Loans Without Bias

Seke Ballard is the founder and CEO of Seattle-based Good Tree Capital, an online platform that raises capital from accredited investors and uses those funds to underwrite small-business loans to vetted, licensed cannabis operators nationwide.

Good Tree Capital’s average loan is $75,000, and its biggest financing so far has been $250,000. The company issued its first loan in 2017 and has since built a portfolio of borrowers in California, Colorado, Massachusetts, Oregon, Washington state and Illinois, where it is particularly active in the social equity space.

 

How does Good Tree Capital do things differently, and how does your business model help affect the changes you want to see in the cannabis industry?

Good Tree Capital’s mission is to reimagine how traditional banks lend money, using more data and less human bias. The current system of underwriting small-business loans—with its heavy reliance on the loan officer—is inefficient and ripe for disruption.

The first issue is cost. Traditional banks employ a network of expensive loan officers working in brick-and-mortar branches to evaluate applicants’ creditworthiness. To preserve profitability in a high-cost environment, banks have created minimum loan thresholds (typically less than $250,000) under which they will not lend. The problem is that 68% of all small business loan applications are under $250,000, which means these applicants are largely overlooked by banks and forced to pursue higher-interest-rate, unsuitable alternatives, such as credit cards.

The second issue is bias. Imagine for a moment that you have two loan applicants with the exact same profile. They have the same credit score, income, outstanding debt and assets—they are essentially identical except for one attribute: race. If one of those applicants is black and the other is white, the black applicant is 2.7 times more likely to be rejected for the loan.

And if the black applicant succeeds in getting the loan, he or she will pay on average 180 basis points  more in interest. This same basic imbalance exists generally between men and women as well.

 

How does your company try to avoid such unequal treatment?

Good Tree Capital’s mission sits at the intersection of these two market inefficiencies, both of which trace their origin to the loan officer. After analyzing over 1.2 million loan records from the Small Business Administration, we built a mathematical model that uses only the financial and operating data about a business to predict, with 98.2% accuracy, whether that business will default on a loan. And unlike a loan officer, our technology can evaluate thousands of loans simultaneously with zero incremental cost. But most important is the fact that we built our algorithm with intentionality, avoiding factors that have no predictive value such as race and gender. Our output is a more equitable distribution of capital with borrowers who more closely reflect the diversity of our society.

 

Why have you chosen cannabis to launch this new way of lending?

Cannabis is the ideal industry to operationalize our model. Banks are sitting on the sidelines while at the same time we’re engaged in a national discussion about access and social equity ownership.

Nationally our default rate is less than 2%, compared to a 17.6% trailing 10-year default rate for SBA-backed loans. Lower default rates result in higher profitability and returns to investors. What’s more, 50% of the Illinois-based cannabis businesses our technology approved for financing are women-owned. With no human intervention, operating on its own, our technology approved as many women-owned businesses as it did men-owned businesses. Nearly
half of our borrowers are minorities, which is a byproduct of our focus on social equity and the degree to which we’ve sought to remove bias from our evaluation process.

 

Is the current capital environment in the cannabis industry affecting your ability to raise money?

Alan Greenspan, the former chairman of the U.S. Federal Reserve, characterized investors’ behavior during the dot-com bubble as “irrational exuberance.” I believe the same thing is happening in cannabis. The lion’s share of invested capital is in equity, financing the operations of many multistate operators (MSOs), but if you look at the top cannabis exchange traded funds (ETFs) in 2019, they are all down—some by as much as 55%. The performance of these ETFs underlines an ominous reality, namely that the billion-dollar M&A headlines and a growth-at-all-cost mentality are destroying shareholder value with no end in sight. Several MSOs have not yet cracked the code on how to make money today, and it doesn’t appear those same companies may know how to do so in the future.

And if you don’t make money, you’re not a business. You’re a nonprofit parading as a business. Smart investors understand this dynamic and are looking at better options to earn returns in cannabis.

 

This interview has been edited for length and clarity.

 

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