Draft Registration Statement No. 3
Table of Contents

As confidentially submitted to the Securities and Exchange Commission on August 17, 2020.

This draft registration statement has not been publicly filed with the

Securities and Exchange Commission and all information herein remains strictly confidential.

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Upstart Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   7389   46-4332431

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

Upstart Holdings, Inc.

2950 S. Delaware Street, Suite 300

San Mateo, California 94403

(650) 204-1000

(Address, including zip code, and telephone number, including

area code, of registrant’s principal executive offices)

 

 

Dave Girouard

Chief Executive Officer

Upstart Holdings, Inc.

2950 S. Delaware Street, Suite 300

San Mateo, California 94403

(650) 204-1000

(Name, address, including zip code, and telephone number, including

area code, of agent for service)

 

 

Copies to:

 

Jeffrey D. Saper

Allison B. Spinner

Shannon R. Delahaye

Wilson Sonsini Goodrich & Rosati, P.C.

650 Page Mill Road

Palo Alto, California 94304

(650) 493-9300

 

Alison Nicoll

Emily Sairafian

Upstart Holdings, Inc.

2950 S. Delaware Street, Suite 300

San Mateo, California 94403

(650) 204-1000

 

John L. Savva

Sullivan & Cromwell LLP

1870 Embarcadero Road

Palo Alto, California 94303

(650) 461-5600

 

 

Approximate date of commencement of proposed sale to the public:

As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box.  

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  

Non-accelerated filer      Smaller reporting company  

Emerging growth company       

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.  

CALCULATION OF REGISTRATION FEE

 

 

Title of each Class of

Securities to be Registered

 

Proposed Maximum 

Aggregate Offering 
Price(1)

 

Amount of

Registration Fee(2)

Common stock, par value $0.0001 per share

  $               $            

 

 

(1)

Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) of the Securities Act of 1933, as amended. Includes the aggregate offering price of additional shares that the underwriters have the option to purchase, if any.

(2)

Calculated pursuant to Rule 457(o) based on an estimate of the proposed maximum aggregate offering price.

 

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant will file a further amendment which specifically states that this Registration Statement will thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement will become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents

The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated           , 2020.

           Shares

 

 

LOGO

Upstart Holdings, Inc.

Common Stock

 

 

This is the initial public offering of shares of common stock of Upstart Holdings, Inc. All of the            shares of common stock are being sold by us.

Prior to this offering, there has been no public market for the common stock. It is currently estimated that the initial public offering price per share will be between $           and $          . Upstart intends to list the common stock on the            under the symbol “UPST”.

We are an “emerging growth company” as that term is defined under the federal securities laws and, as such, we have elected to comply with certain reduced reporting requirements for this prospectus and may elect to do so in future filings.

 

 

See “Risk Factors” beginning on page 18 to read about factors you should consider before buying shares of our common stock.

 

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total  

Initial public offering price

   $                    $                

Underwriting discount(1)

   $        $    

Proceeds, before expenses, to Upstart

   $        $    

 

(1)

See “Underwriting” for a description of the compensation payable to the Underwriters.

To the extent that the underwriters sell more than            shares of common stock, the underwriters have the option to purchase up to an additional           shares from Upstart at the initial public offering price less the underwriting discount.

The underwriters expect to deliver the shares against payment in New York, New York on           , 2020.

 

Goldman Sachs & Co. LLC     BofA Securities   Citigroup

 

Jefferies   Barclays

 

 

Prospectus dated           , 2020.


Table of Contents

TABLE OF CONTENTS

Prospectus

 

     Page  

Prospectus Summary

     1  

Risk Factors

     18  

Special Note Regarding Forward-Looking Statements

     72  

Industry, Market and Other Data

     74  

Use of Proceeds

     76  

Dividend Policy

     77  

Capitalization

     78  

Dilution

     80  

Selected Consolidated Financial and Other Data

     83  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     86  

Business

     112  

Management

     139  

Executive Compensation

     149  

Certain Relationships and Related Party Transactions

     161  

Principal Stockholders

     167  

Description of Capital Stock

     170  

Shares Eligible for Future Sale

     176  

Material U.S. Federal Income Tax Consequences to Non-U.S. Holders of Our Common Stock

     179  

Underwriting

     184  

Validity of Common Stock

     190  

Experts

     190  

Where You Can Find Additional Information

     190  

Index to Consolidated Financial Statements

     F-1  

 

 

Through and including           , 2020 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

 

Neither we nor any of the underwriters have authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses we have prepared. We and the underwriters take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

For investors outside the United States: Neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the shares of our common stock and the distribution of this prospectus outside the United States.


Table of Contents

PROSPECTUS SUMMARY

This summary highlights selected information that is presented in greater detail elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our common stock. You should read this entire prospectus carefully, including the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus, before making an investment decision. Unless the context otherwise requires, the terms “Upstart,” “the company,” “we,” “us” and “our” in this prospectus refer to Upstart Holdings, Inc. and its consolidated subsidiaries. Our fiscal year end is December 31, and our fiscal quarters end on March 31, June 30, September 30 and December 31.

Upstart Holdings, Inc.

Overview

Our mission is to enable effortless credit based on true risk.

We are a leading, cloud-based artificial intelligence lending platform. Artificial intelligence, or AI, lending enables a superior loan product with improved economics that can be shared between consumers and lenders. Our platform aggregates consumer demand for high-quality loans and connects it to our network of Upstart AI-enabled bank partners. Consumers on our platform benefit from higher approval rates, lower interest rates, and a highly automated, efficient, all-digital experience. Our bank partners benefit from access to new customers, lower fraud and loss rates, and increased automation throughout the lending process. Since inception, our bank partners have originated almost 450,000 personal loans that have generated more than 5.5 million repayment events. In the fourth quarter of 2019, approximately 70% of Upstart-powered loans were entirely automated.

Credit is a cornerstone of the U.S. economy, and access to affordable credit is central to unlocking upward mobility and opportunity. The FICO score was invented in 1989 and remains the standard for determining who is approved for credit and at what interest rate.1 While FICO is rarely the only input in a lending decision, most banks use simple, rules-based systems that consider only a limited number of variables. Unfortunately, because legacy credit systems fail to properly identify and quantify risk, millions of creditworthy individuals are left out of the system, and millions more pay too much to borrow money.2

The first generation of online lenders focused on bringing credit online. Analogous to earlier internet pioneers, these companies made shopping for and accessing credit simpler and easier for consumers and businesses. It was no longer necessary to stand in line at a bank branch, to sit across the desk from a loan officer and to wait weeks or months for a decision. These lenders enabled the emergence of personal loan products that were previously unprofitable for banks to offer. While they brought the credit process online, they inherited the decision frameworks that banks had used for decades and did not address the more rewarding and challenging opportunity of reinventing the credit decision.

We leverage the power of AI to more accurately quantify the true risk of a loan. Our AI models have been continuously upgraded, trained and refined for more than seven years. We have discrete AI

 

1 

Rob Kaufman, myFico Blog: The History of the FICO Score, August 2018.

2 

Patrice Ficklin and Paul Watkins, Consumer Financial Protection Bureau Blog: An Update on Credit Access and the Bureau’s First No-Action Letter, August 2019.



 

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models that target fee optimization, income fraud, acquisition targeting, loan stacking, prepayment prediction, identity fraud and time-delimited default prediction. Our models incorporate more than 1,500 variables and benefit from a rapidly growing training dataset that currently contains more than 5.5 million repayment events. The network effects generated by our constantly improving AI models provide a significant competitive advantage—more training data leads to higher approval rates and lower interest rates at the same loss rate.

We have been able to demonstrate through several studies that AI lending works. First, in 2019 the Consumer Financial Protection Bureau, or CFPB, reported that a study by Upstart of its data using a methodology specified by the CFPB showed that our AI model approves 27% more borrowers than a high-quality traditional model, with a 16% lower average APR for approved loans.3 Second, when compared to credit models from several large banks, our AI models approve approximately 2.7 times as many borrowers at the same loss rate.4 Third, for pools of securitized loans, our realized loss rates were approximately half of those predicted by Kroll, a prominent credit rating agency.5 And finally, we regularly monitor the accuracy of our AI models in comparison with simple credit score-based models and have observed higher model accuracy across a variety of statistical measures relating to each model’s predictive accuracy.6

Our AI models are provided to bank partners within a consumer-facing cloud application that streamlines the end-to-end process of originating and servicing a loan. We have built a configurable, multi-tenant cloud application designed to integrate seamlessly into a bank’s existing technology systems. Our highly configurable platform allows each bank to define its own credit policy and determine the significant parameters of its lending program. Our AI models use and analyze data from all of our bank partners. As a result, these models are trained by every Upstart-powered loan, and each bank partner benefits from participating in a shared AI lending platform.

Consumers can discover Upstart-powered loans in one of two ways: either via Upstart.com or through a white-labeled product on our bank partners’ own websites.

Loans issued through our platform can be retained by our originating bank partners, distributed to our broad base of approximately 70 institutional investors and buyers that fund or invest in Upstart-powered loans or funded by Upstart’s balance sheet. In the fourth quarter of 2019, 21% of the loans funded through our platform were retained by the originating bank and 72% of loans were purchased by institutional investors through our loan funding programs. Our institutional investors and buyers that participate in our loan funding programs, which include                     ,                      and                     , fund or invest in Upstart-powered loans through whole loan purchases, purchases of pass-through certificates and investments in asset-backed securitizations. We enter into nonexclusive agreements with our whole loan purchasers and each of the grantor trust entities in our asset-backed

 

3 

Ficklin and Watkins; see the section titled “Industry, Market and Other Data.”

4 

In an internal study, Upstart replicated three bank models using their respective underwriting policies and evaluated their hypothetical loss rates and approval rates using Upstart’s applicant base in late 2017. Such result represents the average rate of improvement exhibited by Upstart’s platform against each of the three respective bank models.

5 

In an internal study, Upstart compared the actual realized loss rates of Upstart loans securitized between June 2017 and September 2019 and the realized loss rate predictions for those loans obtained from KBRA Surveillance Reports published by Kroll Bond Rating Agency in December 2019.

6 

In an internal study in March 2020, Upstart compared the performance of its AI model with that of hypothetical lending models formulated using Upstart’s approximation of credit score variables used in traditional simple rules-based lending models and additional variables including loan amount, debt-to-income ratio, monthly income, number of credit inquiries and number of trade accounts.



 

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securitizations, or ABS, under which our ABS investors benefit from our loan servicing capabilities.7 The remaining 7% of loans funded through our platform in the fourth quarter of 2019 were funded through our balance sheet, primarily for purposes of testing and validating newer aspects of our model.

Our revenue is primarily comprised of fees paid by banks. We charge banks referral fees for each loan originated through Upstart.com, platform fees for each loan originated and loan servicing fees as consumers repay their loans. Our agreements with our bank partners are nonexclusive, have initial terms ranging from one to three years, are subject to certain early termination provisions and minimum fee amounts, and do not include any minimum origination obligation or origination limits. As a usage-based platform, we target positive unit economics on each transaction, resulting in a cash efficient business model that features both high growth rates and profitability. As of March 31, 2020, we had eight bank partners. In 2019, Cross River Bank originated 89% of the loans facilitated on our platform and fees received from Cross River Bank accounted for 80% of our total revenue.8 Our current agreement with Cross River Bank began on January 1, 2019 and has an initial four year term, with a renewal term for an additional two years following the initial four year term.

We have achieved rapid growth while improving our margin profile in recent years. The number of loans facilitated on our platform increased by 88% from 114,125 in 2018 to 215,122 in 2019. Over the same period, revenue increased 65% from $99.3 million to $164.2 million. Net loss decreased from $12.3 million in 2018 to $0.5 million in 2019.9

Industry Overview

Affordable Credit is Critical to Unlocking Upward Mobility and Opportunity

With $4.2 trillion of consumer credit outstanding as of December 2019,10 credit is a cornerstone of the U.S. economy. Access to affordable credit is central to unlocking upward mobility and opportunity. Reducing the price of borrowing for consumers has the potential to dramatically improve the quality of life for millions of people. Studies have demonstrated a strong statistical link among access to affordable credit, personal well-being and income growth.11 The average American has approximately $29,800 in personal debt.12 While access to affordable credit has allowed Americans to purchase and improve their homes, buy cars, pay for college tuition and cover emergency expenses, high interest rates can negatively impact a consumer’s financial health. The U.S. Federal Reserve reports that on average, 10% of household disposable personal income is spent on debt repayment.13 In addition, 16% of Americans spend 50% to 100% of their monthly income repaying debt.14

 

7 

See the sections titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Term loans and revolving loan facilities”, “Business—Institutional Investors” and Note 7 to our consolidated financial statements for more information about our loan funding programs, including the role of our warehouse credit facilities and special purpose entities and our arrangements with institutional investors. See “Note 3. Securitizations and Variable Interest Entities” to our consolidated financial statements for additional information regarding transactions with our VIEs.

8 

See the section titled “Business—Bank Partnerships” for more information about our arrangements with CRB and other bank partners.

9 

Unless otherwise noted, “net loss” refers to “net loss attributable to Upstart Holdings, Inc. common stockholders.”

10 

The Federal Reserve Board, Statistical Release: Consumer Credit, or Federal Reserve Consumer Credit, December 2019.

11 

Kirsten Wysen, Open Source Solutions: Why Credit Scores and Payday Lending Matter for Health, October 2019.

12 

Northwestern Mutual, 2019 Planning & Progress Study: The Debt Debacle, 2019.

13 

The Federal Reserve Board, Household Debt Service and Financial Obligations Ratios, or Federal Reserve Household Debt, December 2019.

14 

Northwestern Mutual; see the section titled “Industry, Market and Other Data.”



 

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Affordable Credit Is Inaccessible for Millions because Existing Systems Fail to Accurately Quantify Risk

The FICO score was invented in 1989 and has not fundamentally changed since that time.15 The FICO score is used by over 90% of lenders to determine who is approved for credit and at what interest rate.16 While FICO is rarely used in isolation, many credit models are simple, rules-based systems. A leading expert found that bank credit models commonly incorporate eight to 15 variables, with the more sophisticated models using as many as 30.17 Unsurprisingly, the world is more complicated than can be represented by these models, so they are limited in their ability to reliably estimate the probability of default.

Many borrowers suffer from the effects of inaccurate credit models. Many are approved for a loan that they ultimately will be unable to repay, negatively impacting both the consumer and the lender. Many others may be declined for a loan that they could have successfully repaid if given the opportunity—again doing harm to both consumer and lender. According to an Upstart retrospective study completed in December 2019, four out of five Americans who have taken out a loan have never defaulted, yet less than half of Americans have access to prime credit.18 Even consumers with high credit scores tend to pay too much for loans because the rates they pay effectively subsidize the losses from borrowers who default.

Banks Will Continue to be at the Forefront of Consumer Lending

Banks have been at the forefront of consumer lending in the U.S. for more than a century. They benefit from long-term structural advantages, including a low cost of funding, a unique regulatory

framework, and high levels of consumer trust. Through large and reliable deposit bases, banks are able to maintain a very low cost of funds—approximately 1% on average.19 These cost savings are passed through to borrowers in the form of lower interest rates, a significant competitive advantage over non-depository lending institutions. Banks also benefit from a regulatory framework that allows them to create nation-wide lending programs that are largely uniform. Given these advantages, we believe that a partnership-based bank enablement approach will be more successful than a disruption strategy.

Banks Must Undergo a Digital Transformation to Remain Competitive

The largest four U.S. banks spend an estimated $38 billion on technology and innovation annually.20 These four banks may attempt to build AI lending models over time, once general market acceptance has been achieved. However, outside the largest four banks, there are approximately 5,200 FDIC insured institutions21 that are at risk of falling behind. Despite holding over $8 trillion in deposits,22 we believe these banks, particularly small to medium-sized banks, have outdated technology and lack the technical resources of larger banks to fund the digitization process.

 

 

15 

Kaufman; see the section titled “Industry, Market and Other Data.”

16 

Kaufman; see the section titled “Industry, Market and Other Data.”

17 

Naeem Siddiqi, Intelligent Credit Scoring: Building and Implementing Better Credit Risk Scorecards—2nd Edition, 2017.

18 

The study defined access to prime credit as individuals with credit reports with VantageScores of 720 or above.

19 

Federal Home Loan Bank of San Francisco, Cost of Funds Index, December 2019.

20 

Adrian D. Garcia, Bankrate: JPM, Big Banks Spend Billions on Tech but Innovation Lags, July 2018.

21 

Federal Deposit Insurance Corporation, or FDIC, Statistics on Depository Institutions, December 2019.

22 

The dollar amount of deposits held by banks, other than the largest four banks, was aggregated by Upstart using data provided by the FDIC; see the section titled “Industry, Market and Other Data.”



 

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At the same time, consumers are increasingly seeking digital, personalized and automated experiences.23 A 2017 Bain survey found that approximately 50% of the U.S. population would be comfortable buying financial products from technology companies.24 We believe that as consumers, both young and old, move their financial lives online, small and medium-sized banks will be increasingly ill-equipped to serve them.

Increasing Recognition from Regulators

Many regulators including the Federal Deposit Insurance Corporation, or FDIC, the Office of the Comptroller of the Currency, or OCC, the Federal Reserve and the CFPB increasingly recognize the opportunity to modernize techniques used in lending.25 In December 2019, these agencies issued an inter-agency report in support of the use of alternative data in lending decisions.26 Additionally, in November 2019, the CFPB director noted that despite external uncertainty regarding how AI will fit into regulatory frameworks, the CFPB is focused on ensuring a path to regulatory clarity because it recognizes the value AI lending products can offer consumers.27 In fact, in 2017, in response to a request by Upstart, the CFPB issued Upstart the first no-action letter, which provides that the CFPB has no present intention to recommend enforcement action with regard to the application of the Equal Credit Opportunity Act against Upstart for its use of alternative variables and AI and machine learning in credit decision-making.28 Such no-action letter expires on September 14, 2020.

The AI Opportunity

AI has the potential to add $13 trillion to the current global economic output by 2030, a 16% increase over today’s output.29 According to the McKinsey Global Institute, AI will be slowly adopted in its early stages, followed by steep acceleration as the technology matures and companies learn how to best deploy it.30 We believe the lending industry will follow this path.

Lending is a compelling application for AI. First, it involves sophisticated decisioning for events that occur millions of times each day. Second, there is an almost unlimited supply of data that has the potential to be predictive and improve the accuracy of credit decisions. Third, given the costs and risks associated with lending, the economic wins from AI are dramatic for both banks and consumers. This means that the significant investment required to overcome the technical and regulatory hurdles is well worth the effort.

 

23 

Bain & Company, Inc., or Bain, Evolving the Customer Experience in Banking, 2017. PricewaterhouseCoopers LLP, or PwC, Experience Is Everything: Here’s How To Get It Right, 2018. RedPoint Global and the Harris Poll, or RedPoint Global, Addressing the Gaps in Customer Experience: A Benchmark Study Exploring the Ever Evolving Customer Experience and How Marketers and Consumers Are Adapting, March 2019.

24 

Bain; see the section titled “Industry, Market and Other Data.”

25 

Board of Governors of the Federal Reserve System, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, National Credit Union Administration and Office of the Comptroller of the Currency, Interagency Statement on the Use of Alternative Data in Credit Underwriting, or FDIC Interagency Statement, December 2019.

26 

FDIC Interagency Statement; see the section titled “Industry, Market and Other Data.”

27 

Kathleen L. Kraninger, Consumer Financial Protection Bureau: Director Kraninger’s Remarks at TCH-BPI Conference, November 2019.

28 

Consumer Financial Protection Bureau, No-Action Letter to Upstart Network, Inc. dated September 14, 2017, or the CFPB No-Action Letter.

29 

McKinsey Global Institute, or McKinsey, Notes From the AI Frontier: Modeling the Impact of AI on the World Economy, September 2018.

30 

McKinsey; see the section titled “Industry, Market and Other Data.”



 

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With our seven-year head start, our AI lending platform is well-positioned to power a significant portion of the U.S. credit market. To date, we have focused on the unsecured personal loan market, the fastest-growing segment of consumer credit.31 In 2018, there were $88 billion32 in U.S. unsecured personal loan originations, representing 20% growth over the prior year.33 In 2019, we facilitated the origination of $2.7 billion in unsecured personal loans, or less than 5% of the total market.34 We not only have a large opportunity to capture market share in unsecured personal loans, but by applying our AI models and technology to adjacent opportunities, we believe we are well-positioned to address the approximately $899 billion35 opportunity in U.S. auto loans, credit cards, student loans, point-of-sale loans and Home Equity Lines of Credit, or HELOCs. Over the longer term, we believe we are also capable of capturing market share in mortgage and small business lending.

Our AI Lending Platform

Our AI models are central to our value proposition and unique position in the industry. Our models incorporate more than 1,500 variables, which are analogous to the columns in a spreadsheet. They have been trained by more than 5.5 million repayment events, analogous to rows of data in a spreadsheet. Interpreting these more than 8 billion cells of data are increasingly sophisticated machine learning algorithms that enable a more predictive model.

These elements of our model are co-dependent; the use of hundreds or thousands of variables is impractical without sophisticated machine learning algorithms to tease out the interactions between them. And sophisticated machine learning depends on large volumes of training data. Over time, we have been able to deploy and blend more sophisticated modeling techniques, leading to a more accurate system. This co-dependency presents a challenge to others who may aim to short-circuit the development of a competitive model. While incumbent lenders may have vast quantities of historical repayment data, their training data lacks the hundreds of columns, or variables, that power our model. For more details regarding the variables, training data, and algorithms in our models, please see “Business—Evolution of Upstart’s AI Model.”

Despite their sophistication, our AI models are delivered to banks in the form of a simple cloud application that shields borrowers from the underlying complexity. Additionally, our platform allows banks to tailor lending applications based on their policies and business needs. Our bank partners can configure many aspects of their lending programs, including factors such as loan duration, loan amount, minimum credit score, maximum debt-to-income ratio and return target by risk grade. Within the construct of each bank’s self-defined lending program, our platform enables the origination of conforming and compliant loans at a low per-loan cost.

Our platform benefits from powerful flywheel effects that drive continuous improvements as our business scales. Our platform benefits first from increasingly sophisticated models, variable expansion and rapid growth of training data. Upgrades to our platform allow us to offer higher approval rates and lower interest rates to consumers, which increases the number of borrowers on our platform. Upgrades to our platform also lead to better borrower selection, which lowers losses and lowers interest rates to borrowers. The flywheel effect created by self-reinforcing AI increases the economic opportunity that can be shared by borrowers and lenders over time.

 

31 

Eldar Beiseitov, Federal Reserve Bank of St. Louis: Unsecured Personal Loans Get a Boost From Fintech Lenders, July 2019.

32 

Based on 2018 loan origination dollar amounts provided by TransUnion.

33 

Based on 2018 loan origination dollar amounts and 2017 loan origination dollar amounts provided by TransUnion.

34 

Based on 2018 loan origination dollar amounts provided by TransUnion.

35 

Based on 2018 loan origination dollar amounts provided by TransUnion.



 

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Our Ecosystem

Our platform connects consumers, banks and institutional investors through a shared AI lending platform. Because AI is a new and disruptive technology, and banking is a traditionally conservative industry, we have brought our technology to market in a way that allows us to grow rapidly and improve on our AI models, while allowing banks to take a prudent and responsible approach to assessing and adopting our platform.

On the consumer side, we aggregate demand on Upstart.com, where consumers are presented with bank-branded offers from our bank partners. In this way, we benefit banks who have adopted our AI lending technology. Bank partners can also offer Upstart-powered loans through a white-labeled interface on their own website or mobile application. Consumers on our platform are generally offered unsecured personal loans ranging from $1,000 to $50,000 in size, at APRs typically ranging from approximately 6.5% to 35.99%, with terms typically ranging from three to five years, with a monthly repayment schedule and no prepayment penalty.

On the funding side, our bank partners can retain loans that align with their business and risk objectives, while the remainder can be sold to our network of institutional investors, which have far broader and more diverse capacity to absorb and distribute risk. This flexible approach allows banks to adopt AI lending at their own pace, while we continue to grow and improve our platform.

