Virgin Money Social Lending – a New Revolution in the Debt Markets

First, I would never loan money to friends or family (with only a handful of exceptions*, one of which is my parents) under any circumstances. To me, money isn’t important – I just want to build and create like a little kid with a Lego set or a real-life version of Sim City. Other people, it seems, have this really big emotional investment in it. If I lend money, it takes away the chips I can use to build my playground. I’m going to want it back, even if I don’t need it, because it becomes about integrity. If someone were to not repay a loan, I wouldn’t be able to be around them because I would always think, “They don’t value our relationship enough to keep a promise.” Thus, it’s better to avoid the mess altogether.

To be perfectly honest, a big part of it has to do with the fact that I can earn better returns elsewhere and I would feel like an idiot loaning money at 10% if I know I can get 20% on some project Aaron and I are doing over on the side.  I mean, I try above all else to be rational.  Allocating capital to low returning investment such as debt isn’t prudent given my age and opportunity cost.

Virgin Money Social Lending Revolutionizes the Debt Markets

Virgin Money, however, has created a unique product that I find intriguing. You pay them a small fee of a few hundred dollars and they will structure a loan between you and a family member or friend. They service the loan, so that the borrower sends all of the payments into Virgin Money, who then tracks the loan balance, interest costs, sends statements, and forwards the money to you in the form of direct deposit. If the borrower doesn’t repay the loan, or is late, that gets reported to the credit bureaus just like any other debt and it could destroy their credit score and/or force them into bankruptcy.

In effect, Virgin Money is creating a social lending institution that stands between borrower and seller so that neither has to get emotional. If payment is made, Virgin is going to take care of it. They get a fee for this. The borrower has his or her credit destroyed. It’s a marvelous innovation that could make lending more palpable for those who otherwise wouldn’t open their pocketbooks for friends or family.

An Interesting Double Standard

There is an interesting double standard to which  I must confess because if one of my older relatives needed money and couldn’t live off the interest rate they were earning at the bank on their certificates of deposit, I would consider issuing privately placed bonds to them at, say, 7% to 8.5%, that allowed them to get far more than they could anywhere else. Technically, that would mean I would be borrowing from a family member (or rather, my businesses would).

My reasoning is this: 1. I don’t need the money, 2. I don’t believe there is any reasonable chance of default, 3. I would simply add the money to our other investments to grow further or keep it on hand as working capital, and 4. I’d feel like I would be doing them a favor.

Likewise, I would think about creating a special type of preferred membership equity share class for my parents or grandparents that wanted dividend income.  It lets them enjoy retirement and I know I can earn an attractive return on capital.

* You may be wondering what the second exception is.  I might do for some of my executives what Warren Buffett did with Ken Chace when he took over Berkshire Hathaway and loaned him $18,000 to buy 1,000 shares of Berkshire Hathaway stock (which now have a market value of nearly $125 million, by the way). If they came to work for me, and wanted to own part of the company once it was publicly traded, I would consider creating a special trust that loaned them money at a predetermined low interest rate to buy shares of my company. If they default, the shares would revert to me and I would have stilled earned some interest income. If they pay the debt off in full, they are a partial owner of the firm. It’s a win-win situation.

Come to think of it, I really like the idea of creating an executive share ownership fund that lends money for stock purchases to employees. Lord knows I’m going to require them to hold a multiple of their base salary in outright share ownership to align interests with the public stockholders so it would make compliance less burdensome.

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