in that culture to turn around and become culinary chefs.”

Breslow spoke briefly with a reporter after appearing on Bloomberg TV in May and was asked about unscrupulous middlemen. “We audit the brokers through the customer feedback,” he said. “We look into that data really closely. We terminate brokers all the time. I think cleaning up this industry will be a good thing—we think this will be a totally mainstream solution in the next three years.

“We’ve created $3.4 billion in economic output; we’ve created jobs,” Breslow added. “You can’t make someone take a loan if they don’t need a loan. That’s not what we do.”
Even with ample funding from Wall Street and Silicon Valley and the high rates it charges borrowers, OnDeck has mostly lost money. After losing $24 million in 2013 and dropping an additional $15 million in the first half of this year, the company made $354,000 in the third quarter, according to the IPO prospectus. One reason it’s been so hard to make money may be that the commissions the company has been paying brokers are adding up. OnDeck needs to show investors it can get money out the door quickly while keeping costs down. “The fastest way to get enormous amounts of loans is to overpay brokers for them,” says Brendan Ross, president of Direct Lending Investments, an $89 million business loan fund in Los Angeles. Ross says his hedge fund will not invest in OnDeck.

“We want to be the Apple of this industry,” Breslow said at the conference in May. “Completely vertically integrated—the origination, the servicing, the data aggregation, and the credit scoring all in a single company.” To that end, OnDeck is spending on direct marketing and TV commercials.

James Giannino, a broker who works with Ferragamo, of the Mob Wives cameo, says OnDeck is starting to contact customers directly to renew paid-off loans. The rejection stings. “To really cut us out and to say we’re no longer going to go in that direction,” he says, “is a little surprising, almost hurtful.”