Value Proposition to Consumers

 

   

Higher approval rates and lower interest rates—The CFPB reported that a study by Upstart of its data using a methodology specified by the CFPB, showed that our AI model approves 27% more borrowers than high-quality traditional lending models with a 16% lower average APR for approved loans.36 Our analyses suggest that our loan offers have improved significantly over time relative to those of competitors.37

 

   

Superior digital experience—Whether consumers apply for a loan through Upstart.com or directly through a bank partner’s website, the application experience is streamlined into a single application process and the loan offers provided are firm. In the fourth quarter of 2019, approximately 70% of Upstart-powered loans were instantly approved with no document upload or phone call required, an increase from 0% in late 2016. Such automation improvements were due in large part to improvements to our AI models and the application of such models to different aspects of the loan process, including data verification and fraud detection.

Value Proposition to Bank Partners

 

   

Competitive digital lending experience—We provide regional banks and credit unions with a cost effective way to compete with the technology budgets of their much larger competitors. The Net Promoter Scores, or NPS, for our bank partners’ lending programs are approximately 80, well above published benchmarks for the largest banks.38

 

36 

Ficklin and Watkins; see the section titled “Industry, Market and Other Data.”

37 

Since 2017, Upstart has used a third-party service to perform quarterly comparative studies of the interest rates offered for Upstart-powered loans versus the interest rates offered by six other companies offering personal loans online.

38 

Upstart used a third-party service to administer surveys to loan applicants immediately following an applicant’s acceptance of a loan on Upstart’s platform. The disclosed figure represents the weighted average of the Net Promoter Scores of each of our bank partners in the fourth quarter of 2019. While the Net Promoter Score methodology used by Upstart’s third-party service was designed to be consistent with the methodology used in the referenced benchmark study, any differences in the timing or method in which the surveys were administered could negatively impact the comparability of such Net Promoter Scores. For further information, see the section titled “Industry, Market and Other Data.”



 

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Expanded customer base—We refer customers that apply for loans through Upstart.com to our bank partners, helping them grow both loan volumes and number of customers. The most common age of Upstart-referred borrowers is 27 years old, a compelling demographic that is often challenging for banks to access.

 

   

Lower loss rates—An internal study comparing our model to that of several large U.S. banks found that our model could enable these banks to lower loss rates by almost 75% while keeping approval rates constant.39

 

   

New product offering—Personal loans are the fastest-growing segment of credit in the U.S.40 Our platform helps banks provide a product their customers want, rather than letting customers seek loans from competitors.

 

   

Institutional investor acceptance—Analyses by credit rating agencies, loan and bond buying institutions, and credit underwriters help banks gain confidence that Upstart-powered loans are subject to significant and constant scrutiny from experts, the results of which are often publicly available.

Our Competitive Strengths

Constantly Improving AI Models

We have been building and refining our AI models for more than seven years, and they have led directly to our growth and profitability. Our models currently incorporate more than 1,500 variables and are trained by more than 5.5 million repayment events. Beyond the advantages accrued by our constantly growing volume of training data, our data science team continues to update our modeling techniques regularly. Model and technology improvements have increased our conversion rate from the initial rate inquiry to funded loan by a factor of four since the beginning of 2016. We have a pipeline of potential model improvements that we expect will further increase our conversion rates in the future.

Flexible Two-Sided Ecosystem

We benefit from aggregating consumer demand on Upstart.com, referring consumers directly to our network of AI-enabled bank partners. Our consumer presence allows us to increase awareness of and interest in Upstart-powered loans, directly contributing to our own growth, as well as the growth and success of our bank partners’ lending programs.

With an expanding list of bank partners, we can solve the borrowing needs of an increasingly diverse array of consumers. As more banks leverage the Upstart platform, consumers benefit from better offers of credit, while experiencing a consistently high-quality experience.

Capital Efficient Fee-Based Business

In 2019, we generated 97% of revenue from fees from banks and loan servicing. We have also achieved a high degree of automation, with approximately 70% of Upstart-powered loans approved instantly and fully automated in the fourth quarter of 2019, driving operating leverage and improving unit economics. We generated more than $1 million of annualized revenue per employee in the fourth quarter of 2019.

 

39 

In an internal study, Upstart replicated three bank models using their respective underwriting policies and evaluated their hypothetical loss rates and approval rates using Upstart’s applicant base in late 2017. To compare the hypothetical loss rates between Upstart’s model and each of the replicated bank models, Upstart held approval rates constant at the rate called for by each bank’s respective underwriting policy. Such result represents the average rate of improvement exhibited by Upstart’s platform against each of the three respective bank models.

40 

Beiseitov; see the section titled “Industry, Market and Other Data.”



 

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Regulatory Compliance

We have worked with regulators since our inception to ensure we operate in compliance with applicable laws and regulations. AI lending expands access to affordable credit by constantly finding new ways to identify qualified borrowers, yet AI models must avoid unlawful disparate impact or statistical bias that would be harmful to protected groups. We have demonstrated to the CFPB that our platform does not introduce unlawful bias to the credit decision, and we have developed sophisticated reporting procedures to ensure future versions of the model remain fair.41

In September 2017, we received the CFPB’s first no-action letter.42 The CFPB issues no-action letters to reduce potential regulatory uncertainty for innovative products that may offer significant consumer benefit.43 At this time, we do not know of any other lending platforms that have received similar no-action letters for fair lending from the CFPB.

Our Growth Strategy

Model Improvements

Our growth has historically been driven by AI model improvements and technology upgrades, and we expect this trend to continue for the foreseeable future. Model upgrades typically result in higher approval rates, better loan offers, higher degrees of automation and other improvements that increase our total number of funded loans. As our model accuracy increases, we are able to re-target and approve consumers who previously visited our site but were not eligible for a loan. A more efficient funnel also has the effect of enabling new marketing and acquisition channels that may not have been economical in the past, providing a second-order growth driver.

More Efficient Funding

Growth is also driven by a reduced cost of funding for Upstart-powered loans. This can happen because more banks adopt our platform, or existing partners increase their budget for Upstart-powered loans. Cost of funding can also be reduced as bank partners gain more confidence in our models and lower some of the constraints they choose to place on their lending program. The cost of funding through institutional investors can also improve regularly, as credit rating agencies and loan and residual buyers gain confidence in the credit performance of Upstart-powered loans.

Our internal data suggests that each 100 basis point reduction in interest rate offered to the consumer increases conversion by 15%.44 Therefore, reduced cost of funding can be a direct driver of growth.

Bank Distribution

Today, the vast majority of borrowers are referred to our bank partners via Upstart.com. But these banks are also beginning to offer Upstart-powered loans through their own websites, supported by their own marketing programs. We expect the bank-driven distribution of Upstart-powered loans to grow over time, as more bank partners roll out white-labeled versions of Upstart to serve their new and existing customers directly.

 

41 

Ficklin and Watkins; see the section titled “Industry, Market and Other Data.”

42 

CFPB No-Action Letter; see the section titled “Industry, Market and Other Data.”

43 

Consumer Financial Protection Bureau, Policy on No-Action Letters, September 2019.

44 

In a series of internal studies conducted in April 2016, September 2016 and January 2018, Upstart compared changes in conversion rates between test groups of Upstart loan applicants when loan offer APRs were increased or decreased for certain groups. The average change in conversion rates across the three studies is presented.



 

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New Products

Personal loans are the fastest-growing segment of consumer credit in the U.S., but they are far from the largest.45 As we apply our AI models and technology to other credit verticals, we will be able to serve the needs of more consumers and to play a broader technology enablement role for our bank partners. There is significant opportunity to expand from personal loans to auto loans, credit cards, student loans, point-of-sale loans and HELOCs. While not a core focus today, we believe that in the long term our platform is also well-positioned to address opportunities in mortgages and small business loans.

Risk Factors Summary

Our business is subject to numerous risks and uncertainties, including those highlighted in the section titled “Risk Factors” immediately following this prospectus summary. These risks include, but are not limited to, the following:

 

   

We are a rapidly growing company with a relatively limited operating history, which may result in increased risks, uncertainties, expenses and difficulties, and makes it difficult to evaluate our future prospects.

 

   

Our revenue growth rate and financial performance in recent periods may not be indicative of future performance and such growth may slow over time.

 

   

If we fail to effectively manage our growth, our business, financial condition and results of operations could be adversely affected.

 

   

We have incurred net losses in the past, and we may not be able to maintain or increase our profitability in the future.

 

   

Our quarterly results are likely to fluctuate and as a result may adversely affect the trading price of our common stock.

 

   

If we are unable to continue to improve our AI models or if our AI models contain errors or are otherwise ineffective, our growth prospects, business, financial condition and results of operations would be adversely affected.

 

   

If our existing bank partners were to cease or limit operations with us or if we are unable to attract and onboard new bank partners, our business, financial condition and results of operations could be adversely affected.

 

   

Cross River Bank accounts for a substantial portion of the total number of loans facilitated by our platform and our revenue.

 

   

The sales and onboarding process of new bank partners could take longer than expected, leading to fluctuations or variability in expected revenues and results of operations.

 

   

Our business may be adversely affected by economic conditions and other factors that we cannot control.

 

   

Our AI models have not yet been tested in down-cycle economic conditions. If our AI models do not accurately reflect a borrower’s credit risk in such economic conditions, the performance of Upstart-powered loans may be worse than anticipated.

 

   

If we are unable to maintain a diverse and robust loan funding program, our growth prospects, business, financial condition and results of operations could be adversely affected.

 

   

Our business is subject to a wide range of laws and regulations, many of which are evolving, and failure or perceived failure to comply with such laws and regulations could harm our business, financial condition and results of operations.

 

45 

Beiseitov; see the section titled “Industry, Market and Other Data.”



 

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We rely on strategic relationships with loan aggregators to attract applicants to our platform, and if we cannot maintain effective relationships with loan aggregators or successfully replace their services, our business could be adversely affected.

 

   

We currently only offer one type of loan product on our platform, and we are thus particularly susceptible to fluctuations in the unsecured personal loan market and do not currently offer a broad suite of products that bank partners may find desirable.

Channels for Disclosure of Information

Investors, the media and others should note that, following the completion of this offering, we intend to announce material information to the public through filings with the Securities and Exchange Commission, or the SEC, our corporate blog at Upstart.com/blog, the investor relations page on our website, press releases, our Twitter account (@Upstart), our Facebook page, our LinkedIn page, public conference calls or webcasts.

The information disclosed by the foregoing channels could be deemed to be material information. As such, we encourage investors, the media, and others to follow the channels listed above and to review the information disclosed through such channels.

Any updates to the list of disclosure channels through which we will announce information will be posted on the investor relations page on our website.

Corporate Information

Upstart Network, Inc. was incorporated in Delaware in 2012. Pursuant to a restructuring, Upstart Holdings, Inc. was incorporated in December 2013 and became the holding company of Upstart Network, Inc. Our principal executive offices are located at 2950 S. Delaware Street, Suite 300, San Mateo, California 94403, and our telephone number is (650) 204-1000. Our website address is www.Upstart.com. Information contained on, or that can be accessed through, our website does not constitute part of this prospectus and inclusions of our website address in this prospectus are inactive textual references only. You should not consider information contained on our website to be part of this prospectus or in deciding whether to purchase shares of our common stock.

Upstart, our logo, and our other registered or common law trademarks, service marks, or trade names appearing in this prospectus are the property of Upstart Holdings, Inc. or one of its subsidiaries. Other trademarks and trade names referred to in this prospectus are the property of their respective owners.

JOBS Act

We qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. An emerging growth company may take advantage of relief from certain reporting requirements and other burdens that are otherwise applicable generally to public companies. These provisions include:

 

   

reduced obligations with respect to financial data, including presenting only two years of audited financial statements and only two years of selected financial data;

 

   

an exception from compliance with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act;

 

   

reduced disclosure about our executive compensation arrangements in our periodic reports, proxy statements, and registration statements; and

 

   

exemptions from the requirements of holding non-binding advisory votes on executive compensation or golden parachute arrangements.



 

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We may take advantage of these provisions for up to five years or such earlier time that we no longer qualify as an emerging growth company. We would cease to be an emerging growth company if we have more than $1.07 billion in annual revenues, have more than $700 million in market value of our capital stock held by non-affiliates or issue more than $1.0 billion of non-convertible debt over a three-year period. We may choose to take advantage of some but not all of these reduced reporting burdens.

In addition, under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have elected to avail ourselves of this exemption from new or revised accounting standards, and, therefore, we will not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies or that have opted out of using such extended transition period, which may make comparison of our financial statements with those of other public companies more difficult. We may take advantage of these reporting exemptions until we no longer qualify as an emerging growth company, or, with respect to adoption of certain new or revised accounting standards, until we irrevocably elect to opt out of using the extended transition period.



 

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The Offering

 

Common stock offered by us

           shares

 

Common stock to be outstanding after this offering

           shares

 

Option to purchase additional shares of common stock from us

We have granted the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to            additional shares from us.

 

Use of proceeds

We estimate that the net proceeds from the sale of shares of our common stock in this offering will be approximately $           (or approximately $           if the underwriters’ option to purchase additional shares of our common stock is exercised in full), based upon the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

 

The principal purposes of this offering are to increase our capitalization and financial flexibility, create a public market for our common stock, and enable access to the public equity markets for us and our stockholders. We intend to use the net proceeds from this offering for general corporate purposes, including working capital, operating expenses, and capital expenditures. Additionally, we may use a portion of the net proceeds to acquire or invest in businesses, products, services, or technologies. However, we do not have agreements or commitments for any material acquisitions or investments at this time. See the section titled “Use of Proceeds” for additional information.

 

Concentration of ownership

Upon completion of this offering, our executive officers, directors, and holders of 5% or more of our common stock will beneficially own, in the aggregate, approximately           % of the outstanding shares of our common stock.

 

Risk factors

See “Risk Factors” and the other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in our common stock.

 

Proposed            trading symbol

“UPST”



 

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The number of shares of our common stock that will be outstanding after this offering is based on            shares of our common stock outstanding as of December 31, 2019, and reflects:

 

   

47,349,577 shares of preferred stock that will automatically convert into shares of common stock immediately prior to the completion of this offering pursuant to the terms of our amended and restated certificate of incorporation, or the Capital Stock Conversion; and

 

   

600,208 shares of our Series B preferred stock issuable upon the automatic net exercise of a warrant outstanding as of December 31, 2019, with an exercise price of $0.01 per share, upon the closing of this offering, which would result in the issuance of            shares of our common stock in connection with the Capital Stock Conversion.

The shares of our common stock outstanding as of December 31, 2019 exclude the following:

 

   

16,502,206 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock outstanding as of December 31, 2019, with a weighted-average exercise price of $1.86 per share;

 

   

319,669 shares of our common stock issuable upon the exercise of warrants outstanding as of December 31, 2019, with a weighted-average exercise price of $1.77 per share;

 

   

1,757,974 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock issued after December 31, 2019, with a weighted-average exercise price of $8.88 per share; and

 

   

           shares of our common stock reserved for future issuance under our equity compensation plans, consisting of:

 

   

           shares of our common stock to be reserved for future issuance under our 2020 Equity Incentive Plan, or our 2020 Plan, which will become effective prior to the completion of this offering; and

 

   

1,319,666 shares of our common stock reserved for future issuance under our 2012 Stock Plan, or our 2012 Plan, which number of shares will be added to the shares of our common stock to be reserved for future issuance under our 2020 Plan upon its effectiveness, at which time we will cease granting awards under our 2012 Plan.

Our 2020 Plan will provide for annual automatic increases in the number of shares reserved thereunder and our 2020 Plan will also provide for increases to the number of shares that may be granted thereunder based on shares under our 2012 Plan that expire, are forfeited, or otherwise repurchased by us, as more fully described in the section titled “Executive Compensation—Employee Benefit and Stock Plans.”

Except as otherwise indicated, all information in this prospectus assumes:

 

   

the Capital Stock Conversion will occur immediately prior to the completion of this offering;

 

   

the filing and effectiveness of our amended and restated certificate of incorporation in Delaware and the effectiveness of our amended and restated bylaws, will each occur immediately prior to the completion of this offering;

 

   

no exercise or cancellation of outstanding stock options subsequent to December 31, 2019; and

 

   

no exercise by the underwriters of their option to purchase an additional            shares of our common stock from us.



 

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SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA

The following tables summarize our consolidated historical financial and other data. We have derived the summary consolidated statements of operations data for the years ended December 31, 2017, 2018 and 2019 and consolidated balance sheet data as of December 31, 2019 from our audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated financial data in this section are not intended to replace our consolidated financial statements and related notes, and our historical results are not necessarily indicative of the results that may be expected in the future. The following summary consolidated financial and other data should be read in conjunction with the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus. The last day of our fiscal year is December 31. Our fiscal quarters end on March 31, June 30, September 30, and December 31.

Consolidated Statements of Operations Data

 

     Year Ended December 31,  
(In thousands, except share and per share amounts)    2017     2018     2019  

Revenue:

      

Revenue from fees, net

   $ 51,161     $ 88,482     $ 159,847  

Interest income and fair value adjustments, net

     6,128       10,831       4,342  
  

 

 

   

 

 

   

 

 

 

Total revenue

     57,289       99,313       164,189  
  

 

 

   

 

 

   

 

 

 

Operating expenses:

      

Sales and marketing(1)

     33,838       63,633       93,175  

Customer operations(1)

     10,232       15,416       24,947  

Engineering and product development(1)

     5,324       8,415       18,777  

General, administrative, and other(1)

     15,431       19,820       31,865  
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     64,825       107,284       168,764  
  

 

 

   

 

 

   

 

 

 

Loss from operations

     (7,536     (7,971     (4,575

Other income

     330       487       1,036  

Expense on warrants and convertible notes, net

     (1,649     (3,734     (1,407
  

 

 

   

 

 

   

 

 

 

Net loss before income taxes

     (8,855     (11,218     (4,946

Provision for income taxes

     6       —         74  
  

 

 

   

 

 

   

 

 

 

Net loss before attribution to noncontrolling interests

     (8,861     (11,218     (5,020

Net (loss) income attributable to noncontrolling interests

     (1,144     1,101       (4,554
  

 

 

   

 

 

   

 

 

 

Net loss attributable to Upstart Holdings, Inc. common stockholders

   $ (7,717   $ (12,319   $ (466
  

 

 

   

 

 

   

 

 

 

Net loss per common share attributable to Upstart Holdings, Inc. common stockholders, basic and diluted(2)

   $ (0.56   $ (0.87   $ (0.03
  

 

 

   

 

 

   

 

 

 

Weighted-average number of shares outstanding used in computing net loss per share attributable to Upstart Holdings, Inc. common stockholders, basic and diluted(2)

     13,873,810       14,128,183       14,335,611  
  

 

 

   

 

 

   

 

 

 

Pro forma net loss per share attributable to Upstart Holdings, Inc. common stockholders, basic and diluted (unaudited)(2)

       $    
      

 

 

 

Weighted-average number of shares used to compute pro forma net loss per share attributable to Upstart Holdings, Inc. common stockholders, basic and diluted (unaudited) (2)

       $    
      

 

 

 


 

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(1)

Includes stock-based compensation expense as follows:

 

     Year ended December 31,  
(In thousands)      2017          2018          2019    

Sales and marketing

   $ 32      $ 183      $ 278  

Customer operations

     124        178        433  

Engineering and product development

     574        753        1,803  

General, administrative, and other

     560        931        1,292  
  

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 1,290      $ 2,045      $ 3,806  
  

 

 

    

 

 

    

 

 

 

 

(2)

See Note 16 to our consolidated financial statements for an explanation of the calculations of our basic and diluted net loss per share attributable to Upstart Holdings, Inc. common stockholders, pro forma net loss per share attributable to Upstart Holdings, Inc. common stockholders and the weighted-average number of shares used in the computation of the per share amounts.

Consolidated Balance Sheet Data

 

     As of December 31, 2019  
(In thousands)    Actual     Pro
Forma(1)
     Pro Forma
as
Adjusted (2) (3)
 

Cash

   $ 44,389     $                    $                

Loans (at fair value)

     232,305       

Notes receivable and residual certificates (at fair value)

     34,116       

Total assets

     393,462       

Borrowings

     118,609       

Payable to securitization note holders and residual certificate holders (includes $89,672 at fair value and $41,343 payable to related parties as of December 31, 2019)

     96,107       

Total liabilities

     292,604       

Convertible preferred stock

     162,546       

Accumulated deficit

     (75,205     

Total Upstart Holdings, Inc. stockholders’ deficit

     (62,714     

Noncontrolling interests

     1,026       

Total stockholders’ deficit

     (61,688     

Total liabilities, convertible preferred stock and stockholders’ deficit

   $ 393,462       

 

(1)

The pro forma column in the balance sheet data table above reflects (a) the Capital Stock Conversion, as if such conversions had occurred on December 31, 2019, (b) the automatic net exercise of a warrant to purchase up to 600,208 shares of our convertible preferred stock and (c) the filing and effectiveness of our amended and restated certificate of incorporation in Delaware that will become effective immediately prior to the completion of this offering.

(2)

The pro forma as adjusted column in the balance sheet data table above gives effect to (a) the pro forma adjustments set forth above and (b) the sale and issuance by us of shares of our common stock in this offering, based upon the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

(3)

Each $1.00 increase or decrease in the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease the amount of our pro forma as adjusted cash, working capital, total assets, and total stockholders’ equity by $          , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions payable by. An increase or decrease of 1.0 million shares in the number of shares offered by us would increase or decrease, as applicable, the amount of our pro forma as adjusted cash, working capital, total assets, and total stockholders’ equity by $           assuming the assumed initial public offering price remains the same, and after deducting estimated underwriting discounts and commissions payable by us.



 

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Key Operating Metrics

We review a number of operating and financial metrics, including the following key metrics to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions.

 

     Year Ended December 31,  
     2017      2018      2019  

Number of Loans Transacted

     70,457        114,125        215,122  

Conversion Rate

     8.1%        9.1%        13.1%  

Percentage of Loans Fully Automated

     34%        53%        66%  

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Operating Metrics” for a description of Number of Loans Transacted, Conversion Rate and Percentage of Loans Fully Automated.

Non-GAAP Financial Measures

 

     Year Ended December 31,  
(In thousands)    2017     2018     2019  

Contribution Profit

   $ 9,265     $ 13,098     $ 48,940  

Adjusted EBITDA

   $ (4,679   $ (6,226   $ 5,595  

See the section titled “Selected Consolidated Financial and Other Data—Non-GAAP Financial Measures” for a description of Contribution Profit and Adjusted EBITDA and the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for a reconciliation of such non-GAAP financial measures to certain directly comparable financial measures calculated in accordance with GAAP.



 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this prospectus, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before making a decision to invest in our common stock. Our business, financial condition, results of operations, or prospects could also be harmed by risks and uncertainties not currently known to us or that we currently do not believe are material. If any of the risks actually occur, our business, financial condition, results of operations, and prospects could be adversely affected. In that event, the market price of our common stock could decline, and you could lose part or all of your investment.

Risks Related to Our Business and Industry

We are a rapidly growing company with a relatively limited operating history, which may result in increased risks, uncertainties, expenses and difficulties, and makes it difficult to evaluate our future prospects.

We were founded in 2012 and have experienced rapid growth in recent years. Our limited operating history may make it difficult to make accurate predictions about our future performance. Assessing our business and future prospects may also be difficult because of the risks and difficulties we face. These risks and difficulties include our ability to:

 

   

improve the effectiveness and predictiveness of our AI models;

 

   

maintain and increase the volume of loans facilitated by our AI lending platform;

 

   

enter into new and maintain existing bank partnerships;

 

   

successfully maintain a diversified loan funding strategy, including bank partnerships and whole loan sales and securitization transactions that enhance loan liquidity for the bank partners that use our loan funding capabilities;

 

   

successfully fund a sufficient quantity of our borrower loan demand with low cost bank funding to help keep interest rates offered to borrowers competitive;

 

   

maintain competitive interest rates offered to borrowers on our platform, while enabling our bank partners to achieve an adequate return over their cost of funds, whether through their own balance sheets or through our loan funding programs;

 

   

successfully build our brand and protect our reputation from negative publicity;

 

   

increase the effectiveness of our marketing strategies, including our direct consumer marketing initiatives;

 

   

continue to expand the number of potential borrowers;

 

   

successfully adjust our proprietary AI models, products and services in a timely manner in response to changing macroeconomic conditions and fluctuations in the credit market;

 

   

comply with and successfully adapt to complex and evolving regulatory environments.

