Growing with Kabbage: Lender Gives Online Businesses a Break

For the past 11 years, Jenny McMillan of Newark, Del., has been running McMillan Books, an online bookstore that primarily stocks used books, CDs and DVDs.

What began for McMillan as an eBay hobby in 2001 became a business by 2005, and she left a full-time marketing job to purvey goods with her husband on Amazon and BarnesandNoble.com, in addition to eBay.

It's a healthy operation, but the nature of the business has often presented the McMillans with sudden chances to purchase rare items and antiquarian books -- opportunities that, due to the outlay required, they typically couldn't afford.

"Without the ready cash, we were not always able to take advantage of these opportunities," McMillan said.

Last year, they decided it was time to find a way to solve that problem, and get access to the capital they needed to help McMillan Books grow.

Enter Kabbage, an online financing company based in Atlanta that provides cash advances to help businesses expand. Focused on online vendors like the McMillans, Kabbage's lending criteria judge businesses on based Web-oriented benchmarks.

It's a sensible lending niche, in an era when traditional loans are increasingly hard to come by from banks.

"In a healthy, competitive financial system, new forms of credit allocating institutions arise to finance promising business when existing financial institutions do not perform this task well," said professor Ross Levine, the Willis H. Booth Chair in Banking and Finance at Berkeley's Haas School of Business.

Both The JOBS Act -- which aims to foster start-ups by allowing businesses engaged in private offerings to publicly solicit funding -- and the rise of peer-to-peer lenders like LendingTree and Prosper cater to a broad swath of entrepreneurs. For small online businesses, Kabbage is an alternative.

Entering The Kabbage Patch at Top Speed

Since its 2009 founding, Kabbage has provided some 30,000 advances ranging from $500 to $40,000 for small businesses to buy inventory, add personnel and purchase equipment.

The lender doesn't charge interest per se, but instead charges fees of between 2% and 7% of the advance if a business repays the funds in 30 days or less. For funds kept between one and six months (the maximum duration of a Kabbage loan), borrowers will pay between 10% and 18%, depending on their risk profile.

"We had this theory that we had to get good solid data to keep track of with the business," said Kabbage CEO Rob Frohwein. "They give us authorization from their eBay or Amazon account, and we take a snapshot, and then go back on a regular basis."

Think of it as lending 2.0: Kabbage doesn't assess a borrower by credit score alone. Instead, the company's algorithms analyze data such as the company's transaction history, user feedback ratings, and even online game play and social-media participation -- with a company's Twitter activity counting as a factor in what it calls the Social Klimbing scale, which tabulates the "Kabbage Skore" to determine how much funding a given business can receive and at what rate.

The biggest competitive advantage of this vetting system is the speed. "You're not going through a lot of people, paper, faxes instead of waiting eight weeks later," said Frohwein. The Kabbage algorithm serves "to leverage unique data sources and do it fast," he says, "without a lot of BS."

That nimbleness made all the difference for McMillan.

"We received the money fast and did not have to go through the traditional loan process which can be challenging for a small business," McMillan said. "With the traditional model of obtaining a loan, the small business owner goes to the bank, fills out enormous amounts of paperwork and attempts to explain to a loan officer the nature of an online business."

With Kabbage, the road to a loan was much smoother.

"I did not have to explain or justify what we do," she said. "They simply looked at our documented sales history."

The McMillans received their loan within minutes. With this new capital and ability to snap up upon available inventory, their annual sales nearly doubled last year.

Liquid Funding When It's Dried Up Elsewhere

Mitch Rezman runs Windy City Parrot, a Chicago-based pet supply shop that has been selling food and accessories for exotic birds online since 2002. He had pursued funding to expand over the past few years through traditional methods.

For example, Rezman spent several weeks in the application process with the Duman Center, a subcontractor of the state of Illinois with a mission to provide loans to small businesses. He submitted more than 100 pages of documents, including a detailed, 29-page business plan that he rewrote many times under the guidance of an appointed Duman mentor.

"At the end of the day, we were denied, because they felt that even though we paid our bills on time our margins were too slim," Rezman said. "Either you're competitive or you're dropping fries at McDonalds."

In the past 18 months, Rezman also unsuccessfully applied for two small business loans with Chase -- one as a direct loan, and one in Chase's capacity as an agent of the SBA.

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But bank loans are hard to come by these days -- neither panned out.

A couple of months ago, having struck out with conventional lenders, Rezman tried Kabbage.

"I went to the website, answered maybe six questions," he said, "And literally in under 10 minutes, I was funded with $4,600 and given an $18,800 spending cap based upon payback history."

Given that one-third of his website's revenue flows into his bank account through PayPal, the metrics were readily attainable in Kabbage's glance at the company.

The repayment time line is pretty tight, Rezman said -- but for small businesses with inconsistent cash flow, paying via PayPal simplifies the process and gives him a 1% monthly rebate: Rezman, for example, owes about $1,000 each month and can pay $100 every second or third day to make the payback process painless.

Pricing the Risk

"Kabbage is providing funding to apparently riskier firms and is charging a comparatively high interest rate," said professor Levine. "Whether the rate is so high that Kabbage generates huge profits or whether the delinquency rates on the loans are so high that Kabbage does not earn positive returns is something that will only be revealed over time."

That said, Kabbage fee percentages are in the manageable single digits for advances paid within 30 days. Rezman, for his part, pays a 5% fee on each advance.

"Between the ease of payback, ease of funding and affordable interest, this nugget turned out to be a Krugerrand," Rezman said.

Before he found Kabbage, Rezman had to purchase his bird food and supplies from distributors who charged 20% to 30% more than he would pay for bulk orders directly from vendors.

But being able to place $3,000 orders with one vendor gave him access to the wholesale prices that distributors pay. This allowed him to lower his retail prices on those products by about 10% to 12%, while increasing his profit margins by 10%. Just last week, Kabbage made another $5,200 available, half of which Rezman took immediately.

And as Rezman grows his business with the additional capital on hand, he is having the last laugh.

"Apparently, the underwriters at Chase, under Jamie Dimon's direction, felt investing in derivatives was safer than investing in small businesses located amongst their many Chicago branches," Rezman said. "Well, Chase lost $7 billion and I'm still here paying my bills -- to Kabbage -- on time. We can file this under 'karma.'"