Top fintech VCs explain how PayPal missed a golden opportunity, and why they wouldn't invest in LendingClub today

Paul Sakuma/AP

Peter Thiel and Elon Musk in the early days of PayPal.

• PayPal made a mistake when it moved too slowly to offer financing to consumers who used its platform, according to Jim Robinson, general partner at RRE Ventures.
• Venture capitalists wouldn't invest in certain consumer and small business lending companies, knowing what they know now, according to Matt Harris, managing director at Bain Capital Ventures.
• The two men spoke on a panel with Hans Morris, the chairman of LendingClub and the managing partner at VC firm Nyca Partners at an invite-only event at Morgan Stanley earlier this month.

PayPal is arguably one of the biggest success stories to come out of Silicon Valley in the last 20 years. It launched the careers of Peter Thiel, Elon Musk and Max Levchin and paved the way for other members of the PayPal mafia to make seed investments in a next generation of startups.

But did it make a strategic mistake?

That's one theory based on the current thinking about the alternative lending industry, according to three of the top venture capitalists who invest in financial technology startups.

The investors - Matt Harris of Bain Capital Ventures, RRE Ventures' Jim Robinson and Hans Morris of Nyca Partners - discussed PayPal's missed opportunity at a recent panel hosted by Morgan Stanley at the firm's third annual invite-only Fintech Summit.

It was part of a bigger discussion about how online lending businesses, like OnDeck and LendingClub, have to go out and find customers and how that stacks up against newer firms like Square, the firm started by Twitter founder Jack Dorsey that offers loans to small businesses and consumers.

"OnDeck and LendingClub have scaled, strong businesses now, but you'd never invest in those companies as start-ups today," said Harris. "I don't think you would look at unsecured personal lending or small business lending where you have to go out and acquire customers in the wild, with no special sauce. That's 10-year-old thinking."

A LendingClub spokeswoman declined to comment, deferring to Morris, who also acts as LendingClub's chairman, to offer a statement on behalf of the company. A spokesman for OnDeck said the compay had too much scale for startups to catch up, thanks to a technology platform and a capital base that continues to grow.

"Obviously, there is a right time for VCs to invest and there is a time where it is too late," the OnDeck spokesman said. "The VCs who invested in OnDeck 10 years ago did well."

The current model many VCs advocate is for companies to find ways to offer additional services, like loans, to existing customers. Acquiring new customers can be expensive, and there's a competitive advantage when you underwrite or target new services to existing customers because they know more about them.

That's the "modern thinking," according to Harris. Square "has an unfair advantage both in terms of customer acquisition and information" because they already know what their customers are doing, he said. "That's the future of alternative credit today."

Morris added that investors like himself overlooked the amount of capital startups need when their traditional sources of money, like retail or institutional investors, dry up.

"Financial services markets are massive and ripe for disruption," Morris said in a follow up statement provided Monday. "That said, building a financial services business requires meeting material capital and regulatory requirements which act simultaneously as a barrier to entry for new players and a substantial competitive moat for existing ones."

LendingClub's stock has fallen 77% from its 2014 IPO through Friday after its founder was forced to resign over compliance issues that later led the Securities and Exchange Commission to charge him with fraud and ban him from the securities industry. Investors have also come to believe that companies like LendingClub and OnDeck should be valued more like lenders than technology firms. OnDeck's stock has fallen 64% since its 2014 IPO.

It's helpful to go back and look at companies that didn't take advantage of their own strengths when you're examining prevailing business models, Robinson said.

"PayPal is in many ways an interesting example of an opportunity not taken," he said. "In fairness to them, the real network technologies that showed up to link things really came a little bit later into their gestation cycle, and they had some pretty big deals with other partners that required a lot of attention."

But, they "could have done a much better job," he said. "They were nowhere in consumer lending. So just because you may have this sort of early position, it doesn't mean that you can't be co-opted by upstarts that are coming along after you."

PayPal, which was founded in 1998 and went public in 2002 only to be bought by eBay, finally got into the credit game with eBay's 2008 purchase of Bill Me Later. It now offers financing options for consumers through retail partnerships, as well as credit cards, as well as small business loans.

"PayPal is always looking at ways to offer consumers new ways to pay," a spokesman said in a statement that also cited its purchase of Bill Me Later.