 

   

protect against increasingly sophisticated fraudulent borrowing and online theft;

 

   

successfully compete with companies that are currently in, or may in the future enter, the business of providing online lending services to financial institutions or consumer financial services to borrowers;

 

   

enter into new markets and introduce new products and services;

 

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effectively secure and maintain the confidentiality of the information received, accessed, stored, provided and used across our systems;

 

   

successfully obtain and maintain funding and liquidity to support continued growth and general corporate purposes;

 

   

attract, integrate and retain qualified employees; and

 

   

effectively manage and expand the capabilities of our operations teams, outsourcing relationships and other business operations.

If we are not able to timely and effectively address these risks and difficulties as well as those described elsewhere in this “Risk Factors” section, our business and results of operations may be harmed.

Our revenue growth rate and financial performance in recent periods may not be indicative of future performance and such growth may slow over time.

We have grown rapidly over the last several years, and our recent revenue growth rate and financial performance may not be indicative of our future performance. In 2017, 2018 and 2019, our revenue was $57.3 million, $99.3 million and $164.2 million, respectively, representing a 73% growth rate from 2017 to 2018 and a 65% growth rate from 2018 to 2019. You should not rely on our revenue for any previous quarterly or annual period as any indication of our revenue or revenue growth in future periods. As we grow our business, our revenue growth rates may slow, or our revenue may decline, in future periods for a number of reasons, which may include slowing demand for our platform offerings and services, increasing competition, a decrease in the growth of our overall credit market, increasing regulatory costs and challenges and our failure to capitalize on growth opportunities. Further, we believe our growth over the last several years has been driven in large part by our AI models and our continued improvements to our AI models. Future incremental improvements to our AI models may not lead to the same level of growth as in past periods. In addition, we believe our growth over the last several years has been driven in part by our ability to rapidly streamline and automate the loan application and origination process on our platform. The Percentage of Loans Fully Automated on our platform was 34% in 2017 and increased to 66% in 2019.46 We expect the Percentage of Loans Fully Automated to level off and remain relatively constant in the long term, and to the extent we expand our loan offerings beyond unsecured personal loans, we expect that such percentage may decrease in the short term. As a result of these factors, our revenue growth rates may slow, and our financial performance may be adversely affected.

If we fail to effectively manage our growth, our business, financial condition and results of operations could be adversely affected.

Over the last several years, we have experienced rapid growth in our business and the Number of Loans Transacted on our AI lending platform, and we expect to continue to experience growth in the future. The Number of Loans Transacted on our platform increased from 70,457 in 2017 to 215,122 in 2019, representing a compound annual growth rate of 75%.47 This rapid growth has placed, and may continue to place, significant demands on our management, processes and operational, technological and financial resources. Our ability to manage our growth effectively and to integrate new employees and technologies into our existing business will require us to continue to retain, attract, train, motivate and manage employees and expand our operational, technological and financial infrastructure.

 

46 

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information on how we define Percentage of Loans Fully Automated.

47 

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information on how we define Number of Loans Transacted.

 

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Continued growth could strain our ability to develop and improve our operational, technological, financial and management controls, enhance our reporting systems and procedures, recruit, train and retain highly skilled personnel and maintain user satisfaction. Any of the foregoing factors could negatively affect our business, financial condition and results of operations.

We have incurred net losses in the past, and we may not be able to maintain or increase our profitability in the future.

For the years ended December 31, 2017, 2018 and 2019, we have experienced net losses of $7.7 million, $12.3 million and $0.5 million, respectively. We intend to continue to expend significant funds to continue to develop and improve our proprietary AI models, improve our marketing efforts to increase the number of borrowers on our platform, enhance the features and overall user experience of our platform, expand the types of loan offerings on our platform and otherwise continue to grow our business, and we may not be able to increase our revenue enough to offset these significant expenditures. We may incur significant losses in the future for a number of reasons, including the other risks described in this section, and unforeseen expenses, difficulties, complications and delays, macroeconomic conditions and other unknown events. Any failure to increase our revenue sufficiently to keep pace with our investments and other expenses could prevent us from maintaining or improving profitability on a consistent basis. If we are unable to successfully address these risks and challenges as we encounter them, our business, financial condition and results of operations could be adversely affected.

Our quarterly results are likely to fluctuate and as a result may adversely affect the trading price of our common stock.

Our quarterly results of operations, including the levels of our revenue, net income and other key metrics, are likely to vary significantly in the future, and period-to-period comparisons of our results of operations may not be meaningful. Accordingly, the results for any one quarter are not necessarily an accurate indication of future performance. Our quarterly financial results may fluctuate due to a variety of factors, many of which are outside of our control. Factors that may cause fluctuations in our quarterly financial results include:

 

   

our ability to improve the effectiveness and predictiveness of our AI models;

 

   

our ability to attract new bank partners and investors of our loan funding programs;

 

   

our ability to maintain relationships with existing bank partners and investors of our loan funding programs;

 

   

our ability to maintain or increase loan volumes, and improve loan mix and the channels through which the loans, bank partners and loan funding are sourced;

 

   

our ability to maintain effective relationships with loan aggregators from which prospective borrowers access our website;

 

   

general economic conditions, including economic slowdowns, recessions and tightening of credit markets;

 

   

improvements to our AI models that negatively impact transaction volume, such as lower approval rates;

 

   

the timing and success of new products and services;

 

   

the effectiveness of our direct marketing and other marketing channels;

 

   

the amount and timing of operating expenses related to maintaining and expanding our business, operations and infrastructure, including acquiring new and maintaining existing bank partners and investors and attracting borrowers to our platform;

 

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our cost of borrowing money and access to loan funding sources;

 

   

the number and extent of prepayments of loans facilitated on our platform;

 

   

changes in the fair value of assets and liabilities on our balance sheet;

 

   

network outages or actual or perceived security breaches;

 

   

our involvement in litigation or regulatory enforcement efforts, or the threat thereof or those that impact our industry generally;

 

   

the length of the onboarding process related to acquisitions of new bank partners;

 

   

changes in laws and regulations that impact our business; and

 

   

changes in the competitive dynamics of our industry, including consolidation among competitors or the development of competitive products by larger well-funded incumbents.

In addition, we experience significant seasonality in the demand for Upstart-powered loans, which is generally lower in the first quarter. This seasonal slowdown is primarily attributable to high loan demand around the holidays in the fourth quarter and the general increase in borrowers’ available cash flows in the first quarter, including cash received from tax refunds, which temporarily reduces their borrowing needs. While our growth has obscured this seasonality in our overall financial results, we expect our results of operations to continue to be affected by such seasonality in the future. Such seasonality and other fluctuations in our quarterly results may also adversely affect and, increase the volatility of, the trading price of our common stock.

If we are unable to continue to improve our AI models or if our AI models contain errors or are otherwise ineffective, our growth prospects, business, financial condition and results of operations would be adversely affected.

Our ability to attract potential borrowers to our platform and increase the number of Upstart-powered loans will depend in large part on our ability to effectively evaluate a borrower’s creditworthiness and likelihood of default and, based on that evaluation, offer competitively priced loans and higher approval rates. Further, our overall operating efficiency and margins will depend in large part on our ability to maintain a high degree of automation in our loan application process and achieve incremental improvements in the degree of automation. If our AI models fail to adequately predict the creditworthiness of borrowers due to the design of our models or programming or other errors, and our AI models do not detect and account for such errors, or any of the other components of our credit decision process fails, we may experience higher than forecasted loan losses. Any of the foregoing could result in sub-optimally priced loans, incorrect approvals or denials of loans, or higher than expected loan losses, which in turn could adversely affect our ability to attract new borrowers and bank partners to our platform, increase the number of Upstart-powered loans or maintain or increase the average size of loans facilitated on our platform.

Our AI models also target and optimize other aspects of the lending process, such as borrower acquisition, fraud detection, default timing, loan stacking, prepayment timing and fee optimization, and our continued improvements to such models have allowed us to facilitate loans inexpensively and virtually instantly, with a high degree of consumer satisfaction and with an insignificant impact on loan performance. However, such applications of our AI models may prove to be less predictive than we expect, or than they have been in the past, for a variety of reasons, including inaccurate assumptions or other errors made in constructing such models, incorrect interpretations of the results of such models and failure to timely update model assumptions and parameters. Additionally, such models may not be able to effectively account for matters that are inherently difficult to predict and beyond our control, such as macroeconomic conditions, credit market volatility and interest rate fluctuations, which

 

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often involve complex interactions between a number of dependent and independent variables and factors. Material errors or inaccuracies in such AI models could lead us to make inaccurate or sub-optimal operational or strategic decisions, which could adversely affect our business, financial condition and results of operations.

Additionally, errors or inaccuracies in our AI models could result in anyone exposed to the credit risk of Upstart-powered loans, whether it be us, our bank partners or investors in our loan funding programs, experiencing higher than expected losses or lower than desired returns, which could impair our ability to retain existing or attract new bank partners and investors to participate in our loan funding programs, reduce the number, or limit the types, of loans bank partners and investors are willing to fund, and limit our ability to increase commitments under our warehouse and other debt facilities. Any of these circumstances could reduce the number of Upstart-powered loans and harm our ability to maintain a diverse and robust loan funding program and could adversely affect our business, financial condition and results of operations.

Continuing to improve the accuracy of our AI models is central to our business strategy. However, such improvements could negatively impact transaction volume, such as by lowering approval rates. For example, a recent upgrade to our AI models related to prepayment predictions led to a temporary decrease in the total number of loans approved. While we believe that continuing to improve the accuracy of our AI models is key to our long-term success, those improvements could, from time to time, lead us to reevaluate the risks associated with certain borrowers, which could in turn cause us to lower approval rates or increase interest rates for any borrowers identified as a higher risk, either of which could negatively impact our growth and results of operations in the short term.

If our existing bank partners were to cease or limit operations with us or if we are unable to attract and onboard new bank partners, our business, financial condition and results of operations could be adversely affected.

In 2019, approximately 90% of our revenue was generated from platform, referral and servicing fees that we receive from our bank partners. Our bank partners include Cross River Bank, FinWise Bank, First Federal Bank of Kansas City, First National Bank of Omaha, KEMBA Financial Credit Union and TCF Bank. If any of our bank partners were to suspend, limit or cease their operations or otherwise terminate their relationships with us, the number of loans facilitated through our platform could decrease and our revenue and revenue growth rates could be adversely affected. Our sales and onboarding process with new bank partners can be long and unpredictable. If we are unable to timely onboard our bank partners, or if our bank partners are not willing to work with us to complete a timely onboarding process, our results of operations could be adversely affected.

We have entered into separate agreements with each of our bank partners. Our agreements with our bank partners are non-exclusive, have initial terms ranging from one to three years, subject to certain early termination provisions and minimum fee amounts, and do not include any minimum origination obligations or origination limits. Our bank partners could decide to stop working with us, ask to modify their agreement terms in a cost prohibitive manner when their agreement is up for renewal or enter into exclusive or more favorable relationships with our competitors. In addition, their regulators may require that they terminate or otherwise limit their business with us, or impose regulatory pressure limiting their ability to do business with us. If the bank partners listed above or any of our other bank partners were to stop working with us, suspend, limit or cease their operations or otherwise terminate their relationship with us, the number of loans facilitated through our platform could decrease and our revenue and revenue growth rates could be adversely affected. We could in the future have disagreements or disputes with any of our bank partners, which could negatively impact or threaten our relationship with them. In our agreements with bank partners, we make certain representations and warranties and covenants concerning our compliance with specific policies of a bank partner, our compliance with certain procedures and guidelines related to laws and regulations applicable to our

 

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bank partners, as well as the services to be provided by us. If those representations and warranties were not accurate when made or if we fail to perform a covenant, we may be liable for any resulting damages, including potentially any losses associated with impacted loans, and our reputation and ability to continue to attract new bank partners would be adversely affected. Additionally, our bank partners may engage in mergers, acquisitions or consolidations with each other, our competitors or with third parties, any of which could be disruptive to our existing and prospective relationships with our bank partners.

In addition, our bank partners have increasingly retained loans for their own customer base and balance sheet. In the fourth quarter of 2019, approximately 21% of Upstart-powered loans were retained on our bank partners’ balance sheets, while about 72% of Upstart-powered loans were purchased by investors through our loan funding programs. The percentage of Upstart-powered loans funded by our bank partners’ balance sheets has increased in the last few years. In general, banks can fund loans at lower rates due to the lower cost of funds available to them from their deposit base than is otherwise available in the broader institutional investment markets. Accordingly, loans retained on our bank partners’ balance sheets generally carry lower interest rates for borrowers, which leads to better conversion rates and faster growth for our platform. Separately, as our number of bank partners grows, such banks will increasingly source new prospective borrowers from their own existing customer base and provide an incremental channel to attract borrowers. If we are unable to attract new bank partners or if we are unable to maintain or expand the number of loans held on their balance sheets, our financial performance would suffer.

Cross River Bank accounts for a substantial portion of the total number of loans facilitated by our platform and our revenue.

Cross River Bank, or CRB, a New Jersey-chartered community bank, originates a substantial majority of the loans on our platform. In 2019, CRB originated approximately 89% of the loans facilitated on our platform. CRB also accounts for a large portion of our revenues. In 2019, fees received from CRB accounted for 80% of our total revenue. CRB funds a certain portion of these originated loans by retaining them on its own balance sheet, and sells the remainder of the loans to us, which we in turn sell to institutional investors and to our warehouse trust special purpose entities. Our most recent commercial arrangement with CRB began on January 1, 2019 and has a term of four years with an automatic renewal provision for an additional two years following the initial four year term. Either party may choose to not renew by providing the other party 120 days’ notice prior to the end of the initial term or any renewal term. In addition, even during the term of our arrangement, CRB could choose to reduce the volume of Upstart-powered loans that it chooses to fund and retain on its balance sheet or to originate at all. We or CRB may terminate our arrangement immediately upon a material breach and failure to cure such breach within a cure period, if any representations or warranties are found to be false and such error is not cured within a cure period, bankruptcy or insolvency of either party, receipt of an order or judgement by a governmental entity, a material adverse effect, or a change of control whereby such party involved in such change of control provides 90 days’ notice to the other and payment of a termination fee of $450,000. If we are unable to continue to increase the number of other bank partners on our platform or if CRB were to suspend, limit or cease their operations or otherwise terminate their relationship with us, our business, financial condition and results of operations would be adversely affected.

The sales and onboarding process of new bank partners could take longer than expected, leading to fluctuations or variability in expected revenues and results of operations.

Our sales and onboarding process with new bank partners can be long and typically takes between six to 15 months. As a result, revenues and results of operations may vary significantly from

 

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period to period. Prospective bank partners are often cautious in making decisions to implement our platform and related services because of the risk management alignment and regulatory uncertainties related to their use of our AI models, including their oversight, model governance and fair lending compliance obligations associated with using such models. In addition, prospective banks undertake an extensive diligence review of our platform, compliance and servicing activities before choosing to partner with us. Further, the implementation of our AI lending model often involves shifts by the bank partner to a new software and/or hardware platform or changes in their operational procedures, which may involve significant time and expense to implement. Delays in onboarding new bank partners can also arise while prospective bank partners complete their internal procedures to approve expenditures and test and accept our applications. Consequently, we face difficulty predicting the quarter in which new bank partners will begin using our platform and the volume of fees we will receive, which can lead to fluctuations in our revenues and results of operations.

Our business may be adversely affected by economic conditions and other factors that we cannot control.

Uncertainty and negative trends in general economic conditions, including significant tightening of credit markets, historically have created a difficult operating environment for our industry. Many factors, including factors that are beyond our control, may impact our results of operations or financial condition and the overall success by affecting a borrower’s willingness to incur loan obligations or willingness or capacity to make payments on their loans. These factors include interest rates, unemployment levels, conditions in the housing market, immigration policies, gas prices, energy costs, government shutdowns, trade wars and delays in tax refunds, as well as events such as natural disasters, acts of war, terrorism, catastrophes and pandemics.

For example, nearly all personal loans presently facilitated through our platform are issued with fixed interest rates. If interest rates rise, potential borrowers could seek to defer loans as they wait for interest rates to stabilize. As a result, fluctuations in the interest rate environment may discourage bank partners, investors and borrowers from engaging with our platform and as a result, reduce the volume of Upstart-powered loans.

Many new consumers on the Upstart platform have limited or no credit history. Accordingly, such borrowers have historically been, and may in the future become, disproportionately affected by adverse macroeconomic conditions. In addition, major medical expenses, divorce, death or other issues that affect borrowers could affect a borrower’s willingness or ability to make payments on their loans. If borrowers default on loans facilitated on our platform, the cost to service these loans may also increase without a corresponding increase in our servicing fees or other related fees and the value of the loans held on our balance sheet could decline. Higher default rates by these borrowers may lead to lower demand by our bank partners and institutional investors to fund loans facilitated by our platform, which would adversely affect our business, financial condition and results of operations.

During periods of economic slowdown or recession, our current and potential investors in our loan funding programs may reduce the number of loans or interests in loans they purchase or demand terms that are less favorable to us, to compensate for any increased risks. A reduction in the volume of the loans and loan financing products we sell would negatively impact our ability to maintain or increase the number of loans facilitated by our platform. Any sustained decline in demand for loans or loan financing products, or any increase in delinquencies, defaults or foreclosures that result from economic downturns, may harm our ability to maintain a robust loan funding program, which would adversely affect our business, financial condition and results of operations.

If there is an economic downturn that affects our current and prospective borrowers or our bank partners and institutional investors, our business, financial condition and results of operations could be adversely affected.

 

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Our AI models have not yet been tested in down-cycle economic conditions. If our AI models do not accurately reflect a borrower’s credit risk in such economic conditions, the performance of Upstart-powered loans may be worse than anticipated.

The performance of loans facilitated by our platform is significantly dependent on the effectiveness of our proprietary AI models used to evaluate a borrower’s credit profile and likelihood of default. Our AI models have been developed during a period of sustained economic growth, and our AI models have not been tested in a down-cycle economy or recession. There is no assurance that our AI models can accurately predict loan performance under adverse economic conditions. If our AI models are unable to accurately reflect the credit risk of loans under such economic conditions, our bank partners, investors in our loan funding programs and we may experience greater than expected losses on such loans, which would harm our reputation and erode the trust we have built with our bank partners and investors in our loan funding programs. In addition, the fair value of the loans on our balance sheet may decline. Any of these factors could adversely affect our business, financial condition and results of operations.

If we are unable to maintain a diverse and robust loan funding program, our growth prospects, business, financial condition and results of operations could be adversely affected.

Our business depends on sourcing and maintaining a diverse and robust loan funding program to fund Upstart-powered loans that our bank partners are unable or unwilling to retain on their balance sheets. In the fourth quarter of 2019, approximately 21% of Upstart-powered loans were retained through our bank partners’ balance sheets while approximately 72% of Upstart-powered loans were purchased by investors through our loan funding program, which includes whole loan sales to institutional investors, asset-backed securitization transactions, and utilization of committed and uncommitted warehouse credit facilities. While our loan funding program is diverse, only a limited portion of such funding sources are committed or guaranteed. We cannot be sure that these funding sources will continue to be available on reasonable terms or at all beyond the current maturity dates of our existing securitizations and debt financing arrangements.

Further, events of default or breaches of financial, performance or other covenants, or worse than expected performance of certain pools of loans underpinning our asset-backed securitizations or other debt facilities, could reduce or terminate our access to funding from institutional investors. Loan performance is dependent on a number of factors, including the predictiveness of our AI models and social and economic conditions. The availability and capacity of certain loan funding sources also depends on many factors that are outside of our control, such as credit market volatility and regulatory reforms. In the event of a sudden or unexpected shortage or restriction on the availability of loan funding sources, we may not be able to maintain the necessary levels of funding to retain current loan volume without incurring substantially higher funding costs, which could adversely affect our business, financial condition and results of operations.

Our business is subject to a wide range of laws and regulations, many of which are evolving, and failure or perceived failure to comply with such laws and regulations could harm our business, financial condition and results of operations.

The legal and regulatory environment surrounding our AI lending platform is relatively new, susceptible to change and may require clarification or interpretive guidance with respect to existing laws and regulations. The body of laws and regulations applicable to our business are complex and subject to varying interpretations, in many cases due to the lack of specificity regarding the application of AI and related technologies to the already highly regulated consumer lending industry. As a result, the application of such laws and regulations in practice may change or develop over time through judicial decisions or as new guidance or interpretations are provided by regulatory and governing bodies, such as federal, state and local administrative agencies.

 

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Since we launched our AI lending platform, we have been proactively working with state and local governments and regulatory bodies to ensure that our AI lending platform and other services are in compliance with applicable laws and regulations. For example, in 2017, after significant collaboration with the CFPB, the CFPB issued Upstart the first no-action letter regarding the use of alternative variables and AI and machine learning in credit decision-making. Such no-action letter will expire on September 14, 2020. We intend to apply for relief under the CFPB’s new no-action letter policies adopted in 2018, which replace the prior policy under which our current no-action letter was issued. We can provide no assurance that the CFPB will provide such relief or will not change its position regarding supervisory or enforcement action against us in the future. We plan to continue working and collaborating closely with regulators to provide visibility into AI and related emerging technologies and the potential benefits such technologies can have on the consumer lending industry, while also addressing the related risks. New laws and regulations and changes to existing laws and regulations continue to be adopted, implemented and interpreted in response to our industry and the emergence of AI and related technologies. As we expand our business into new markets, introduce new loan products on our platform and continue to improve and evolve our AI models, regulatory bodies or courts may claim that we are subject to additional requirements. Such regulatory bodies could reject our applications for licenses or deny renewals, delay or impede our ability to operate, charge us fees or levy fines or penalties, or otherwise disrupt our ability to operate our AI lending platform, any of which could adversely affect our business, financial condition and results of operations.

Recent financial, political and other events may increase the level of regulatory scrutiny on financial technology companies. Regulatory bodies may enact new laws or promulgate new regulations or view matters or interpret laws and regulations differently than they have in the past, or commence investigations or inquiries into our business practices. For example, in February 2020, we received a letter from certain members of the U.S. Senate asking questions in connection with claims of discriminatory lending made by an advocacy group. We have responded to this inquiry. Any such investigations or inquiries, whether or not accurate or warranted, or whether concerning us or one of our competitors, could negatively affect our brand and reputation and the overall market acceptance of and trust in our AI lending platform. Any of the foregoing could harm our business, financial condition and results of operations.

We rely on strategic relationships with loan aggregators to attract applicants to our platform, and if we cannot maintain effective relationships with loan aggregators or successfully replace their services, our business could be adversely affected.

A significant number of consumers that apply for a loan on Upstart.com learn about and access Upstart.com through the website of a loan aggregator, typically with a hyperlink from such loan aggregator’s website to a landing page on our website. For example, in 2019, 38% of loan originations were derived from traffic from Credit Karma. Our current agreement with Credit Karma began on August 1, 2014 and was most recently amended on July 1, 2019. Either party may terminate our arrangement immediately upon a material breach of any provision of the agreement or at any time, with or without cause, by providing no less than 30 days’ notice. Even during the term of our agreement, our agreement does not require Credit Karma to display offers from lenders on Upstart.com nor prohibit them from working with our competitors or from offering competing services. Further, there is no assurance that Credit Karma will continue its contract with us on commercially reasonable terms or at all. For example, Intuit Inc. recently announced that it has agreed to acquire Credit Karma. If such acquisition is completed, Intuit may not continue our agreement on commercially reasonable terms or at all, which would adversely affect our business.

While we are planning to move towards more direct acquisition channels, we anticipate that we will continue to depend in significant part on relationships with loan aggregators to maintain and grow our business. Our current agreements with these loan aggregators do not require them to display

 

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offers from lenders on Upstart.com nor prohibit them from working with our competitors or from offering competing services. Further, there is no assurance that a loan aggregator will renew its contract with us on commercially reasonable terms or at all. Our competitors may be effective in providing incentives to loan aggregators to favor their products or services or in reducing the volume of loans facilitated through our platform. Loan aggregators may not perform as expected under our agreements with them, and we may have disagreements or disputes with them, which could adversely affect our brand and reputation. If we cannot successfully enter into and maintain effective strategic relationships with loan aggregators, our business could be adversely affected.

In addition, the limited information such loan aggregators collect from applicants does not always allow us to offer rates to applicants that we would otherwise be able to through direct applicant traffic to Upstart.com. Typically, the rates offered to borrowers who come to Upstart.com directly are lower and more competitive than those rates offered through aggregators. In the event we do not successfully optimize direct traffic, our ability to attract borrowers would be adversely affected.

Such loan aggregators also face litigation and regulatory scrutiny for their part in the consumer lending ecosystem, and as a result, their business models may require fundamental change or may not be sustainable in the future. For example, loan aggregators are increasingly required to be licensed as loan brokers or lead generators in many states, subjecting them to increased regulatory supervision and more stringent business requirements. While we require loan aggregators to make certain disclosures in connection with our bank partners’ offers and restrict how loan aggregators may display such loan offers, loan aggregators may nevertheless alter or even remove these required disclosures without notifying us, which may result in liability to us. Further, we do not have control over any content on loan aggregator websites, and it is possible that our brand and reputation may be adversely affected by being associated with such content. An unsatisfied borrower could also seek to bring claims against us based on the content presented on a loan aggregator’s website. Such claims could be costly and time consuming to defend and could distract management’s attention from the operation of the business.

We currently only offer one type of loan product on our platform, and we are thus particularly susceptible to fluctuations in the unsecured personal loan market and do not currently offer a broad suite of products that bank partners may find desirable.

While we plan to expand the type of loan products offered on our platform, the only loan product currently available on our platform is unsecured personal loans. The market for unsecured personal loans has grown rapidly in recent years, and it is unclear to what extent such market will continue to grow, if at all. A wide variety of factors could impact the market for unsecured personal loans, including macroeconomic conditions, competition, regulatory developments and other developments in the credit market. For example, FICO has recently changed its methodology in calculating credit scores in a manner that potentially penalizes borrowers who take out personal loans to pay off or consolidate credit card debt. This change could negatively affect the overall demand for personal loans. Our success will depend in part on the continued growth of the unsecured personal loan market, and if such market does not further grow or grows more slowly than we expect, our business, financial condition and results of operations could be adversely affected.

In addition, bank partners may in the future seek partnerships with competitors that are able to offer them a broader array of credit products. Over time, in order to preserve and expand our relationships with our existing bank partners, and enter into new bank partnerships, it may become increasingly important for us to be able to offer a wider variety of products than we currently provide. We are also susceptible to competitors that may intentionally underprice their loan products, even if such pricing practices lead to losses. Such practices by competitors would negatively affect the overall demand for personal loans facilitated on our platform.

 

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Further, because such personal loans are unsecured, there is a risk that borrowers will not prioritize repayment of such loans, particularly in any economic downcycle. To the extent borrowers have or incur other indebtedness that is secured, such as a mortgage, a home equity line of credit or an auto loan, borrowers may choose to repay obligations under such secured indebtedness before repaying their Upstart-powered loans. In addition, borrowers may not view Upstart-powered loans, which were originated through an online lending platform, as having the same significance as other credit obligations arising under more traditional circumstances, such as loans from banks or other commercial financial institutions. Any of the forgoing could lead to higher default rates and decreased demand by our bank partners and institutional investors to fund loans facilitated by our platform, which would adversely affect our business, financial condition and results of operations.

We are also more susceptible to the risks of changing and increased regulations and other legal and regulatory actions targeted towards the unsecured personal loan market. It is possible that regulators may view unsecured personal loans as high risk for a variety of reasons, including that borrowers will not prioritize repayment of such loans due to the unsecured nature of such loans or because existing laws and regulations may not sufficiently address the benefits and corresponding risks related to financial technology as applied to consumer lending. If we are unable to manage the risks associated with the unsecured personal loan market, our business, financial condition and results of operations could be adversely affected.

We are continuing to develop new loan products and services offerings, and if we are unable to manage the related risks, our growth prospects, business, financial condition and results of operations could be adversely affected.

We are continuing to invest in developing new loan products and service offerings, such as auto loans, student loans, point-of-sale loans and home equity lines of credit, as well as a credit decision application programming interface to allow banks to utilize our AI underwriting models to support their loan origination process for personal, auto, and student loans. New initiatives are inherently risky, as each involves unproven business strategies, new regulatory requirements and new financial products and services with which we, and in some cases our bank partners, have limited or no prior development or operating experience.

We cannot be sure that we will be able to develop, commercially market and achieve market acceptance of any new products and services. In addition, our investment of resources to develop new products and services may either be insufficient or result in expenses that are excessive in light of revenue actually derived from these new products and services. If the profile of loan applicants using any new products and services is different from that of those currently served by our existing loan products, our AI models may not be able to accurate evaluate the credit risk of such borrowers, and our bank partners and investors in our loan funding programs may in turn experience higher levels of delinquencies or defaults. Failure to accurately predict demand or growth with respect to our new products and services could have an adverse impact on our reputation and business, and there is always risk that new products and services will be unprofitable, will increase our costs, decrease operating margins or take longer than anticipated to achieve target margins. In addition, any new products or services may raise new and potentially complex regulatory compliance obligations, which would increase our costs and may cause us to change our business in unexpected ways. Further, our development efforts with respect to these initiatives could distract management from current operations and will divert capital and other resources from our existing business.

We may also have difficulty with securing adequate funding for any such new loan products and services, and if we are unable to do so, our ability to develop and grow these new offerings and services will be impaired. If we are unable to effectively manage the foregoing risks, our growth prospects, business, financial condition and results of operations could be adversely affected.

 

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Our reputation and brand are important to our success, and if we are unable to continue developing our reputation and brand, our ability to retain existing and attract new bank partners, our ability to attract borrowers to our platform and our ability to maintain and improve our relationship with regulators of our industry could be adversely affected.

We believe maintaining a strong brand and trustworthy reputation is critical to our success and our ability to attract borrowers to our platform, attract new bank partners and maintain good relations with regulators. Factors that affect our brand and reputation include: perceptions of artificial intelligence, our industry and our company, including the quality and reliability of our AI lending platform; the accuracy of our AI models; perceptions regarding the application of artificial intelligence to consumer lending specifically; our loan funding programs; changes to the Upstart platform; our ability to effectively manage and resolve borrower complaints; collection practices; privacy and security practices; litigation; regulatory activity; and the overall user experience of our platform. Negative publicity or negative public perception of these factors, even if inaccurate, could adversely affect our brand and reputation.

For example, consumer advocacy groups, politicians and certain government and media reports have, in the past, advocated governmental action to prohibit or severely restrict consumer loan arrangements where banks contract with a third-party platform such as ours to provide origination assistance services to bank customers. These arrangements have sometimes been criticized as “renting-a-bank charter.” Such criticism has frequently been levied in the context of payday loan marketers, though other entities operating programs through which loans similar to Upstart-powered loans are originated have also faced criticism. The perceived improper use of a bank charter by these entities has been challenged by both governmental authorities and private litigants, in part because of the high rates and fees charged to consumers in certain payday and small-dollar lending programs. Bank regulators have even required banks to exit third-party programs that the regulators determined involved unsafe and unsound practices. The payday or “small-dollar” loans that have been subject to more frequent criticism and challenge are fundamentally different from Upstart-powered loans in many ways, including that Upstart-powered loans typically have lower interest rates and longer terms, and Upstart-powered loans do not renew. In particular, interest rates of Upstart-powered loans have always been and are currently less than 36%, as compared to the triple-digit interest rates of many payday or small dollar loans that have been subject to such criticism. If we are nevertheless associated with such payday or small-dollar consumer loans, or if we are associated with increased criticism of non-payday loan programs involving relationships between bank originators and non-bank lending platforms and program managers, demand for Upstart-powered loans could significantly decrease, which could cause our bank partners to reduce their origination volumes or terminate their arrangements with us, impede our ability to attract new bank partners or delay the onboarding of bank partners, impede our ability to attract institutional investors to participate in our loan funding programs or reduce the number of potential borrowers who use our platform. Any of the foregoing could adversely affect our results of operations and financial condition.

Any negative publicity or public perception of Upstart-powered loans or other similar consumer loans or the consumer lending service we provide may also result in us being subject to more restrictive laws and regulations and potential investigations and enforcement actions. In addition, regulators may decide they are no longer supportive of our AI lending platform if there is enough negative perception surrounding such practices. We may also become subject to lawsuits, including class action lawsuits, or other challenges such as government enforcement or arbitration, against our bank partners or us for loans originated by our bank partners on our platform, loans we service or have serviced. If there are changes in the laws or in the interpretation or enforcement of existing laws affecting consumer loans similar to those offered on our platform, or our marketing and servicing of such loans, or if we become subject to such lawsuits, our business, financial condition and results of operations would be adversely affected.

 

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Artificial intelligence and related technologies are subject to public debate and heightened regulatory scrutiny. Any negative publicity or negative public perception of artificial intelligence could negatively impact demand for our AI lending platform, hinder our ability to attract new bank partners or slow the rate at which banks adopt our AI lending platform. From time to time, certain advocacy groups have made claims that unlawful or unethical discriminatory effects may result from the use of AI technology by various companies, including ours. Such claims, whether or not accurate, and whether or not concerning us or our AI lending platform, may harm our ability to attract prospective borrowers to our platform, retain existing and attract new bank partners and achieve regulatory acceptance of our business. For example, in February 2020, we received a letter from certain members of the U.S. Senate asking questions in connection with claims of discriminatory lending made by such an advocacy group. We have responded to this inquiry. Negative public perception, actions by advocacy groups or legislative and regulatory interest groups could lead to lobbying for and enactment of more restrictive laws and regulations that impact the use of AI technology in general, AI technology as applied to lending operations generally or as used in our applications more specifically. Any of the foregoing could negatively impact our business, financial condition and results of operations.

Harm to our reputation can also arise from many other sources, including employee or former employee misconduct, misconduct by outsourced service providers or other counterparties, failure by us or our bank partners to meet minimum standards of service and quality, and inadequate protection of borrower information and compliance failures and claims. If we are unable to protect our reputation, our business, financial condition and results of operations would be adversely affected.

If we do not compete effectively in our target markets, our business, results of operations and financial condition could be harmed.

The consumer lending market is highly competitive and increasingly dynamic as emerging technologies continue to enter into the marketplace. With the introduction of new technologies and the influx of new entrants, competition may persist and intensify in the future, which could have an adverse effect on our operations or business.

Our inability to compete effectively could result in reduced loan volumes, reduced average size of loans facilitated on our platform, reduced fees, increased marketing and borrower acquisition costs or the failure of the Upstart platform to achieve or maintain more widespread market acceptance, any of which could have an adverse effect on our business and results of operations.

Consumer lending is a vast and competitive market, and we compete to varying degrees with all other sources of unsecured consumer credit. This can include banks, non-bank lenders including retail-based lenders and other financial technology lending platforms. Because personal loans often serve as a replacement for credit cards, we also compete with the convenience and ubiquity that credit cards represent. Many of our competitors operate with different business models, such as lending-as-a-service or point-of-sale lending, have different cost structures or regulatory obligations, or participate selectively in different market segments. They may ultimately prove more successful or more adaptable to new regulatory, economic, technological and other developments, including utilizing new data sources or credit models. We may also face competition from banks or companies that have not previously competed in the consumer lending market, including companies with access to vast amounts of consumer-related information that could be used in the development of their own credit risk models. Our current or potential competitors may be better at developing new products due to their large and experienced data science and engineering teams, who are able to respond more quickly to new technologies. Many of our current or potential competitors have significantly more resources, such as financial, technical and marketing resources, than we do and may be able to devote greater resources to the development, promotion, sale and support of their platforms and distribution channels. We face competition in areas such as compliance capabilities, commercial financing terms and costs of

 

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capital, interest rates and fees (and other financing terms) available to consumers from our bank partners, approval rates, model efficiency, speed and simplicity of loan origination, ease-of-use, marketing expertise, service levels, products and services, technological capabilities and integration, borrower experience, brand and reputation, and terms available to our loan funding investor base. Our competitors may also have longer operating histories, lower commercial financing costs or costs of capital, more extensive borrower bases, more diversified products and borrower bases, operational efficiencies, more versatile or extensive technology platforms, greater brand recognition and brand loyalty, broader borrower and partner relationships, more extensive and/or more diversified loan funding investor bases than we have, and more extensive product and service offerings than we have. Furthermore, our existing and potential competitors may decide to modify their pricing and business models to compete more directly with us. Our ability to compete will also be affected by our ability to provide our bank partners with a commensurate or more extensive suite of loan products than those offered by our competitors. In addition, current or potential competitors, including financial technology lending platforms and existing or potential bank partners, may also acquire or form strategic alliances with one another, which could result in our competitors being able to offer more competitive loan terms due to their access to lower-cost capital. Such acquisitions or strategic alliances among our competitors or potential competitors could also make our competitors more adaptable to a rapidly evolving regulatory environment. To stay competitive, we may need to increase our regulatory compliance resources spend or our ability to compete may be adversely affected.

Our industry is driven by constant innovation. We utilize artificial intelligence and machine learning, which is characterized by extensive research efforts and rapid technological progress. If we fail to anticipate or respond adequately to technological developments, our ability to operate profitably could suffer. There can be no assurance that research, data accumulation and development by other companies will not result in AI models that are superior to our AI models or result in products superior to those we develop or that any technologies, products or services we develop will be preferred to any existing or newly-developed technologies, products or services. If we are unable to compete with such companies or fail to meet the need for innovation in our industry, the use of the Upstart platform could stagnate or substantially decline, or our loan products could fail to maintain or achieve more widespread market acceptance, which could harm our business, results of operations and financial condition.

Our proprietary AI models rely in part on the use of loan applicant and borrower data and other third-party data, and if we lose the ability to use such data, or if such data contain inaccuracies, our business could be adversely affected.

We rely on our proprietary AI models, which are statistical models built using a variety of data-sets. Our AI models rely on a wide variety of data sources, including data collected from applicants and borrowers, credit bureau data and our credit experience gained through monitoring the payment performance of borrowers over time. Under our agreements with our bank partners, we receive licenses to use data collected from loan applicants and borrowers. If we are unable to access and use data collected from applicants and borrowers, repayment data collected as part of our loan servicing activities, or other third-party data used in our AI models, or our access to such data is limited, our ability to accurately evaluate potential borrowers, detect fraud and verify applicant data would be compromised. Any of the foregoing could negatively impact the accuracy of our pricing decisions, the degree of automation in our loan application process and the volume of loans facilitated on our platform.

Third-party data sources on which we rely include the consumer reporting agencies regulated by the CFPB and other alternative data sources. Such data is electronically obtained from third parties and used in our AI models to price applicants and in our fraud model to verify the accuracy of applicant-reported information. Data from national credit bureaus and other consumer reporting agencies and other information that we receive from third parties about an applicant or borrower, may

 

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be inaccurate or may not accurately reflect the applicant or borrower’s creditworthiness for a variety of reasons, including inaccurate reporting by creditors to the credit bureaus, errors, staleness or incompleteness. For example, loan applicants’ credit scores may not reflect such applicants’ actual creditworthiness because the credit scores may be based on outdated, incomplete or inaccurate consumer reporting data, including, as a consequence of us utilizing credit reports for a specific period of time after issuance before such reports are deemed to be outdated. Similarly, the data taken from an applicant’s credit report may also be based on outdated, incomplete or inaccurate consumer reporting data. Although we use numerous third-party data sources and multiple credit factors within our proprietary models, which helps mitigate this risk, it does not eliminate the risk of an inaccurate individual report.

Further, although we attempt to verify the income, employment and education information provided by certain selected applicants, we cannot guarantee the accuracy of applicant information. Our fraud model relies in part on data we receive from a number of third-party verification vendors, data collected from applicants, and our experience gained through monitoring the performance of borrowers over time. Information provided by borrowers may be incomplete, inaccurate or intentionally false. Applicants may also misrepresent their intentions for the use of loan proceeds. We do not verify or confirm any statements by applicants as to how loan proceeds are to be used after loan funding. If an applicant supplied false, misleading or inaccurate information and our fraud detection processes do not flag the application, repayments on the corresponding loan may be lower, in some cases significantly lower, than expected, leading to losses for the bank partner or investor.

In addition, if third party data used to train and improve our AI models is inaccurate, or access to such third-party data is limited or becomes unavailable to us, our ability to continue to improve our AI models would be adversely affected. Any of the foregoing could result in sub-optimally and inefficiently priced loans, incorrect approvals or denials of loans, or higher than expected loan losses, which in turn could adversely affect our ability to attract new borrowers and partners to our platform or increase the number of Upstart-powered loans and adversely affect our business, financial condition and results of operations.

If we are unable to manage the risks associated with fraudulent activity, our brand and reputation, business, financial condition and results of operations could be adversely affected.

Fraud is prevalent in the financial services industry and is likely to increase as perpetrators become more sophisticated. We are subject to the risk of fraudulent activity associated with borrowers and third parties handling borrower information and in limited situations cover certain fraud losses of our bank partners and investors in our loan funding programs. Fraud rates could also increase in a downcycle economy. We use several identity and fraud detection tools, including tools provided by third-party vendors and our proprietary AI models, to predict and otherwise validate or authenticate applicant-reported data and data derived from third-party sources. If such efforts are insufficient to accurately detect and prevent fraud, the level of fraud-related losses of Upstart-powered loans could increase, which would decrease confidence in our AI lending platform. In addition, our bank partners, investors in our loan funding programs or we may not be able to recover amounts disbursed on loans made in connection with inaccurate statements, omissions of fact or fraud, which could erode the trust in our brand and negatively impact our ability to attract new bank partners and investors in our loan funding programs.

High profile fraudulent activity also could negatively impact our brand and reputation. In addition, significant increases in fraudulent activity could lead to regulatory intervention, which could increase our costs and also negatively impact our brand and reputation. Further, if there is any increase in fraudulent activity that increases the need for human intervention in screening loan application data, the level of automation on our platform could decline and negatively affect our unit economics. If we

 

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are unable to manage these risks, our business, financial condition and results of operations could be adversely affected.

We depend on our key personnel and other highly skilled personnel, and if we fail to attract, retain and motivate our personnel, our business, financial condition and results of operations could be adversely affected.

Our success significantly depends on the continued service of our senior management team, including Dave Girouard, our Co-Founder and Chief Executive Officer, and Paul Gu, our Co-Founder and SVP of Product and Data Science, and other highly skilled personnel. Our success also depends on our ability to identify, hire, develop, motivate and retain highly qualified personnel for all areas of our organization.

Competition for highly skilled personnel, including engineering and data analytics personnel, is extremely intense, particularly in the San Francisco Bay Area where our headquarters is located. We have experienced, and expect to continue to face, difficulty identifying and hiring qualified personnel in many areas, especially as we pursue our growth strategy. We may not be able to hire or retain such personnel at compensation levels consistent with our existing compensation and salary structure. Many of the companies with which we compete for experienced employees have greater resources than we have and may be able to offer more attractive terms of employment. In particular, candidates making employment decisions, specifically in high-technology industries, often consider the value of any equity they may receive in connection with their employment. Any significant volatility in the price of our stock after this offering may adversely affect our ability to attract or retain highly skilled technical, financial and marketing personnel.

In addition, we invest significant time and expense in training our employees, which increases their value to competitors who may seek to recruit them. If we fail to retain our employees, we could incur significant expenses in hiring and training their replacements. While we are in the process of training their replacements, the quality of our services and our ability to serve our bank partners, investors and borrowers whose loans we service may suffer, resulting in an adverse effect on our business.

Security breaches of borrowers’ confidential information that we store may harm our reputation, adversely affect our results of operations and expose us to liability.

We are increasingly dependent on information technology systems and infrastructure to operate our business. In the ordinary course of our business, we collect, process, transmit and store large amounts of sensitive information, including personal information, credit information and other sensitive data of borrowers and potential borrowers. It is critical that we do so in a manner designed to maintain the confidentiality, integrity and availability of such sensitive information. We also have arrangements in place with certain of our third-party vendors that require us to share consumer information. We have outsourced elements of our operations (including elements of our information technology infrastructure) to third parties, and as a result, we manage a number of third-party vendors who may have access to our computer networks and sensitive or confidential information. In addition, many of those third parties may in turn subcontract or outsource some of their responsibilities to other third parties. As a result, our information technology systems, including the functions of third parties that are involved or have access to those systems, is large and complex, with many points of entry and access. While all information technology operations are inherently vulnerable to inadvertent or intentional security breaches, incidents, attacks and exposures, the size, complexity, accessibility and distributed nature of our information technology systems, and the large amounts of sensitive information stored on those systems, make such systems potentially vulnerable to unintentional or malicious, internal and external attacks. Any vulnerabilities can be exploited from inadvertent or intentional actions of our employees,

 

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third-party vendors, bank partners, loan investors, or by malicious third parties. Attacks of this nature are increasing in their frequency, levels of persistence, sophistication and intensity, and are being conducted by sophisticated and organized groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, “hacktivists,” nation states and others. In addition to the extraction of sensitive information, such attacks could include the deployment of harmful malware, ransomware, denial-of-service attacks, social engineering and other means to affect service reliability and threaten the confidentiality, integrity and availability of information and systems. In addition, the prevalent use of mobile devices increases the risk of data security incidents. Significant disruptions of our, our third-party vendors’ and/or business partners’ information technology systems or other similar data security incidents could adversely affect our business operations and result in the loss, misappropriation, or unauthorized access, use or disclosure of, or the prevention of access to, sensitive information, which could result in financial, legal, regulatory, business and reputational harm to us.

Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until they are launched against a target, we and our vendors may be unable to anticipate these techniques or to implement adequate preventative measures. In addition, many governments have enacted laws requiring companies to notify individuals of data security breaches involving their personal data. These mandatory disclosures regarding a security breach are costly to implement and often lead to widespread negative publicity following a breach, which may cause borrowers and potential borrowers to lose confidence in the effectiveness of our data security measures on our platform. Any security breach, whether actual or perceived, would harm our reputation and ability to attract new borrowers to our platform.

We also face indirect technology, cybersecurity and operational risks relating to the borrowers, bank partners, investors, vendors and other third parties with whom we do business or upon whom we rely to facilitate or enable our business activities, including vendors, payment processors, and other parties who have access to confidential information due to our agreements with them. In addition, any security compromise in our industry, whether actual or perceived, or information technology system disruptions, whether from attacks on our technology environment or from computer malware, natural disasters, terrorism, war and telecommunication and electrical failures, could interrupt our business or operations, harm our reputation, erode borrower confidence, negatively affect our ability to attract new borrowers, or subject us to third-party lawsuits, regulatory fines or other action or liability, which could adversely affect our business and results of operations.

Like other financial services firms, we have been and continue to be the subject of actual or attempted unauthorized access, mishandling or misuse of information, computer viruses or malware, and cyber-attacks that could obtain confidential information, destroy data, disrupt or degrade service, sabotage systems or cause other damage, distributed denial of service attacks, data breaches and other infiltration, exfiltration or other similar events.

While we regularly monitor data flow inside and outside the company, attackers have become very sophisticated in the way they conceal access to systems, and we may not be aware that we have been attacked. Any event that leads to unauthorized access, use or disclosure of personal information or other sensitive information that we or our vendors maintain, including our own proprietary business information and sensitive information such as personal information regarding borrowers, loan applicants or employees, could disrupt our business, harm our reputation, compel us to comply with applicable federal and/or state breach notification laws and foreign law equivalents, subject us to time consuming, distracting and expensive litigation, regulatory investigation and oversight, mandatory corrective action, require us to verify the correctness of database contents, or otherwise subject us to liability under laws, regulations and contractual obligations, including those that protect the privacy and security of personal information. This could result in increased costs to us and result in significant legal

 

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and financial exposure and/or reputational harm. In addition, any failure or perceived failure by us or our vendors to comply with our privacy, confidentiality or data security-related legal or other obligations to third parties, actual or perceived security breaches, or any security incidents or other events that result in the unauthorized access, release or transfer of sensitive information, which could include personally identifiable information, may result in governmental investigations, enforcement actions, regulatory fines, litigation, or public statements against us by advocacy groups or others, and could cause third parties to lose trust in us or we could be subject to claims by third parties that we have breached our privacy- or confidentiality-related obligations, which could harm our business and prospects. Moreover, data security incidents and other inappropriate access can be difficult to detect, and any delay in identifying them may lead to increased harm of the type described above. There can be no assurance that our security measures intended to protect our information technology systems and infrastructure will successfully prevent service interruptions or security incidents. For example, in April 2020, we were made aware of a software error which allowed access to certain consumers’ accounts through the Upstart website without providing such consumers’ passwords. As a result, certain of such consumers’ personal information, such as their name, address and job information (but not full social security information), could be accessed by a third party. We promptly deployed an update to our software to address such vulnerability and are conducting an internal investigation. Thus far, we are not aware of any information being compromised as a result of this error. We cannot provide any assurance that similar vulnerabilities will not arise in the future as we continue to expand the features and functionalities of our platform and introduce new loan products on our platform, and we expect to continue investing substantially to protect against security vulnerabilities and incidents.

We maintain errors, omissions, and cyber liability insurance policies covering certain security and privacy damages. However, we cannot be certain that our coverage will continue to be available on economically reasonable terms or will be available in sufficient amounts to cover one or more large claims, or that an insurer will not deny coverage as to any future claim, or that any insurer will be adequately covered by reinsurance or other risk mitigants or that any insurer will offer to renew policies at an affordable rate or offer such coverage at all in the future. The successful assertion of one or more large claims against us that exceed available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have an adverse effect on our business, financial condition and results of operations.

If we are unable to manage the risks related to our loan servicing and collections obligations, our business, financial condition and results of operations could be adversely affected.

Upstart-powered loans are not secured by any collateral, guaranteed or insured by any third party or backed by any governmental authority. As a result, we are limited in our ability to collect on such loans on behalf of our bank partners and investors of our loan funding programs if a borrower is unwilling or unable to repay them. Substantially all our collection duties and obligations for loans we service that are more than 30 days past due are subcontracted to several collection agencies. If such collection agencies do not perform as expected under our agreements with them or if these collection agents act unprofessionally and otherwise harm the user experience for borrowers of Upstart-powered loans, our brand and reputation could be harmed and our ability to attract potential borrowers to our platform could be negatively impacted. For example, during periods of increased delinquencies caused by economic downturns or otherwise, it is important that the collection agents are proactive and consistent in contacting a borrower to bring a delinquent balance current and ultimately avoid the related loan becoming charged off, which in turn makes it extremely important that the collection agents are properly staffed and trained to take prompt and appropriate action. If the collection agents are unable to maintain a high quality of service, or fulfill their servicing obligations at all due to resource constraints resulting from the increased delinquencies, it could result in increased delinquencies and charge-offs on the loans, which could decrease fees payable to us, cause our bank partners to

 

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decrease the volume of Upstart-powered loans kept on their balance sheets, erode trust in our platform or increase the costs of our loan funding programs. In addition, loan servicing is a highly manual process and an intensely regulated activity. If we are unable to comply with such laws and regulations, we could lose one or more of our licenses or authorizations, become subject to greater scrutiny by regulatory agencies or become subject to sanctions or litigation, which may have an adverse effect on our ability to perform our servicing obligations or make our platform available to borrowers in particular states. Any of the foregoing could adversely affect our business, financial condition and results of operations.

We primarily rely on two collection agents to perform substantially all of our duties as the servicer for delinquent and defaulted loans. One or more collection agents could take actions that result in our arrangements becoming cost prohibitive or enter into exclusive or more favorable relationships with our competitors. If any of our collection agencies were to suspend or cease operations, or our relationship with one or more of them were to otherwise terminate, such as in the case of resource constraints caused by an economic downturn, we may need to implement substantially similar arrangements with other collection agencies on terms that may not be commercially attractive. Transitioning this aspect of loan servicing to a new collection agency may result in disruptions to our ability to service the loans made on our platform and loan performance may be impacted as a result. If we are unsuccessful in maintaining our relationships with our current collection agencies, our business, financial condition or results of operations may be adversely affected.

In addition, we charge our loan holders a fixed percentage servicing fee based on the outstanding balance of loans serviced. If we fail to efficiently service such loans and the costs incurred exceed the servicing fee charged, our results of operations would be adversely affected.

In connection with our loan funding programs, we make representations and warranties concerning the loans sold, and if such representations and warranties are not accurate when made, we could be required to repurchase the loans.

In our loan funding programs, including asset-backed securitizations and whole loan sales, we make numerous representations and warranties concerning the characteristics of the Upstart-powered loans sold and transferred in connection with such transactions, including representations and warranties that the loans meet the eligibility requirements of those facilities and of investors in our loan funding programs. If those representations and warranties were not accurate when made, we may be required to repurchase the underlying loans. Failure to repurchase so-called ineligible loans when required could constitute an event of default or termination event under the agreements governing our various loan funding programs. Through June 30, 2020, the number of repurchased Upstart-powered loans as a result of inaccurate representations and warranties represents less than 0.5% of all Upstart-powered loans. While only a small number of Upstart-powered loans have been historically repurchased by the Company, there can be no assurance that we would have adequate cash or other qualifying assets available to make such repurchases if and when required. Such repurchases could be limited in scope, relating to small pools of loans, or significant in scope, across multiple pools of loans. If we were required to make such repurchases and if we do not have adequate liquidity to fund such repurchases, our business, financial condition and results of operations could be adversely affected.

Borrowers may prepay a loan at any time without penalty, which could reduce our servicing fees and deter our bank partners and investors from investing in loans facilitated by our platform.

A borrower may decide to prepay all or a portion of the remaining principal amount on a loan at any time without penalty. If the entire or a significant portion of the remaining unpaid principal amount of a loan is prepaid, we would not receive a servicing fee, or we would receive a significantly lower servicing fee associated with such prepaid loan. Prepayments may occur for a variety of reasons,

 

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including if interest rates decrease after a loan is made. If a significant volume of prepayments occurs, the amount of our servicing fees would decline, which could harm our business and results of operations. Our AI models are designed to predict prepayment rates. However, if a significant volume of prepayments occur that our AI models do not accurately predict, returns targeted by our bank partners and investors in our loan funding programs would be adversely affected and our ability to attract new bank partners and investors in our loan funding programs would be negatively affected.

Our marketing efforts and brand promotion activities may not be effective.

Promoting awareness of our AI lending platform is important to our ability to grow our business, attract new bank partners, increase the number of potential borrowers on our platform and attract investors to participate in our loan funding programs. We believe that the importance of brand recognition will increase as competition in the consumer lending industry expands. However, because our bank partners are increasingly adopting our white-labeled version of our AI lending platform through their own websites, potential borrowers may not be aware they are experiencing our AI lending platform, which may hinder recognition of our brand. Successful promotion of our brand will depend largely on the effectiveness of marketing efforts and the overall user experience of our bank partners and potential borrowers on the Upstart platform, which factors are outside our control. The marketing channels that we employ may also become more crowded and saturated by other lending platforms, which may decrease the effectiveness of our marketing campaigns and increase borrower acquisition costs. Also, the methodologies, policies and regulations applicable to marketing channels may change. For example, internet search engines could revise their methodologies, which could adversely affect borrower volume from organic ranking and paid search. Search engines may also implement policies that restrict the ability of companies such as us to advertise their services and products, which could prevent us from appearing in a favorable location or any location in the organic rankings or paid search results when certain search terms are used by the consumer.

Our brand promotion activities may not yield increased revenues. If we fail to successfully build trust in our AI lending platform and the performance and predictability of Upstart-powered loans, we may lose existing bank partners and investors in our loan funding programs to our competitors or be unable to attract new bank partners and investors in our loan funding programs, which in turn would harm our business, results of operations and financial condition. Even if our marketing efforts result in increased revenue, we may be unable to recover our marketing costs through increases in loan volume, which could result in a higher borrower acquisition cost per account. Any incremental increases in loan servicing costs, such as increases due to greater marketing expenditures, could have an adverse effect on our business, financial condition and results of operations.

Any significant disruption in our AI lending platform could prevent us from processing loan applicants and servicing loans, reduce the effectiveness of our AI models and result in a loss of bank partners or borrowers.

In the event of a system outage or other event resulting in data loss or corruption, our ability to process loan applications, service loans or otherwise facilitate loans on our platform would be adversely affected. We also rely on facilities, components, and services supplied by third parties, including data center facilities and cloud storage services. We host our AI lending platform using Amazon Web Services, or AWS, a provider of cloud infrastructure services. In the event that our AWS service agreements are terminated, or there is a lapse of service, interruption of internet service provider connectivity or damage to AWS data centers, we could experience interruptions in access to our platform as well as delays and additional expense in the event we must secure alternative cloud infrastructure services. Any interference or disruption of our technology and underlying infrastructure or our use of third-party services could adversely affect our relationships with our bank partners and investors in our funding programs, and the overall user experience of our platform. Also, as our

 

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business grows, we may be required to expand and improve the capacity, capability and reliability of our infrastructure. If we are not able to effectively address capacity constraints, upgrade our systems as needed and continually develop our technology and infrastructure to reliably support our business, our business, financial condition and results of operations could be adversely affected.

Additionally, in the event of damage or interruption, our insurance policies may not adequately compensate us for any losses incurred. Our disaster recovery plan has not been tested under actual disaster conditions, and we may not have sufficient capacity to recover all data and services in the event of an outage or other event resulting in data loss or corruption. These factors could prevent us from processing or posting payments on the loans, damage our brand and reputation, divert our employees’ attention, subject us to liability and cause borrowers to abandon our business, any of which could adversely affect our business, results of operations and financial condition.

Our platform and internal systems rely on software that is highly technical, and if our software contains undetected errors, our business could be adversely affected.

Our platform and internal systems rely on software that is highly technical and complex. In addition, our platform and internal systems depend on the ability of such software to store, retrieve, process and manage high volumes of data. The software in which we rely has contained, and may now or in the future contain, undetected errors or bugs. Some errors may only be discovered after the code has been released for external or internal use. Errors or other design defects within the software on which we rely may result in failure to accurately predict a loan applicant’s creditworthiness, failure to comply with applicable laws and regulations, approval of sub-optimally priced loans, failure to detect fraudulent activity on our platform, a negative experience for consumers or bank partners, delayed introductions of new features or enhancements, or failure to protect borrower data or our intellectual property. Any errors, bugs or defects discovered in the software on which we rely could result in harm to our reputation, loss of consumers or bank partners, increased regulatory scrutiny, fines or penalties, loss of revenue or liability for damages, any of which could adversely affect our business, financial condition and results of operations.

We rely on third-party vendors and if such third parties do not perform adequately or terminate their relationships with us, our costs may increase and our business, financial condition and results of operations could be adversely affected.

Our success depends in part on our relationships with third-party vendors. In some cases, third-party vendors are one of a limited number of sources. For example, we rely on national consumer reporting agencies, such as TransUnion, for a large portion of the data used in our AI models. In addition, we rely on third-party verification technologies and services that are critical to our ability to maintain a high level of automation on our platform. In addition, because we are not a bank, we cannot belong to or directly access the ACH payment network. As a result, we rely on one or more banks with access to the ACH payment network to process collections on Upstart-powered loans. Most of our vendor agreements are terminable by either party without penalty and with little notice. If any of our third-party vendors terminates its relationship with us or refuses to renew its agreement with us on commercially reasonable terms, we would need to find an alternate provider, and may not be able to secure similar terms or replace such providers in an acceptable timeframe. We also rely on other software and services supplied by vendors, such as communications, analytics and internal software, and our business may be adversely affected to the extent such software and services do not meet our expectations, contain errors or vulnerabilities, are compromised or experience outages. Any of these risks could increase our costs and adversely affect our business, financial condition and results of operations. Further, any negative publicity related to any of our third-party partners, including any publicity related to quality standards or safety concerns, could adversely affect our reputation and brand, and could potentially lead to increased regulatory or litigation exposure.

 

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We incorporate technology from third parties into our platform. We cannot be certain that our licensors are not infringing the intellectual property rights of others or that the suppliers and licensors have sufficient rights to the technology in all jurisdictions in which we may operate. Some of our license agreements may be terminated by our licensors for convenience. If we are unable to obtain or maintain rights to any of this technology because of intellectual property infringement claims brought by third parties against our suppliers and licensors or against us, or if we are unable to continue to obtain the technology or enter into new agreements on commercially reasonable terms, our ability to develop our platform containing that technology could be severely limited and our business could be harmed. Additionally, if we are unable to obtain necessary technology from third parties, we may be forced to acquire or develop alternate technology, which may require significant time and effort and may be of lower quality or performance standards. This would limit and delay our ability to provide new or competitive loan products or service offerings and increase our costs. If alternate technology cannot be obtained or developed, we may not be able to offer certain functionality as part of our platform and service offerings, which could adversely affect our business, financial condition and results of operations.

Failure by our third-party vendors or our failure to comply with legal or regulatory requirements or other contractual requirements could have an adverse effect on our business.

We have significant vendors that provide us with a number of services to support our platform. If any third-party vendors fail to comply with applicable laws and regulations or comply with their contractual requirements, including failure to maintain adequate systems addressing privacy and data protection and security, we could be subject to regulatory enforcement actions and suffer economic and reputational harm that could harm our business. Further, we may incur significant costs to resolve any such disruptions in service or failure to provide contracted services, which could adversely affect our business.

The CFPB and each of the prudential bank regulators that supervise our bank partners have issued guidance stating that institutions under their supervision may be held responsible for the actions of the companies with which they contract. As a service provider to those supervised entities, we must ensure we have implemented an adequate vendor management program. We or our bank partners could be adversely impacted to the extent our vendors fail to comply with the legal requirements applicable to the particular products or services being offered. Our use of third-party vendors is subject to increasing regulatory attention.

The CFPB and other regulators have also issued regulatory guidance that has focused on the need for financial institutions to perform increased due diligence and ongoing monitoring of third-party vendor relationships, thus increasing the scope of management involvement in connection with using third-party vendors. Moreover, if regulators conclude that we or our bank partners have not met the heightened standards for oversight of our third-party vendors, we or our bank partners could be subject to enforcement actions, civil monetary penalties, supervisory orders to cease and desist or other remedial actions, which could have an adverse effect on our business, financial condition and results of operations.

Unfavorable outcomes in legal proceedings may harm our business and results of operations.

We are, and may in the future become, subject to litigation, claims, examinations, investigations, legal and administrative cases and proceedings, whether civil or criminal, or lawsuits by governmental agencies or private parties, which may affect our results of operations. Due to the consumer-oriented nature of our business and the application of certain laws and regulations, participants in our industry are regularly named as defendants in litigation alleging violations of federal and state laws and

 

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regulations and consumer law torts, including fraud. Many of these legal proceedings involve alleged violations of consumer protection laws. In addition, we have in the past and may in the future be subject to litigation, claims, examinations, investigations, legal and administrative cases and proceedings related to the offer and sale of Upstart-powered loans.

In particular, lending programs that involve originations by a bank in reliance on origination-related services being provided by non-bank lending platforms and/or program managers are subject to potential litigation and government enforcement claims based on “rent-a-charter” or “true lender” theories, particularly where such programs involve the subsequent sale of such loans or interests therein to the platform. See—“If loans facilitated through our platform for one or more bank partners were subject to successful challenge that the bank partner was not the “true lender,” such loans may be unenforceable, subject to rescission or otherwise impaired, we or other program participants may be subject to penalties, and/or our commercial relationships may suffer, each which would adversely affect our business and results of operations,” below. In addition, loans originated by banks (which are exempt from certain state requirements under federal banking laws), followed by the sale, assignment, or other transfer to non-banks of such loans are subject to potential litigation and government enforcement claims based on the theory that transfers of loans from banks to non-banks do not transfer the ability to enforce contractual terms such as interest rates and fees from which only banks benefit under federal preemption principles. See—“If loans originated by our bank partners were found to violate the laws of one or more states, whether at origination or after sale by the originating bank partner, loans facilitated through our platform may be unenforceable or otherwise impaired, we or other program participants may be subject to, among other things, fines and penalties, and/or our commercial relationships may suffer, each of which would adversely affect our business and results of operations,” below. If we were subject to such litigation or enforcement, then any unfavorable results of pending or future legal proceedings may result in contractual damages, usury related claims, fines, penalties, injunctions, the unenforceability, rescission or other impairment of loans originated on our platform or other censure that could have an adverse effect on our business, results of operations and financial condition. Even if we adequately address the issues raised by an investigation or proceeding or successfully defend a third-party lawsuit or counterclaim, we may have to devote significant financial and management resources to address these issues, which could harm our business, financial condition and results of operations.

Corporate and asset-backed debt ratings could adversely affect our ability to fund loans through our loan funding programs at attractive rates, which could negatively affect our results of operations, financial condition and liquidity.

Our unsecured senior corporate debt currently has no rating, and we have never issued unsecured debt securities in the capital markets. Asset-backed securities sponsored by us are currently rated by a limited number of corporate debt rating agencies. Structured finance ratings reflect these rating agencies’ opinions of our receivables credit performance and ability of the receivables cash flows to pay interest on a timely basis and repay the principal of such asset-backed securitizations, as well as our ability to service the receivables and comply with other obligations under such programs, such as the obligation to repurchase loans subject to breaches of loan-level representations and warranties. Such ratings also reflect the rating agencies’ opinions of other service providers in such transactions, such as trustees, back-up servicers, charged-off loan purchasers and others.

Any future downgrade or non-publication of ratings may increase the interest rates that are required to attract investment in such asset-backed securities, adversely impacting our ability to provide loan liquidity to our bank partners and whole loan purchasers. As a result, our lack of parent debt rating and any possible downgrades to the ratings of our asset-backed securities could negatively impact our business, financial condition and results of operations.

 

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If loans originated by our bank partners were found to violate the laws of one or more states, whether at origination or after sale by the originating bank partner, loans facilitated through our platform may be unenforceable or otherwise impaired, we or other program participants may be subject to, among other things, fines and penalties, and/or our commercial relationships may suffer, each of which would adversely affect our business and results of operations.

When establishing the interest rates and structures (and the amounts and structures of certain fees constituting interest under federal banking law, such as origination fees, late fees and non-sufficient funds fees) that are charged to borrowers on loans originated on our platform, our bank partners rely on certain authority under federal law to export the interest rate requirements of the state where each bank partner is located to borrowers in all other states. Further, certain of our bank partners and institutional investors rely on the ability of subsequent holders to continue charging such rate and fee structures and enforce other contractual terms agreed to by our bank partners which are permissible under federal banking laws following the acquisition of the loans. The current annual percentage rates of the loans facilitated through our platform typically range from approximately 6.5% to 35.99%. In some states, the interest rates of certain Upstart-powered loans exceed the maximum interest rate permitted for consumer loans made by non-bank lenders to borrowers residing in or that have nexus to such states. In addition, the rate structures for Upstart-powered loans may not be permissible in all states for non-bank lenders and/or the amount or structures of certain fees charged in connection with Upstart-powered loans may not be permissible in all states for non-bank lenders.

Usury, fee, and disclosure related claims involving Upstart-powered loans may be raised in multiple ways. Program participants may face litigation, government enforcement or other challenge, for example, based on claims that bank lenders did not establish loan terms that were permissible in the state they were located or did not correctly identify the home or host state in which they were located for purposes of interest exportation authority under federal law. Alternatively, we or our investors may face litigation, government enforcement or other challenge, for example, based on claims that rates and fees were lawful at origination and through any period during which the originating bank partner retained the loan and interests therein, but that subsequent purchasers were unable to enforce the loan pursuant to its contracted-for terms, or that certain disclosures were not provided at origination because while such disclosures are not required of banks they may be required of non-bank lenders.

In Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015), cert. denied, 136 S.Ct. 2505 (June 27, 2016), for example, the United States Court of Appeals for the Second Circuit held that the non-bank purchaser of defaulted credit card debt could not rely on preemption standards under the National Bank Act applicable to the originator of such debt in defense of usury claims. Madden addressed circumstances under which a defaulted extension of credit under a consumer credit card account was assigned, following default, to a non-bank debt buyer that then attempted to collect the loan and to continue charging interest at the contracted-for rate. The debtor filed a suit claiming, among other claims, that the rate charged by the non-bank collection entity exceeded the usury rates allowable for such entities under New York usury law. Reversing a lower court decision, the Second Circuit held that preemption standards under the National Bank Act applicable to the bank that issued the credit card were not available to the non-bank debt buyer as a defense to usury claims. Following denial of a petition for rehearing by the Second Circuit, the defendant sought review by the United States Supreme Court. Following the United States Supreme Court’s request that the Solicitor General file a brief setting forth the government’s position on whether the Supreme Court should hear the case in 2016, the Solicitor General filed its brief recommending that the petition for a writ of certiorari be denied for certain vehicle suitability reasons, although the Solicitor General’s brief concluded that the Second Circuit’s decision was substantively incorrect as a matter of law. The Supreme Court denied certiorari on June 27, 2016, such that the Second Circuit’s decision remains binding on federal courts in the Second Circuit (which include all federal courts in New York, Connecticut, and Vermont). Upon

 

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remand to the District Court for consideration of additional issues, including whether a choice of law provision in the debtor’s credit card agreement was enforceable to displace New York usury law and class certification, the parties settled the matter in 2019.

The scope and validity of the Second Circuit’s Madden decision remain subject to challenge and clarification. In January 2017, for example, the Colorado Administrator of the Colorado Uniform Consumer Credit Code, or the UCCC, filed complaints against two online lending platforms whose operations share certain commonalities with ours, including with respect to the role of bank partners and sale of loans to investors. The complaints include, among other claims, allegations, grounded in the Second Circuit’s Madden decision, that the rates and fees for certain loans could not be enforced lawfully by non-bank purchasers of bank-originated loans. Following a process during which the defendants unsuccessfully sought removal of the complaints to federal court, the Colorado state court heard and denied defendants’ motions to dismiss the cases. The Colorado Administrator then amended its complaints to include similar claims against the trustees of securitization trusts that held program loans, and the state court heard and denied motions to dismiss from such trustees. The Colorado cases remain pending.

In addition, in June 2019 private plaintiffs filed class action complaints against multiple traditional credit card securitization programs, including, Petersen, et al. v. Chase Card Funding, LLC, et al., (No. 1:19-cv-00741-LJV (June 6, 2019)) and Cohen, et al. v. Capital One Funding, LLC et al., (No. 19-03479 (E.D.N.Y. June 12, 2019)). These cases seek class action status for plaintiffs against certain defendants affiliated with a national bank that have acted as special purpose entities in securitization transactions sponsored by the bank. The complaint alleges that the defendants’ acquisition, collection and enforcement of the bank’s credit card receivables violated New York’s civil usury law and that, as in Madden, the defendants, as non-bank entities, are not entitled to the benefit of federal preemption of state usury law. The complaint seeks a judgment declaring the receivables unenforceable, monetary damages and other legal and equitable remedies, such as disgorgement of all sums paid in excess of the usury limit. In each case, the defendants moved to dismiss. On January 22, 2020, the magistrate judge in Petersen issued a report and recommendation responding to the defendants’ motion to dismiss. The magistrate recommended that the motion to dismiss be granted as to both of the plaintiffs’ claims (usury and unjust enrichment). The final opinion of the District Court in that matter has not yet been issued, and there can be no assurance as to how any ultimate resolution of the matter may affect usury or related risks. Cohen remains pending, as well.

Moreover, in November 2019, the FDIC proposed amendments to certain federal banking regulations seeking, in part, to address the Madden decision. The rulemaking would, if finalized as proposed, provide that the interest permissible for loans made by FDIC-insured banks (such as certain of our bank partners) “is determined as of the date the loan was made” and “shall not be affected by any subsequent events, including a change in State law, a change in the relevant commercial paper rate after the loan was made, or the sale, assignment, or other transfer of the loan.” The rulemaking would also clarify other standards relevant to the interest rate authority of FDIC-insured banks. The proposal has not been finalized, and there can be no assurance that: (i) the proposal will be finalized, or that, if finalized, it will be finalized as proposed; or (ii) any final rule adopted by the FDIC to address the Madden decision will be given effect by courts and regulators in a manner that actually mitigates usury and related risks to us, our institutional investors, or Upstart-powered loans.

There are factual distinctions between our program and the circumstances addressed in the Second Circuit’s Madden decision, as well as the circumstances in the Colorado UCCC litigation, credit card securitization litigation, and similar cases. As noted above, there are also bases on which the Madden decision’s validity might be subject to challenge or the Madden decision may be addressed by federal regulation or legislation. Nevertheless, there can be no guarantee that a Madden-like claim will not be brought successfully against us or other Upstart program participants.

 

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If a borrower or any state agency were to successfully bring a claim against us, our bank partners, our securitization vehicles and/or the trustees of such vehicles or our institutional investors for a state usury law or fee restriction violation and the rate or fee at issue on the loan was impermissible under applicable state law, we, our bank partners, securitization vehicles and/or trustees or investors in our loan funding programs may face various commercial and legal repercussions, including that such parties would not receive the total amount of interest expected, and in some cases, may not receive any interest or principal, may hold loans that are void, voidable, rescindable, or otherwise impaired or may be subject to monetary, injunctive or criminal penalties. Were such repercussions to apply to us, we may suffer direct monetary loss or may be a less attractive candidate for bank partners, securitization trustees or institutional investors to enter into or renew relationships; and were such repercussions to apply to our bank partners or institutional investors, such parties could be discouraged from using our platform. We may also be subject to payment of damages in situations where we agreed to provide indemnification, as well as fines and penalties assessed by state and federal regulatory agencies.

If loans facilitated through our platform for one or more bank partners were subject to successful challenge that the bank partner was not the “true lender,” such loans may be unenforceable, subject to rescission or otherwise impaired, we or other program participants may be subject to penalties, and/or our commercial relationships may suffer, each which would adversely affect our business and results of operations.

Upstart-powered loans are originated in reliance on the fact that our bank partners are the “true lenders” for such loans. That true lender status determines various Upstart-powered loan program details, including that we do not hold licenses required solely for being the party that extends credit to consumers, and Upstart-powered loans may involve interest rates and structures (and certain fees and fees structures) permissible at origination only because the loan terms and lending practices are permissible only when the lender is a bank, and/or the disclosures provided to borrowers would be accurate and compliant only if the lender is a bank. Because the loans facilitated by our platform are originated by our bank partners, many state consumer financial regulatory requirements, including usury restrictions (other than the restrictions of the state in which a bank partner originating a particular loan is located) and many licensing requirements and substantive requirements under state consumer credit laws, are treated as inapplicable based on principles of federal preemption or express exemptions provided in relevant state laws for certain types of financial institutions or loans they originate.

Certain recent litigation and regulatory enforcement has challenged, or is currently challenging, the characterization of bank partners as the “true lender” in connection with programs involving origination and/or servicing relationships between a bank partner and non-bank lending platform or program manager. For example, on January 27, 2017, the Colorado Administrator of the UCCC filed complaints against two online lending platforms whose operations share certain commonalities with ours, including with respect to the role of bank partners and sale of loans to investors. In addition to usury allegations grounded in the Second Circuit’s Madden decision, see—“If loans originated by our bank partners were found to violate the laws of one or more states, whether at origination or after sale by the originating bank partner, loans facilitated through our platform may be unenforceable or otherwise impaired, we or other program participants may be subject, among other things, fines and to penalties, and/or our commercial relationships may suffer, each which would adversely affect our business and results of operations,” above, the Colorado Administrator’s allegations included that the online lending platforms, rather than their bank partners, were the “true lenders” for loans originated under each program. Following a process during which the defendants unsuccessfully sought removal of the complaints to federal court, the Colorado state court heard and denied defendants’ motions to dismiss the cases, and the cases remain pending.

 

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We, bank partners, securitization vehicles and similarly situated parties could become subject to challenges like that presented by the Colorado litigation (whether in Colorado or otherwise) and, if so, we could face penalties and/or Upstart-powered loans may be void, voidable or otherwise impaired in a manner that may have adverse effects on our operations (directly, or as a result of adverse impact on our relationships with our bank partners, institutional investors or other commercial counterparties).

In particular, we are a licensed supervised lender in Colorado in connection with origination assistance activities we perform for our bank partners and have been subject to examinations, inquiries and information requests from the Colorado Administrator from time to time and have routinely provided information to the Colorado Administrator in response to such requests. The Colorado loans originated by our bank partners on our platform are not purchased by us and therefore appear to be outside the scope of the specific theories grounding the Colorado Administrators’ pending actions. There have been no formal proceedings against us or indication of any proceedings against us to date, but there can be no assurance that the Colorado Administrator will not make assertions similar to those made in its present actions with respect to the loans facilitated by our platform in the future.

It is also possible that other state agencies or regulators could make similar assertions. If a court, or a state or federal enforcement agency, were to deem Upstart, rather than our bank partners, the “true lender” for loans originated on our platform, and if for this reason (or any other reason) the loans were deemed subject to and in violation of certain state consumer finance laws, we could be subject to fines, damages, injunctive relief (including required modification or discontinuation of our business in certain areas) and other penalties or consequences, and the loans could be rendered void or enforceable in whole or in part, any of which could have a material adverse effect on our business (directly, or as a result of adverse impact on our relationships with our bank partners, institutional investors or other commercial counterparties).

It may be difficult and costly to protect our intellectual property rights, and we may not be able to ensure their protection.

Our ability to operate our platform depends, in part, upon our proprietary technology. We may be unable to protect our proprietary technology effectively which would allow competitors to duplicate our AI models or AI lending platform and adversely affect our ability to compete with them. We rely on a combination of copyright, trade secret, patent, trademark laws and other rights, as well as confidentiality procedures and contractual provisions to protect our proprietary technology, processes and other intellectual property. While we have two patent applications pending, we do not yet have patent protection and our patent applications may not be successful. The steps we take to protect our intellectual property rights may be inadequate. For example, a third party may attempt to reverse engineer or otherwise obtain and use our proprietary technology without our consent. The pursuit of a claim against a third party for infringement of our intellectual property could be costly, and there can be no guarantee that any such efforts would be successful. Our failure to secure, protect and enforce our intellectual property rights could adversely affect our brand and adversely impact our business.

Our proprietary technology, including our AI models, may actually or may be alleged to infringe upon third-party intellectual property, and we may face intellectual property challenges from such other parties. We may not be successful in defending against any such challenges or in obtaining licenses to avoid or resolve any intellectual property disputes. If we are unsuccessful, such claim or litigation could result in a requirement that we pay significant damages or licensing fees, or we could in some circumstances be required to make changes to our business to avoid such infringement, which would negatively impact our financial performance. We may also be obligated to indemnify parties or pay substantial settlement costs, including royalty payments, in connection with any such claim or litigation and to modify applications or refund fees, which could be costly. Even if we were to prevail in such a dispute, any litigation regarding our intellectual property could be costly and time consuming and divert the attention of our management and key personnel from our business operations.

 

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Moreover, it has become common in recent years for individuals and groups to purchase intellectual property assets for the sole purpose of making claims of infringement and attempting to extract settlements from companies such as ours. Even in instances where we believe that claims and allegations of intellectual property infringement against us are without merit, defending against such claims is time consuming and expensive and could result in the diversion of time and attention of our management and employees. In addition, although in some cases a third party may have agreed to indemnify us for such costs, such indemnifying party may refuse or be unable to uphold its contractual obligations. In other cases, our insurance may not cover potential claims of this type adequately or at all, and we may be required to pay monetary damages, which may be significant.

Furthermore, our technology may become obsolete or inadequate, and there is no guarantee that we will be able to successfully develop, obtain or use new technologies to adapt our models and systems to compete with other technologies as they develop. If we cannot protect our proprietary technology from intellectual property challenges, or if our technology becomes obsolete or inadequate, our ability to maintain our model and systems, facilitate loans or perform our servicing obligations on the loans could be adversely affected.

Some aspects of our business processes include open source software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business.

We incorporate open source software into processes supporting our business. Such open source software may include software covered by licenses like the GNU General Public License and the Apache License. The terms of various open source licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that limits our use of the software, inhibits certain aspects of our systems and negatively affects our business operations.

Some open source licenses contain requirements that we make source code available at no cost for modifications or derivative works we create based upon the type of open source software we use. We may face claims from third parties claiming ownership of, or demanding the release or license of, such modifications or derivative works (which could include our proprietary source code or AI models) or otherwise seeking to enforce the terms of the applicable open source license. If portions of our proprietary AI models are determined to be subject to an open source license, or if the license terms for the open source software that we incorporate change, we could be required to publicly release the affected portions of our source code, re-engineer all or a portion of our model or change our business activities, any of which could negatively affect our business operations and potentially our intellectual property rights. If we were required to publicly disclose any portion of our proprietary models, it is possible we could lose the benefit of trade secret protection for our models.

In addition to risks related to license requirements, the use of open source software can lead to greater risks than the use of third-party commercial software, as open source licensors generally do not provide warranties or controls on the origin of the software. Use of open source software may also present additional security risks because the public availability of such software may make it easier for hackers and other third parties to determine how to breach our website and systems that rely on open source software. Many of the risks associated with the use of open source software cannot be eliminated and could adversely affect our business.

We may evaluate and potentially consummate acquisitions, which could require significant management attention, consume our financial resources, disrupt our business and adversely affect our financial results.

Our success will depend, in part, on our ability to grow our business. In some circumstances, we may determine to do so through the acquisition of complementary businesses and technologies rather

 

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than through internal development. The identification of suitable acquisition candidates can be difficult, time-consuming, and costly, and we may not be able to successfully complete identified acquisitions. In the future, we may acquire, assets or businesses. The risks we face in connection with acquisitions include:

 

   

diversion of management time and focus from operating our business to addressing acquisition integration challenges;

 

   

utilization of our financial resources for acquisitions or investments that may fail to realize the anticipated benefits;

 

   

inability of the acquired technologies, products or businesses to achieve expected levels of revenue, profitability, productivity or other benefits;

 

   

coordination of technology, product development and sales and marketing functions and integration of administrative systems;

 

   

transition of the acquired company’s borrowers to our systems;

 

   

retention of employees from the acquired company;

 

   

regulatory risks, including maintaining good standing with existing regulatory bodies or receiving any necessary approvals, as well as being subject to new regulators with oversight over an acquired business;

 

   

attracting financing;

 

   

cultural challenges associated with integrating employees from the acquired company into our organization;

 

   

the need to implement or improve controls, procedures and policies at a business that prior to the acquisition may have lacked effective controls, procedures and policies;

 

   

potential write-offs of loans or intangibles or other assets acquired in such transactions that may have an adverse effect on our results of operations in a given period;

 

   

liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, violations of laws, commercial disputes, tax liabilities and other known and unknown liabilities;

 

   

assumption of contractual obligations that contain terms that are not beneficial to us, require us to license or waive intellectual property or increase our risk for liability; and

 

   

litigation, claims or other liabilities in connection with the acquired company.

Our failure to address these risks or other problems encountered in connection with any future acquisitions and investments could cause us to fail to realize the anticipated benefits of these acquisitions or investments, cause us to incur unanticipated liabilities and harm our business generally. Future acquisitions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, amortization expenses or the write-off of goodwill, any of which could harm our financial condition.

We rely on borrowings under our corporate and warehouse credit facilities to fund certain aspects of our operations, and any inability to meet our obligations as they come due or to comply with various covenants could harm our business.

Our corporate credit facilities consist of term loans and revolving loan facilities that we have drawn on to finance our operations and for other corporate purposes. As of December 31, 2019, we had $22.7 million outstanding principal under the term loans and revolving credit facilities. These

 

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borrowings are secured by all the assets of the company that have not otherwise been sold or pledged to secure bank debt or securities associated with structured finance facilities, such as assets belonging to our consolidated warehouse trust special purpose entities and securitization trusts. These credit agreements contain operating and financial covenants, including customary limitations on the incurrence of certain indebtedness and liens, restrictions on certain transactions and limitations on dividends and stock repurchases. Our ability to comply with or renegotiate these covenants may be affected by events beyond our control, and breaches of these covenants could result in a default under such agreements and any future financial agreements into which we may enter. If we were to default on our credit obligations and such defaults were not waived, our lenders may require repayment of any outstanding debt and terminate their agreements with us.

In addition, we, via our warehouse trust special purpose entities have entered into warehouse credit facilities to partially finance the purchase of loans from certain banks that originate loans via our platform, which credit facilities are secured by the purchased loans. We generally hold these loans on our balance sheet until we can contribute them into term securitization transactions or otherwise liquidate them. Occasionally some of these loans may stay on our balance sheet indefinitely, including some loans that are the result of product development activities. Under our warehouse credit facilities, we may borrow up to $252.0 million until May 2020. Repayment of any outstanding principal, together with any accrued and unpaid interest, are due and payable by the applicable warehouse trust special purpose entities in May 2021. As of December 31, 2019, outstanding borrowings under these warehouse credit facilities were $79.1 million, and $126.3 million of aggregate fair value of loans purchased were pledged as collateral.48

Our warehouse credit facilities impose operating and financial restrictions on the warehouse trust special purpose entities, and under certain events of default in these credit facilities, all the associated borrowings would become immediately due and payable. If we are unable to repay our obligations at maturity or in the event of default, the borrowing warehouse trust special purpose entity may have to liquidate the loans held as collateral at an inopportune time or price or, if the lender liquidated the loans, such warehouse trust would have to pay any amount by which the original purchase price exceeded their sale price. An event of default would negatively impact our ability to purchase loans from our platform and require us to rely on alternative funding sources, which might increase our costs or which might not be available when needed. If we were unable to arrange new or alternative methods of financing on favorable terms, we might have to curtail our loan funding programs, which could have an adverse effect on our bank partners’ ability or willingness to originate new loans, which in turn would have an adverse effect on our business, results of operations and financial condition.

Some of our borrowings carry a floating rate of interest linked to the London Inter-bank Offered Rate, or LIBOR. On July 27, 2017, the United Kingdom Financial Conduct Authority, or FCA, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. As a result, while the FCA and the submitting LIBOR banks have indicated they will support the LIBOR indices through 2021 to allow for an orderly transition to an alternative reference rate, it is possible that beginning in 2022, LIBOR will no longer be available as a reference rate. In particular, the interest rate of borrowings under our warehouse credit facilities and certain related interest rate hedging arrangements are predominately based upon LIBOR. While these agreements generally include alternative rates to LIBOR, if a change in indices results in interest rate increases on our debt, debt service requirements will increase, which could adversely affect our cash flow and results of operations. We do not expect a materially adverse change to our financial condition or liquidity as a result of any such changes or any other reforms to LIBOR that may be enacted in the United Kingdom or elsewhere.

 

48 

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Term loans and revolving loan facilities” and Note 7 to our consolidated financial statements for more information about our term loans and revolving loan facilities.

 

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We may need to raise additional funds in the future, including through equity, debt or convertible debt financings, to support business growth and those funds may not be available on acceptable terms, or at all.

We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new loan products, enhance our AI models, improve our operating infrastructure, or acquire complementary businesses and technologies. Accordingly, we may need to engage in equity, debt or convertible debt financings to secure additional funds. If we raise additional funds by issuing equity securities or securities convertible into equity securities, our stockholders may experience dilution. Debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. Any debt or additional equity financing that we raise may contain terms that are not favorable to us or our stockholders.

If we are unable to obtain adequate financing or on terms satisfactory to us when we require it, we may be unable to pursue certain business opportunities and our ability to continue to support our business growth and to respond to business challenges could be impaired and our business may be harmed.

Taxing authorities may successfully assert that we should have collected or in the future should collect sales and use, gross receipts, value added or similar taxes and may successfully impose additional obligations on us, and any such assessments or obligations could adversely affect our business, financial condition and results of operations.

The application of indirect taxes, such as sales and use tax, value-added tax, goods and services tax, business tax and gross receipts tax, to platform businesses is a complex and evolving issue. Many of the fundamental statutes and regulations that impose these taxes were established before the adoption and growth of the Internet and e-commerce. Significant judgment is required on an ongoing basis to evaluate applicable tax obligations and as a result amounts recorded are estimates and are subject to adjustments. In many cases, the ultimate tax determination is uncertain because it is not clear how new and existing statutes might apply to our business.

In addition, governments are increasingly looking for ways to increase revenue, which has resulted in discussions about tax reform and other legislative action to increase tax revenue, including through indirect taxes. For example, on November 6, 2018, voters in San Francisco approved “Proposition C,” which authorizes San Francisco to impose additional taxes on businesses in San Francisco that generate a certain level of gross receipts. Such taxes would adversely affect our financial condition and results of operations.

We may face various indirect tax audits in various U.S. jurisdictions. In certain jurisdictions, we collect and remit indirect taxes. However, tax authorities may raise questions about or challenge or disagree with our calculation, reporting or collection of taxes and may require us to collect taxes in jurisdictions in which we do not currently do so or to remit additional taxes and interest, and could impose associated penalties and fees. For example, after the U.S. Supreme Court decision in South Dakota v. Wayfair Inc., certain states have adopted, or started to enforce, laws that may require the calculation, collection and remittance of taxes on sales in their jurisdictions, even if we do not have a physical presence in such jurisdictions. A successful assertion by one or more tax authorities requiring us to collect taxes in jurisdictions in which we do not currently do so or to collect additional taxes in a jurisdiction in which we currently collect taxes, could result in substantial tax liabilities, including taxes on past sales, as well as penalties and interest, could harm our business, financial condition and results of operations. Although we have reserved for potential payments of possible past tax liabilities in our financial statements, if these liabilities exceed such reserves, our financial condition will be harmed.

 

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As a result of these and other factors, the ultimate amount of tax obligations owed may differ from the amounts recorded in our financial statements and any such difference may adversely impact our results of operations in future periods in which we change our estimates of our tax obligations or in which the ultimate tax outcome is determined.

Our ability to use our deferred tax assets to offset future taxable income may be subject to certain limitations that could subject our business to higher tax liability.

We may be limited in the portion of net operating loss carryforwards, or NOLs, that we can use in the future to offset taxable income for U.S. federal and state income tax purposes. The Tax Cuts and Jobs Act, or the Tax Act, made broad and complex changes to U.S. tax law, including changes to the uses and limitations of NOLs. For example, while the Tax Act allows for federal NOLs incurred in tax years beginning after December 31, 2017 to be carried forward indefinitely, the Tax Act also imposes an 80% limitation on the use of NOLs that are generated in tax years beginning after December 31, 2017. However, NOLs generated prior to December 31, 2017 will still have a 20-year carryforward period, but are not subject to the 80% limitation. As of December 31, 2019, we had federal and state NOLs of approximately $65.9 million and $57.5 million, respectively, to offset future taxable income. Certain of these federal and state net operating loss carry-forwards will begin expiring in 2034. A lack of future taxable income would adversely affect our ability to utilize these NOLs. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its NOLs to offset future taxable income. We performed an ownership analysis and identified two previous ownership changes, as defined under Section 382 and 383 of the Code in 2013 and 2015. However, neither resulted in a material limitation that will reduce the total amount of our NOLs and credits that can be utilized. Future changes in our stock ownership, including this or future offerings, as well as other changes that may be outside of our control, could result in additional ownership changes under Section 382 of the Code. Our NOLs may also be impaired under similar provisions of state law. We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. On the basis of this evaluation, a full valuation allowance has historically been recorded to recognize only deferred tax assets that are more likely than not to be realized. Certain of our deferred tax assets may expire unutilized or underutilized, which could prevent us from offsetting future taxable income.

Changes in U.S. tax laws could have a material adverse effect on our business, financial condition and results of operations.

The Tax Act contains significant changes to U.S. tax law, including a reduction in the corporate tax rate and a transition to a new territorial system of taxation. The primary impact of the new legislation on our provision for income taxes was a reduction of the future tax benefits of our deferred tax assets as a result of the reduction in the corporate tax rate. The impact of the Tax Act will likely be subject to ongoing technical guidance and accounting interpretation, which we will continue to monitor and assess. As we expand the scale of our business activities, any changes in the U.S. taxation of such activities may increase our effective tax rate and harm our business, financial condition and results of operations.

Our business is subject to the risks of natural disasters and other catastrophic events, and to interruption by man-made problems.

Significant natural disasters or other catastrophic events, such as earthquakes, fires, hurricanes, blizzards, or floods (many of which are becoming more acute and frequent as a result of climate change), or interruptions by strikes, crime, terrorism, pandemics, cyber-attacks, computer viruses, internal or external system failures, telecommunications failures, or power outages, could have an

 

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adverse effect on our business, results of operations and financial condition. For example, the outbreak of the novel coronavirus in early 2020 has had a significant impact on the global economy and consumer confidence. If the outbreak persists or worsens, it could continue to adversely impact the economy and consumer confidence, and could negatively impact our operations and our platform, each of which could seriously harm our business. Further, our headquarters is located in the San Francisco Bay Area, a region known for seismic activity and forest fires, and our operations team is located in Columbus, Ohio, a region subject to blizzards.

In addition, acts of war and other armed conflicts, disruptions in global trade, travel restrictions and quarantines, terrorism and other geo-political unrest could cause disruptions in our business and lead to interruptions, delays or loss of critical data. Any of the foregoing risks may be further increased if our business continuity plans prove to be inadequate and there can be no assurance that both personnel and non-mission critical applications can be fully operational after a declared disaster within a defined recovery time. If our personnel, systems or data centers are impacted, we may suffer interruptions and delays in our business operations. In addition, to the extent these events impact the ability of borrowers to timely repay their loans, our business could be negatively affected.

We may not maintain sufficient business interruption or property insurance to compensate us for potentially significant losses, including potential harm to our business that may result from interruptions in our ability to provide our financial products and services.

If our estimates or judgments relating to our critical accounting policies prove to be incorrect or financial reporting standards or interpretations change, our results of operations could be adversely affected.

The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires our management to make estimates and assumptions that affect the amounts reported and disclosed in our consolidated financial statements and accompanying notes. We base our estimates and assumptions on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets, liabilities, and equity, and the amount of revenue and expenses that are not readily apparent from other sources. Significant assumptions and estimates used in preparing our consolidated financial statements include those related to fair value determinations, stock-based compensation, consolidation of variable interest entities, and provision for income taxes, net of valuation allowance for deferred tax assets. Our results of operations may be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our results of operations to fall below the expectations of industry or financial analysts and investors, resulting in a decline in the trading price of our common stock.

Additionally, we regularly monitor our compliance with applicable financial reporting standards and review new pronouncements and drafts thereof that are relevant to us. As a result of new standards, or changes to existing standards, and changes in their interpretation, we might be required to change our accounting policies, alter our operational policies and implement new or enhance existing systems so that they reflect new or amended financial reporting standards, or we may be required to restate our published financial statements. Such changes to existing standards or changes in their interpretation may have an adverse effect on our reputation, business, financial condition, and profit and loss, or cause an adverse deviation from our revenue and operating profit and loss target, which may negatively impact our results of operations.

 

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If we fail to maintain an effective system of disclosure controls and internal control over financial reporting, our ability to produce timely and accurate financial statements or comply with applicable regulations could be impaired.

As a public company, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the rules and regulations of the applicable listing standards of the           . We expect that the requirements of these rules and regulations will continue to increase our legal, accounting, and financial compliance costs, make some activities more difficult, time-consuming, and costly, and place significant strain on our personnel, systems, and resources.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. We are continuing to develop and refine our disclosure controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we will file with the SEC is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that information required to be disclosed in reports under the Exchange Act is accumulated and communicated to our principal executive and financial officers. We are also continuing to improve our internal control over financial reporting. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, we have expended, and anticipate that we will continue to expend, significant resources, including accounting-related costs, and significant management oversight. Our current controls and any new controls that we develop may become inadequate because of changes in conditions in our business.

Further, weaknesses in our disclosure controls and internal control over financial reporting have been discovered in the past and may be discovered in the future. For example, we identified a material weakness in our internal control over financial reporting that contributed to the revision of our previously-issued 2017 and 2018 financial statements. A “material weakness” is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. This material weakness principally related to a lack of adequate review processes and controls within our accounting and finance organization and a lack of sufficient financial reporting and accounting personnel with the technical expertise to appropriately account for certain transactions including loan servicing and securitizations. During 2019, we took a number of actions to improve our internal control over financial reporting, such as hiring external specialists and personnel with technical accounting expertise, designing additional review procedures in our accounting and finance organization, and identifying and implementing improved processes and controls. Our management believes that these and other actions taken during 2019 have been fully implemented and are operating effectively. As a result, we have concluded that our remediation efforts have been successful and that the previously-identified material weakness in our internal controls has been remediated as of December 31, 2019.

However, we cannot assure you that the measures we have taken to date, or any measures we may take in the future, will be sufficient to identify or prevent future material weaknesses or deficiencies. The nature of our business is such that our financial statements involve a number of complex accounting policies, many of which involve significant elements of judgment, including determinations regarding the consolidation of variable interest entities, determinations regarding the fair value of financial assets and liabilities (including loans, notes receivable, payable to securitization note holders and residual certificate holders, notes payable and servicing assets and liabilities) and the appropriate classification of various items within our financial statements. See Note 1 to our consolidated financial statements for more information about our significant accounting policies. The inherent complexity of these accounting matters and the nature and variety of transactions in which we are involved require that we have sufficient qualified accounting personnel with an appropriate level of

 

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experience and controls in our financial reporting process commensurate with the complexity of our business. While we believe we have sufficient internal accounting personnel and external resources and appropriate controls to address the demands of our business, we expect that the growth and development of our business will place significant additional demands on our accounting resources. Any failure to develop or maintain effective controls or any difficulties encountered in their implementation or improvement could harm our results of operations or cause us to fail to meet our reporting obligations and may result in a restatement of our financial statements for prior periods. Any failure to implement and maintain effective internal control over financial reporting could also adversely affect the results of periodic management evaluations and annual independent registered public accounting firm attestation reports regarding the effectiveness of our internal control over financial reporting that we will eventually be required to include in our periodic reports that will be filed with the SEC. Ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of our common stock. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on the           . We are not currently required to comply with the SEC rules that implement Section 404 of the Sarbanes-Oxley Act and are therefore not required to make a formal assessment of the effectiveness of our internal control over financial reporting for that purpose. As a public company, we will be required to provide an annual management report on the effectiveness of our internal control over financial reporting. There can be no assurance that we will maintain internal control over financial reporting sufficient to enable us to identify or avoid material weaknesses in the future.

Our independent registered public accounting firm is not required to formally attest to the effectiveness of our internal control over financial reporting until after we are no longer an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. At such time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our internal control over financial reporting is documented, designed, or operating. Any failure to maintain effective disclosure controls and internal control over financial reporting could materially and adversely affect our business, results of operations, and financial condition and could cause a decline in the trading price of our common stock.

Some of our market opportunity estimates, growth forecasts and key metrics included in this prospectus could prove to be inaccurate, and any real or perceived inaccuracies may harm our reputation and negatively affect our business.

Market opportunity estimates and growth forecasts included in this prospectus, including those we have generated ourselves, are subject to significant uncertainty and are based on assumptions and estimates that may not prove to be accurate. The estimates and forecasts in this prospectus relating to the size and expected growth of our target market may prove to be inaccurate. It is impossible to offer every loan product, term or feature that every customer wants or that any given bank partner is necessarily capable of supporting, and our competitors may develop and offer loan products, terms or features that we do not offer. The variables that go into the calculation of our market opportunity are subject to change over time, and there is no guarantee that any particular number or percentage of the loans covered by our market opportunity estimates will generate any particular level of revenues for us. Even if the markets in which we compete meet the size estimates and growth forecasted in this prospectus, we may be unable to address these markets successfully and our business could fail to grow for a variety of reasons outside of our control, including competition in our industry. We regularly review and may adjust our processes for calculating our key metrics to improve their accuracy. Our key metrics may differ from estimates published by third parties or from similarly titled metrics of our competitors due to differences in methodology. If investors or analysts do not perceive our metrics to be accurate representations of our business, or if we discover material inaccuracies in our metrics, our reputation, business, results of operations, and financial condition would be adversely affected.

 

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RISKS RELATED TO OUR REGULATORY ENVIRONMENT

Litigation, regulatory actions and compliance issues could subject us to significant fines, penalties, judgments, remediation costs and/or requirements resulting in increased expenses.

In the ordinary course of business, we have been named as a defendant in various legal actions, including class actions and other litigation. Generally, this litigation arises from the dissatisfaction of a consumer with the products or services offered on our platform; some of this litigation, however, has arisen from other matters, including claims of violation of laws related to do-not-call, credit reporting and collections. All such legal actions are inherently unpredictable and, regardless of the merits of the claims, litigation is often expensive, time-consuming, disruptive to our operations and resources, and distracting to management. In addition, certain actions may include claims for indeterminate amounts of damages. Our involvement in any such matter also could cause significant harm to our or our bank partners’ reputations and divert management attention from the operation of our business, even if the matters are ultimately determined in our favor. If resolved against us, legal actions could result in excessive verdicts and judgments, injunctive relief, equitable relief, and other adverse consequences that may affect our financial condition and how we operate our business.

In addition, a number of participants in the consumer financial services industry have been the subject of putative class action lawsuits, state attorney general actions and other state regulatory actions, federal regulatory enforcement actions, including actions relating to alleged unfair, deceptive or abusive acts or practices, violations of state licensing and lending laws, including state usury and disclosure laws, actions alleging discrimination on the basis of race, ethnicity, gender or other prohibited bases, and allegations of noncompliance with various state and federal laws and regulations relating to originating, servicing, and collecting consumer finance loans and other consumer financial services and products. The current regulatory environment, increased regulatory compliance efforts and enhanced regulatory enforcement have resulted in us undertaking significant time-consuming and expensive operational and compliance improvement efforts, which may delay or preclude our or our bank partners’ ability to provide certain new products and services. There is no assurance that these regulatory matters or other factors will not, in the future, affect how we conduct our business and, in turn, have a material adverse effect on our business. In particular, legal proceedings brought under state consumer protection statutes or under several of the various federal consumer financial services statutes may result in a separate fine assessed for each statutory and regulatory violation or substantial damages from class action lawsuits, potentially in excess of the amounts we earned from the underlying activities.

Some of our agreements used in the course of our business include arbitration clauses. If our arbitration agreements were to become unenforceable for any reason, we could experience an increase to our consumer litigation costs and exposure to potentially damaging class action lawsuits, with a potential material adverse effect on our business and results of operations.

We contest our liability and the amount of damages, as appropriate, in each pending matter. The outcome of pending and future matters could be material to our results of operations, financial condition and cash flows, and could materially adversely affect our business.

In addition, from time to time, through our operational and compliance controls, we identify compliance issues that require us to make operational changes and, depending on the nature of the issue, result in financial remediation to impacted borrowers. These self-identified issues and voluntary remediation payments could be significant, depending on the issue and the number of borrowers impacted, and could generate litigation or regulatory investigations that subject us to additional risk.

 

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We are subject to or facilitate compliance with a variety of federal, state, and local laws, including those related to consumer protection and loan financings.

We must comply with regulatory regimes or facilitate compliance with regulatory regimes on behalf of our bank partners that are independently subject to federal and/or state oversight by bank regulators, including those applicable to our referral and marketing services, consumer credit transactions, loan servicing and collection activities and the purchase and sale of whole loans and other related transactions. Certain state laws generally regulate interest rates and other charges and require certain disclosures. In addition, other federal and state laws may apply to the origination, servicing and collection of loans originated on our platform, the purchase and sale of whole loans or asset-backed securitizations. In particular, certain laws, regulations and rules we or our bank partners are subject to include:

 

   

state lending laws and regulations that require certain parties to hold licenses or other government approvals or filings in connection with specified activities, and impose requirements related to loan disclosures and terms, fees and interest rates, credit discrimination, credit reporting, servicemember relief, debt collection, repossession, unfair or deceptive business practices and consumer protection, as well as other state laws relating to privacy, information security, conduct in connection with data breaches and money transmission;

 

   

the Truth-in-Lending Act and Regulation Z promulgated thereunder, and similar state laws, which require certain disclosures to borrowers regarding the terms and conditions of their loans and credit transactions, require creditors to comply with certain lending practice restrictions, limit the ability of a creditor to impose certain loan terms and impose disclosure requirements in connection with credit card origination;

 

   

the Equal Credit Opportunity Act and Regulation B promulgated thereunder, and similar state fair lending laws, which prohibit creditors from discouraging or discriminating against credit applicants on the basis of race, color, sex, age, religion, national origin, marital status, the fact that all or part of the applicant’s income derives from any public assistance program or the fact that the applicant has in good faith exercised any right under the federal Consumer Credit Protection Act;

 

   

the Fair Credit Reporting Act and Regulation V promulgated thereunder, imposes certain obligations on users of consumer reports and those that furnish information to consumer reporting agencies, including obligations relating to obtaining consumer reports, marketing using consumer reports, taking adverse action on the basis of information from consumer reports, addressing risks of identity theft and fraud and protecting the privacy and security of consumer reports and consumer report information;

 

   

Section 5 of the Federal Trade Commission Act, which prohibits unfair and deceptive acts or practices in or affecting commerce, and Section 1031 of the Dodd-Frank Act, which prohibits unfair, deceptive or abusive acts or practices in connection with any consumer financial product or service, and analogous state laws prohibiting unfair, deceptive or abusive acts or practices;

 

   

the Credit Practices Rule which (i) prohibits lenders from using certain contract provisions that the Federal Trade Commission has found to be unfair to consumers; (ii) requires lenders to advise consumers who co-sign obligations about their potential liability if the primary obligor fails to pay; and (iii) prohibits certain late charges;

 

   

the Fair Debt Collection Practices Act and similar state debt collection laws, which provide guidelines and limitations on the conduct of third-party debt collectors (and some limitation on creditors collecting their own debts) in connection with the collection of consumer debts;

 

   

the Gramm-Leach-Bliley Act and Regulation P promulgated thereunder, which includes limitations on financial institutions’ disclosure of nonpublic personal information about a

 

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consumer to nonaffiliated third parties, in certain circumstances requires financial institutions to limit the use and further disclosure of nonpublic personal information by nonaffiliated third parties to whom they disclose such information and requires financial institutions to disclose certain privacy notices and practices with respect to information sharing with affiliated and unaffiliated entities as well as to safeguard personal borrower information, and other privacy laws and regulations;

 

   

the Bankruptcy Code, which limits the extent to which creditors may seek to enforce debts against parties who have filed for bankruptcy protection;

 

   

the Servicemembers Civil Relief Act, which allows military members to suspend or postpone certain civil obligations, requires creditors to reduce the interest rate to 6% on loans to military members under certain circumstances, and imposes restrictions on enforcement of loans to servicemembers, so that the military member can devote his or her full attention to military duties;

 

   

the Military Lending Act, which requires those who lend to “covered borrowers”, including members of the military and their dependents, to only offer Military APRs (a specific measure of all-in-cost-of-credit) under 36%, prohibits arbitration clauses in loan agreements, and prohibits certain other loan agreement terms and lending practices in connection with loans to military servicemembers, among other requirements, and for which violations may result in penalties including voiding of the loan agreement;

 

   

the Electronic Fund Transfer Act and Regulation E promulgated thereunder, which provide guidelines and restrictions on the electronic transfer of funds from consumers’ bank accounts, including a prohibition on a creditor requiring a consumer to repay a credit agreement in preauthorized (recurring) electronic fund transfers and disclosure and authorization requirements in connection with such transfers;

 

   

the Telephone Consumer Protection Act and the regulations promulgated thereunder, which impose various consumer consent requirements and other restrictions in connection with telemarketing activity and other communication with consumers by phone, fax or text message, and which provide guidelines designed to safeguard consumer privacy in connection with such communications;

 

   

the Federal Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 and the Telemarketing Sales Rule and analogous state laws, which impose various restrictions on marketing conducted use of email, telephone, fax or text message;

 

   

the Electronic Signatures in Global and National Commerce Act and similar state laws, particularly the Uniform Electronic Transactions Act, which authorize the creation of legally binding and enforceable agreements utilizing electronic records and signatures and which require creditors and loan servicers to obtain a consumer’s consent to electronically receive disclosures required under federal and state laws and regulations;

 

   

the Right to Financial Privacy Act and similar state laws enacted to provide the financial records of financial institution customers a reasonable amount of privacy from government scrutiny;

 

   

the Bank Secrecy Act and the USA PATRIOT Act, which relate to compliance with anti-money laundering, borrower due diligence and record-keeping policies and procedures;

 

   

the regulations promulgated by the Office of Foreign Assets Control under the U.S. Treasury Department related to the administration and enforcement of sanctions against foreign jurisdictions and persons that threaten U.S. foreign policy and national security goals, primarily to prevent targeted jurisdictions and persons from accessing the U.S. financial system;

 

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federal and state securities laws, including, among others, the Securities Act of 1933, as amended, or the Securities Act, the Exchange Act, the Investment Advisers Act of 1940, as amended, or the IAA, and the Investment Company Act of 1940, as amended, or the Investment Company Act, rules and regulations adopted under those laws, and similar state laws and regulations, which govern how we offer, sell and transact in our loan financing products; and

 

   

other state-specific and local laws and regulations.

We may not always have been, and may not always be, in compliance with these and other applicable laws, regulations and rules. Compliance with these requirements is also costly, time-consuming and limits our operational flexibility. Additionally, Congress, the states and regulatory agencies, as well as local municipalities, could further regulate the consumer financial services industry in ways that make it more difficult or costly for us to offer our AI lending platform and related services or facilitate the origination of loans for our bank partners. These laws also are often subject to changes that could severely limit the operations of our business model. For example, in 2019, a bill was introduced in the U.S. Senate that would create a national cap of the lesser of 15% APR or the maximum rate permitted by the state in which the consumer resides. Although such a bill may never be enacted into law, if such a bill were to be enacted, it would greatly restrict the number of loans that could be funded through our platform. Further, changes in the regulatory application or judicial interpretation of the laws and regulations applicable to financial institutions also could impact the manner in which we conduct our business. The regulatory environment in which financial institutions operate has become increasingly complex, and following the financial crisis that began in 2008, supervisory efforts to apply relevant laws, regulations and policies have become more intense. Additionally, states are increasingly introducing and, in some cases, passing laws that restrict interest rates and APRs on loans similar to the loans made on our platform. For example, the governors of California and New York independently announced in 2020 proposed state budgets which, among other things, would strengthen state consumer protection authority of state regulators to police debt collections and unfair, deceptive or abusive acts and practices. Additionally, voter referendums have been introduced and, in some cases, passed, restrictions on interest rates and/or APRs. If such legislation or bills were to be propagated, or state or federal regulators seek to restrict regulated financial institutions such as our bank partners from engaging in business with Upstart in certain ways, our bank partners’ ability to originate loans in certain states could be greatly reduced, and as a result, our business, financial condition and results of operations would be adversely affected.

Where applicable, we seek to comply with state broker, credit service organization, small loan, finance lender, servicing, collection, money transmitter and similar statutes. Nevertheless, if we are found to not comply with applicable laws, we could lose one or more of our licenses or authorizations, become subject to greater scrutiny by other state regulatory agencies, face other sanctions or be required to obtain a license in such jurisdiction, which may have an adverse effect on our ability to continue to facilitate loans, perform our servicing obligations or make our platform available to consumers in particular states, which may harm our business. Further, failure to comply with the laws and regulatory requirements applicable to our business and operations may, among other things, limit our ability to collect all or part of the principal of or interest on Upstart-powered loans. In addition, non-compliance could subject us to damages, revocation of required licenses, class action lawsuits, administrative enforcement actions, rescission rights held by investors in securities offerings and civil and criminal liability, all of which would harm our business.

Internet-based loan origination processes may give rise to greater risks than paper-based processes.

We use the internet to obtain application information and distribute certain legally required notices to applicants and borrowers, and to obtain electronically signed loan documents in lieu of paper

 

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documents with actual borrower signatures. These processes may entail greater risks than would paper-based loan origination processes, including risks regarding the sufficiency of notice for compliance with consumer protection laws, risks that borrowers may challenge the authenticity of loan documents, and risks that despite internal controls, unauthorized changes are made to the electronic loan documents. In addition, our software could contain “bugs” that result in incorrect calculations or disclosures or other non-compliance with federal or state laws or regulations. If any of those factors were to cause any loans, or any of the terms of the loans, to be unenforceable against the borrowers, or impair our ability to service loans, the performance of the underlying promissory notes could be adversely affected.

If we are found to be operating without having obtained necessary state or local licenses, our business, financial condition and results of operations could be adversely affected.

Certain states have adopted laws regulating and requiring licensing by parties that engage in certain activities regarding consumer finance transactions, including facilitating and assisting such transactions in certain circumstances. Furthermore, certain states and localities have also adopted laws requiring licensing for consumer debt collection or servicing and/or purchasing or selling consumer loans. While we believe we have obtained or are in the process of obtaining all necessary licenses, the application of some consumer finance licensing laws to our AI lending platform and the related activities we perform is unclear. In addition, state licensing requirements may evolve over time, including, in particular, recent trends toward increased licensing requirements and regulation of parties engaged in loan solicitation and student loan servicing activities. If we were found to be in violation of applicable state licensing requirements by a court or a state, federal, or local enforcement agency, we could be subject to fines, damages, injunctive relief (including required modification or discontinuation of our business in certain areas), criminal penalties and other penalties or consequences, and the loans originated by our bank partners on our platform could be rendered void or unenforceable in whole or in part, any of which could have a material adverse effect on our business.

The CFPB is a relatively new agency that has sometimes taken expansive views of its authority to regulate consumer financial services, creating uncertainty as to how the agency’s actions or the actions of any other new agency could impact our business.

The CFPB, which commenced operations in July 2011, has broad authority to create and modify regulations under federal consumer financial protection laws and regulations, such as the Truth in Lending Act and Regulation Z, the Equal Credit Opportunity Act, or the ECOA. and Regulation B, the Fair Credit Reporting Act, the Electronic Funds Transfer Act and Regulation E, among other regulations, and to enforce compliance with those laws. The CFPB supervises banks, thrifts and credit unions with assets over $10 billion and examines certain of our bank partners. Further, the CFPB is charged with the examination and supervision of certain participants in the consumer financial services market, including short-term, small dollar lenders, and larger participants in other areas of financial services. The CFPB is also authorized to prevent “unfair, deceptive or abusive acts or practices” through its rulemaking, supervisory and enforcement authority. To assist in its enforcement, the CFPB maintains an online complaint system that allows consumers to log complaints with respect to various consumer finance products, including our loan products. This system could inform future CFPB decisions with respect to its regulatory, enforcement or examination focus. The CFPB may also request reports concerning our organization, business conduct, markets and activities and conduct on-site examinations of our business on a periodic basis if the CFPB were to determine, through its complaint system, that we were engaging in activities that pose risks to consumers.

Although we are the only online lending platform to have ever received a no-action letter from the CFPB with respect to our ECOA compliance as it pertains to underwriting applicants for unsecured non-revolving credit, there continues to be uncertainty about the future of the CFPB and as to how its

 

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strategies and priorities, including in both its examination and enforcement processes, will impact our business and our results of operations going forward. Actions by the CFPB could result in requirements to alter or cease offering affected financial products and services, making them less attractive and restricting our ability to offer them. The CFPB could also implement rules that restrict our effectiveness in servicing our financial products and services.

Future actions by the CFPB (or other regulators) against us or our competitors that discourage the use of our or their services, or against our bank partners in connection with the products they offer on our platform, could result in reputational harm and adversely affect our business. If the CFPB changes regulations that were adopted in the past by other regulators and transferred to the CFPB by the Dodd-Frank Act, or modifies through supervision or enforcement past regulatory guidance or interprets existing regulations in a different or stricter manner than they have been interpreted in the past by us, the industry or other regulators, our compliance costs and litigation exposure could increase materially. If future regulatory or legislative restrictions or prohibitions are imposed that affect our ability to offer certain of our products or that require us to make significant changes to our business practices, and if we are unable to develop compliant alternatives with acceptable returns, these restrictions or prohibitions could have a material adverse effect on our business. If the CFPB were to issue a consent decree or other similar order against us, this could also directly or indirectly affect our results of operations.

Although we have committed resources to enhancing our compliance programs, actions by the CFPB or other regulators against us, our bank partners or our competitors could result in reputational harm and a loss of bank partners, borrowers or investors in our loan funding programs. Our compliance and operational costs and litigation exposure could increase if and when the CFPB amends or finalizes any proposed regulations, including the regulations discussed above or if the CFPB or other regulators enact new regulations, change regulations that were previously adopted, modify, through supervision or enforcement, past regulatory guidance, or interpret existing regulations in a manner different or stricter than have been previously interpreted.

We have been in the past and may in the future be subject to federal and state regulatory inquiries regarding our business.

We have, from time to time in the normal course of our business, received, and may in the future receive or be subject to, inquiries or investigations by state and federal regulatory agencies and bodies such as the CFPB, state Attorneys General, the SEC, state financial regulatory agencies and other state or federal agencies or bodies regarding the Upstart platform, including the marketing of loans for lenders, underwriting and pricing of consumer loans for our bank partners, our fair lending compliance program and licensing and registration requirements. We have addressed these inquiries directly and engaged in open dialogue with regulators. For example, following constructive and transparent discussions with the CFPB regarding the manner in which our platform operates in compliance with federal fair lending laws, we applied for and received a no-action letter from the CFPB that stated the CFPB had no present intent to recommend initiation of supervisory or enforcement action against us with respect to the ECOA as it pertains to underwriting applicants for unsecured non-revolving credit. Under the terms of the no-action letter, we are required to continue to share certain information with the CFPB regarding the loan applications we receive, how we decide which loans should be recommended to bank partners for approval and how we will mitigate risk to consumers, as well as information on how our AI models expand access to credit for traditionally underserved populations. Such no-action letter will expire on September 14, 2020. We intend to apply for relief under the CFPB’s new no-action letter policies adopted in 2018, which replace the prior policy under which our current no-action letter was issued. We can provide no assurance that the CFPB will provide such relief or change its position regarding supervisory or enforcement action against us in the future. Moreover, were we determined to be conducting business contrary to the facts presented to, and relied

 

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on, by the CFPB in issuing the no-action letter, we would be subject to heightened enforcement risk by the CFPB.

We have also received inquiries from state regulatory agencies regarding requirements to obtain licenses from or register with those states, including in states where we have determined that we are not required to obtain such a license or be registered with the state, and we expect to continue to receive such inquiries. Any such inquiries or investigations could involve substantial time and expense to analyze and respond to, could divert management’s attention and other resources from running our business, and could lead to public enforcement actions or lawsuits and fines, penalties, injunctive relief, and the need to obtain additional licenses that we do not currently possess. Our involvement in any such matters, whether tangential or otherwise and even if the matters are ultimately determined in our favor, could also cause significant harm to our reputation, lead to additional investigations and enforcement actions from other agencies or litigants, and further divert management attention and resources from the operation of our business. As a result, the outcome of legal and regulatory actions arising out of any state or federal inquiries we receive could be material to our business, results of operations, financial condition and cash flows and could have a material adverse effect on our business, financial condition or results of operations.

The collection, processing, storage, use and disclosure of personal data could give rise to liabilities as a result of existing or new governmental regulation, conflicting legal requirements or differing views of personal privacy rights.

We receive, transmit and store a large volume of personally identifiable information and other sensitive data from applicants and borrowers. Each bank partner can access information about their respective borrowers and declined applicants via daily loan reports and other reporting tools that are provided via the platform. For loan investors, while we generally limit access to personally identifiable information, we do share some personally identifiable information about borrowers with certain investors in our loan funding programs. There are federal, state and foreign laws regarding privacy and the storing, sharing, use, disclosure and protection of personally identifiable information and sensitive data. Specifically, cybersecurity and data privacy issues, particularly with respect to personally identifiable information are increasingly subject to legislation and regulations to protect the privacy and security of personal information that is collected, processed and transmitted. For example, the Gramm-Leach-Bliley Act includes limitations on financial institutions’ disclosure of nonpublic personal information about a consumer to nonaffiliated third parties, in certain circumstances requires financial institutions to limit the use and further disclosure of nonpublic personal information by nonaffiliated third parties to whom they disclose such information and requires financial institutions to disclose certain privacy notices and practices with respect to information sharing with affiliated and unaffiliated entities as well as to safeguard personal borrower information. In addition, the California Consumer Privacy Act, or the CCPA, which went into effect on January 1, 2020, requires, among other things, that covered companies provide disclosures to California consumers and afford such consumers new abilities to opt-out of certain sales or retention of their personal information by us. The CCPA has been amended on multiple occasions and is the subject of proposed regulations of the California Attorney General that were originally published on October 11, 2019, and further amended February 10, 2020. Aspects of the CCPA and its interpretation remain unclear. We cannot fully predict the impact of the CCPA on our business or operations, but it may require us to further modify our data infrastructure and data processing practices and policies and to incur additional costs and expenses in an effort to continue to comply. Additionally, other U.S. states are proposing and enacting laws and regulations that impose obligations similar to the CCPA or that otherwise involve significant obligations and restrictions. Compliance with current and future borrower privacy data protection and information security laws and regulations could result in higher compliance, technical or operating costs. Further, any actual or perceived violations of these laws and regulations may require us to change our business practices, data infrastructure or operational structure, address legal claims and regulatory

 

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investigations and proceedings and sustain monetary penalties and/or other harms to our business. We could also be adversely affected if new legislation or regulations are adopted or if existing legislation or regulations are modified such that we are required to alter our systems or change our business practices or privacy policies.

As the regulatory framework for artificial intelligence and machine learning technology evolves, our business, financial condition and results of operations may be adversely affected.

The regulatory framework for artificial intelligence and machine learning technology is evolving and remains uncertain. It is possible that new laws and regulations will be adopted in the United States, or existing laws and regulations may be interpreted in new ways, that would affect the operation of our platform and the way in which we use artificial intelligence and machine learning technology, including with respect to fair lending laws. Further, the cost to comply with such laws or regulations could be significant and would increase our operating expenses, which could adversely affect our business, financial condition and results of operations.

If we are required to register under the Investment Company Act, our ability to conduct business could be materially adversely affected.

The Investment Company Act contains substantive legal requirements that regulate the manner in which “investment companies” are permitted to conduct their business activities. We believe we have conducted, and we intend to continue to conduct, our business in a manner that does not result in our company or any affiliate being required to register as an investment company. In general, an “investment company” is a company that holds more than 40% of the total value of its assets (minus cash and government securities) in “investment securities.” For purposes of this test, while we do not think the loans held on our balance sheet are securities, the loans nonetheless could be deemed “investment securities,” which could in turn cause Upstart Holdings, Inc., Upstart Network, Inc., or an affiliate to be viewed as an “investment company” subject to regulation under the Investment Company Act. To provide clarity on this issue, we intend to apply for an exemptive order from the SEC finding that our company is not an investment company because it is primarily engaged in a business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities. We anticipate, but cannot guarantee, that an exemptive order under the Investment Company Act will be approved by the SEC prior to the sale of our common stock as described in this prospectus. If we are not successful in securing exemptive relief, there is risk that we could be subject to regulation under the Investment Company Act. In addition, exemptive orders provided by the SEC under the Investment Company Act are only effective as long as the facts and analysis upon which they are based do not materially change. It is possible that our business will change in the future in a way that causes the exemptive order to no longer apply to our business. If we are deemed to be an investment company, we may be required to institute burdensome compliance requirements and our activities may be restricted, which would adversely affect our business, financial condition and results of operations. If we were ever deemed to be in non-compliance with the Investment Company Act, we could also be subject to various penalties, including administrative or judicial proceedings that might result in censure, fine, civil penalties, cease-and-desist orders or other adverse consequences, as well as private rights of action, any of which could materially adversely affect our business.

If we are required to register under the Investment Advisers Act, our ability to conduct business could be materially adversely affected.

The IAA contains substantive legal requirements that regulate the manner in which “investment advisers” are permitted to conduct their business activities. We do not believe that we or our affiliates are required to register as an investment adviser with either the SEC or any of the various states, because our business consists of providing a platform for consumer lending and loan financing for

 

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which investment adviser registration and regulation does not apply under applicable federal or state law. However, one of our affiliates, Upstart Network, Inc., has notice filed as an exempt reporting adviser with the state of California based on its limited activities advising two funds.

While we believe our current practices do not require us or any of our other affiliates subsidiaries to register or notice file as an investment adviser, or require us to extend regulations related to Upstart Network, Inc.’s status as an exempt reporting adviser to our other operations, if a regulator were to disagree with our analysis with respect to any portion of our business, we or a subsidiary may be required to register or notice file as an investment adviser and to comply with applicable law. Registering as an investment adviser could adversely affect our method of operation and revenues. For example, the IAA requires that an investment adviser act in a fiduciary capacity for its clients. Among other things, this fiduciary obligation requires that an investment adviser manage a client’s portfolio in the best interests of the client, have a reasonable basis for its recommendations, fully disclose to its client any material conflicts of interest that may affect its conduct and seek best execution for transactions undertaken on behalf of its client. The IAA also limits the ways in which a company can market its services and offerings. It could be difficult for us to comply with these obligations without meaningful changes to our business operations, and there is no guarantee that we could do so successfully. If we were ever deemed to be in non-compliance with applicable investment adviser regulations, we could also be subject to various penalties, including administrative or judicial proceedings that might result in censure, fine, civil penalties, cease-and-desist orders or other adverse consequences, as well as private rights of action, any of which could materially adversely affect our business.

If our transactions with investors in our loan funding programs are found to have been conducted in violation of the Securities Act or similar state law, or we have generally violated any applicable law, our ability to obtain financing for loans facilitated through our platform could be materially adversely affected, and we could be subject to private or regulatory actions.

Certain transactions in our loan funding programs are conducted pursuant to exemptions from the registration requirements of the Securities Act provided for in Regulation D or Section 4(a)(2) of the Securities Act. If any of these transactions were found to not be in compliance with the requirements necessary to qualify for these exemptions from Securities Act registration, or otherwise found to be in violation of the federal or state securities laws, our business could be materially adversely affected. The SEC or state securities regulators could bring enforcement actions against us, or we could be subject to private litigation risks as a result of any violation of the federal or state securities laws, which could result in civil penalties, injunctions and cease and desist orders from further violations, as well as monetary penalties of disgorgement, pre-judgment interest, rescission of securities sales, or civil penalties, any of which could materially adversely affect our business.

If we are found to be in violation of state or federal law generally, we also may be limited in our ability to conduct future transactions. For example, we could in the future become ineligible to sell securities under Regulation D if we become subject to “bad actor” disqualification pursuant to Rule 506(d) of Regulation D. Under Rule 506(d), issuers are ineligible “bad actors” if they or certain related persons, including directors and certain affiliates, are subject to disqualifying events, including certain cease-and-desist orders obtained by the SEC. If we were subject to this or other “bad actor” provisions of the securities laws, we may not be able to continue sales of whole loans, fractional interests in loans, or asset-backed securities, or we could be subject to significant additional expense associated with making our offerings, which would adversely affect our business, financial condition and results of operations.

 

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If we are required to register with the SEC or under state securities laws as a broker-dealer, our ability to conduct business could be materially adversely affected.

We are not currently registered with the SEC as a broker-dealer under the Exchange Act or any comparable state law. The SEC heavily regulates the manner in which broker-dealers are permitted to conduct their business activities. We believe we have conducted, and we intend to continue to conduct, our business in a manner that does not result in our being characterized as a broker-dealer, based on guidance published by the SEC and its staff. Among other reasons, this is because we do not believe we take any compensation that would be viewed as being based on any transactions in securities in any of our business lines. To the extent that the SEC or its staff publishes new or different guidance with respect to these matters, we may be required to adjust our business operations accordingly. Any additional guidance from the SEC staff could provide additional flexibility to us, or it could inhibit our ability to conduct our business operations. There can be no assurance that the laws and regulations governing our broker-dealer status or that SEC guidance will not change in a manner that adversely affects our operations. If we are deemed to be a broker-dealer, we may be required to institute burdensome compliance requirements and our activities may be restricted, which would adversely affect our business, financial condition and results of operations. We may also be subject to private litigation and potential rescission of certain investments investors in our loan financing products have made, which would harm our operations as well.

Similarly, we do not believe that our sales of whole loans and asset-backed securities will subject us to broker-dealer registration in any state in which we operate, primarily because we do not accept compensation that we believe could be viewed as transaction-based. However, if we were deemed to be a broker-dealer under a state’s securities laws, we could face civil penalties, or costly registration requirements, that could adversely affect our business.

Anti-money laundering, anti-terrorism financing and economic sanctions laws could have adverse consequences for us.

We maintain a compliance program designed to enable us to comply with all applicable anti-money laundering and anti-terrorism financing laws and regulations, including the Bank Secrecy Act and the USA PATRIOT Act and U.S. economic sanctions laws administered by the Office of Foreign Assets Control. This program includes policies, procedures, processes and other internal controls designed to identify, monitor, manage and mitigate the risk of money laundering and terrorist financing and engaging in transactions involving sanctioned countries persons and entities. These controls include procedures and processes to detect and report suspicious transactions, perform borrower due diligence, respond to requests from law enforcement, and meet all recordkeeping and reporting requirements related to particular transactions involving currency or monetary instruments. No assurance is given that our programs and controls will be effective to ensure compliance with all applicable anti-money laundering and anti-terrorism financing laws and regulations, and our failure to comply with these laws and regulations could subject us to significant sanctions, fines, penalties, contractual liability to our bank partners or institutional investors, and reputational harm, all of which could harm our business.

Our securitizations, whole loan sales and warehouse facilities expose us to certain risks, and we can provide no assurance that we will be able to access the securitization or whole loan sales markets, or secured warehouse lines of credit, in the future, which may require us to seek more costly financing.

We have facilitated the securitizations, and may in the future facilitate securitizations, of certain loans acquired from our bank partners in order to allow certain of our originating bank partners, our whole loan purchasers and ourselves to liquidate their loans through the asset-backed securities

 

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markets or through other capital markets products. In term asset-backed securities transactions, we sell and convey pools of loans to a special purpose entity, or SPE. We likewise fund certain loans on our balance sheet by selling loans to two warehouse trust SPEs, which loan sales are partially financed with associated warehouse lines of credit from banks. Concurrently, each SPE issues notes or certificates pursuant to the terms of indentures and trust agreements, or in the case of the warehouse facilities, borrows money from banks pursuant to credit and security agreements. The securities issued by the SPEs in asset-backed securitization transactions and the lines of credit borrowed by the warehouse SPEs are each secured by the pool of loans owned by the applicable SPE. In exchange for the sale of a portion of a given pool of loans to the SPE, we and/or our whole loan purchasers who contribute loans to the transactions receive cash and/or securities representing equity interests in such SPE, which are the proceeds from the sale of the securities. The equity interests the SPEs are residual interests in that they entitle the equity owners of such SPEs, including us, to residual cash flows, if any, from the loans and to any assets remaining in such SPEs once the notes are satisfied and paid in full (or in the case of a revolving loan, paid in full and all commitments terminated). As a result of challenging credit and liquidity conditions, the value of the subordinated securities we or other transaction participants retain in such SPEs might be reduced or, in some cases, eliminated.

During the financial crisis that began in 2008, the securitization market was constrained, and this could occur again in the future. In addition, other matters, such as (i) accounting standards applicable to securitization transactions and (ii) capital and leverage requirements applicable to banks and other regulated financial institutions holding asset-backed securities, could result in decreased investor demand for securities issued through our securitization transactions, or increased competition from other institutions that undertake securitization transactions. In addition, compliance with certain regulatory requirements, including the Dodd-Frank Act and the Investment Company Act and the so-called “Volcker Rule,” may affect the type of securitizations that we are able to complete.

Our securitizations are subject to regulation under federal law, and failure to comply with those laws could adversely affect our business.

Our loan securitizations and sales of asset-backed securities are subject to capital and leverage requirements applicable to banks and other regulated financial institutions holding asset-based securities. These requirements, which are costly to comply with, could decrease investor demand for securities issued through our securitization transactions. For example, the Credit Risk Retention rule, codified as Regulation RR under the Exchange Act, was jointly adopted by the SEC, the Department of the Treasury, the Federal Reserve System, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, and the Department of Housing and Urban Development in 2014. Regulation RR generally requires the sponsor of asset-backed securities to retain not less than 5 percent of the credit risk of the assets collateralizing the securities, and generally prohibits the sponsor or its affiliate from directly or indirectly hedging or otherwise selling or transferring the retained credit risk for a specified period of time, depending on the type of asset that is securitized. Some aspects of these risk retention rules have not been the subject of significant separate guidance. We believe, but cannot be certain, that we have conducted our business, and will continue to conduct our business, in such a way that we are compliant with these risk retention rules. However, if we have failed to comply, or should fall out of compliance with these rules, it could adversely affect our source of funding and our business.

We may also face regulatory risks related to compliance with Section 13 of the Bank Holding Company Act, commonly known as the “Volcker Rule,” which prohibits banking entities from acquiring an ownership interest in entities that are investment companies for purposes of the Investment Company Act, or would be investment companies but for Sections 3(c)(1) or 3(c)(7) of the Investment Company Act, which are generally known as “private funds.” This means that in order for a banking entity regulated under the Volcker Rule to purchase certain asset-backed securities issued by our affiliates, such affiliates may need to rely on another exemption or exception from being deemed

 

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“investment companies.” Currently, those affiliates generally rely on Rule 3a-7 under the Investment Company Act, which provides an exclusion to the definition of an investment company for issuers that pool income-producing assets and issue securities backed by those assets. However, if a regulator or other third party were to find or assert that our analysis under Rule 3a-7 (or, where applicable, some other exemption or exemption) is incorrect, banks that have purchased asset-backed securities may be able to rescind those sales, which would adversely affect our business. We believe, but cannot guarantee, that we have conducted our business, and will continue to conduct our business, in such a way that enables our applicable banking entity investors to be compliant with the Volcker Rule.

If it is not possible or economical for us to securitize loans in the future due to the applicable regulatory requirements, we would need to seek alternative financing to support our loan funding programs and to meet our existing debt obligations. Such funding may not be available on commercially reasonable terms, or at all. If the cost of such loan funding mechanisms were to be higher than our securitizations, the fair value of the loans would likely be reduced, which would negatively impact our results of operations. If we are unable to access such financing, our ability to originate loans and our results of operations, financial condition and liquidity would be materially adversely affected.

The gain on sale and related servicing fees generated by our whole loan sales, and the servicing fees based on sales of asset-backed securities and interests in our legacy fractional loan program, also represent a significant source of our earnings. We cannot assure you that our loan purchasers will continue to purchase loans or interests in loans on our platform (either through whole loan sales, sales of fractionalized interests in loans, or asset-backed securities) or that they will continue to purchase loans in transactions that generate the same spreads and/or fees that we have historically obtained. Factors that may affect loan purchaser demand for loans include:

 

   

competition among loan originators that can sell either larger pools of loans than we are able to sell or pools of loans that have characteristics that are more desirable to certain loan purchasers than the characteristics that our loan pools have;

 

   

the extent to which servicing fees and other expenses may reduce overall net return on purchased pools of loans;

 

   

the actual or perceived credit performance and loan grade and term mix of the portfolios of loans offered for sale;

 

   

loan purchasers’ sector and company investment diversification requirements and strategies;

 

   

higher yielding investment opportunities at a risk profile deemed similar to our sold loan portfolios;

 

   

borrower prepayment behavior within the underlying pools;

 

   

regulatory or investment governance surrounding maintaining net asset value, mark-to-market and similar metrics surrounding pools of purchased loans; and

 

   

the ability of our loan purchasers to access funding and liquidity channels, including securitization markets on terms they find acceptable to deliver an appropriate return net of funding costs, as well as general market trends that affect the appetite for loan financing investments.

Potential investors in our loan funding programs may also reduce the prices investors in those products are willing to pay for the loans or interests in loans they purchase during periods of economic slowdown or recession to compensate for any increased risks. A reduction in the sale price of the loans and loan financing products we sell would negatively impact our operations and returns. Any sustained decline in demand for loans or loan financing products, or any increase in delinquencies, defaults or foreclosures that result from economic downturns, may also reduce the price we receive on future loan sales.

 

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RISKS RELATED TO THIS OFFERING AND OWNERSHIP OF OUR COMMON STOCK

An active trading market for our common stock may never develop or be sustained.

We plan to apply to list our common stock on the            under the symbol “UPST”. However, we cannot assure you that an active trading market for our common stock will develop on that exchange or elsewhere or, if developed, that any market will be sustained. Accordingly, we cannot assure you of the liquidity of any trading market, your ability to sell your shares of our common stock when desired, or the prices that you may obtain for your shares.

The trading price of our common stock may be volatile, and you could lose all or part of your investment.

Prior to this offering, there has been no public market for shares of our common stock. The initial public offering price of our common stock was determined through negotiation among us and the underwriters. This price does not necessarily reflect the price at which investors in the market will be willing to buy and sell shares of our common stock following this offering. In addition, the trading price of our common stock following this offering is likely to be volatile and could be subject to fluctuations in response to various factors, some of which are beyond our control. These fluctuations could cause you to lose all or part of your investment in our common stock since you might be unable to sell your shares at or above the price you paid in this offering. Factors that could cause fluctuations in the trading price of our common stock include:

 

   

price and volume fluctuations in the overall stock market from time to time;

 

   

volatility in the trading prices and trading volumes of financial technology stocks;

 

   

changes in operating performance and stock market valuations of other financial technology companies and technology companies that offer services to financial institutions;

 

   

sales of shares of our common stock by us or our stockholders;

 

   

failure of securities analysts to maintain coverage of us, changes in financial estimates by securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors;

 

   

the financial projections we may provide to the public, any changes in those projections, or our failure to meet those projections;

 

   

announcements by us or our competitors of new products, features, or services;

 

   

the public’s reaction to our press releases, other public announcements, and filings with the SEC;

 

   

rumors and market speculation involving us or other companies in our industry;

 

   

actual or anticipated changes in our results of operations or fluctuations in our results of operations;

 

   

changes in prevailing interest rates;

 

   

quarterly fluctuations in demand for the loans we facilitate through our platform;

 

   

fluctuations in the trading volume of our shares or the size of our public float;

 

   

actual or anticipated developments in our business, our competitors’ businesses or the competitive landscape generally;

 

   

litigation involving us, our industry, or both, or investigations by regulators into our operations or those of our competitors;

 

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compliance with government policies or regulations;

 

   

the issuance of any cease-and-desist orders from regulatory agencies that we are subject to;

 

   

developments or disputes concerning our intellectual property or other proprietary rights;

 

   

actual or perceived data security breaches or other data security incidents;

 

   

announced or completed acquisitions of businesses, products, services, or technologies by us or our competitors;

 

   

new laws or regulations or new interpretations of existing laws or regulations applicable to our business;

 

   

changes in accounting standards, policies, guidelines, interpretations, or principles;

 

   

recruitment or departure of key personnel; and

 

   

general economic conditions and slow or negative growth of our markets.

The stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of listed companies. Broad market and industry factors may seriously affect the market price of our common stock, regardless of our actual operating performance. In the past, following periods of volatility in the overall market and the market prices of particular companies’ securities, securities class action litigation has often been instituted against these companies. Litigation of this type, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

Certain insiders have significant voting power, which could limit your ability to influence the outcome of key transactions, including a change of control.

Our directors, officers, and each of our stockholders who own greater than 5% of our outstanding capital stock and their affiliates, in the aggregate, beneficially own a majority of the outstanding shares of our capital stock. As a result, these stockholders, if acting together, will be able to influence matters requiring approval by our stockholders, including the election of directors and the approval of mergers, acquisitions, or other extraordinary transactions. They may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This concentration of ownership may have the effect of delaying, preventing or deterring a change of control, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale, and might ultimately affect the trading price of our common stock.

A substantial portion of the outstanding shares of our common stock after this offering will be restricted from immediate resale but may be sold on a stock exchange in the near future. The large number of shares of our capital stock eligible for public sale or subject to rights requiring us to register them for public sale could depress the market price of our common stock.

The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market after this offering, and the perception that these sales could occur may also depress the market price of our common stock. Based on            shares of our common stock (after giving effect to the Capital Stock Conversion and the automatic net exercise of a preferred stock warrant) outstanding as of December 31, 2019, we will have            shares of our common stock outstanding immediately after this offering. Our executive officers, directors, and the holders of substantially all of our capital stock and securities convertible into or exchangeable for our capital stock have entered into market standoff agreements with us or have entered into lock-up agreements with the underwriters under which they have agreed, subject to specific exceptions, not to sell any of our stock for 180 days following the date of this prospectus. We refer to such period as

 

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the lock-up period. In addition, the underwriter representatives may, in their discretion, release all or some portion of the shares subject to lock-up agreements prior to the expiration of the lock-up period. See “Shares Eligible for Future Sale” for more information. Sales of a substantial number of such shares upon expiration, or the perception that such sales may occur, or early release of the lock-up, could cause our share price to fall or make it more difficult for you to sell your common stock at a time and price that you deem appropriate.

As a result of these agreements and the provisions of our investors’ rights agreement described further in the section titled “Description of Capital Stock—Registration Rights,” and subject to the provisions of Rule 144 or Rule 701 under the Securities Act, shares of our common stock will be available for sale in the public market as follows based on the shares of our capital stock outstanding as of December 31, 2019 (after giving effect to the Capital Stock Conversion):

 

   

beginning on the date of this prospectus, all            shares of our common stock sold in this offering will be immediately available for sale in the public market; and

 

   

beginning 181 days after the date of this prospectus (subject to the terms of the lock-up agreements and market standoff agreements described above), an additional            shares of our common stock will be eligible for sale in the public market from time to time thereafter, of which            shares of our common stock will be subject to the volume and other restrictions of Rule 144, as described below.

Upon completion of this offering, stockholders owning an aggregate of up to            shares of our common stock will be entitled, under our investors’ rights agreement, to require us to register shares owned by them for public sale in the United States. In addition, we intend to file a registration statement to register shares reserved for future issuance under our equity compensation plans. Upon effectiveness of the registration statement of which this prospectus forms a part, subject to the satisfaction of applicable exercise periods and the expiration or waiver of the market standoff agreements and lock-up agreements referred to above, the shares issued upon exercise of outstanding stock options will be available for immediate resale in the United States in the open market.

Sales of our shares as restrictions end or pursuant to registration rights may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. These sales also could cause the trading price of our common stock to fall and make it more difficult for you to sell shares of our common stock.

Our common stock does not provide any rights directly related to the loans we hold.

Investors in our common stock own a form of equity that may provide returns based on either an increase in the value of the stock or any distributions made to common stockholders. Investors will not, however, receive any interest in or fees based on the loans or other assets we hold on our balance sheet. In particular, investors in our common stock will not receive any distributions directly based on principal or interest payments made by borrowers on the loans we hold. Those loans are not directly related in any way to the common stock investors’ purchase.

You may be diluted by the future issuance of additional common stock in connection with our equity incentive plans, acquisitions or otherwise.

After this offering and the use of proceeds to us therefrom, we will have an aggregate of            shares of common stock authorized but unissued, and our amended and restated certificate of incorporation will authorize us to issue these shares of common stock and rights relating to common stock for the consideration and on the terms and conditions established by our board of directors in its sole discretion, whether in connection with acquisitions or otherwise. We have reserved            shares

 

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for issuance under our 2020 Equity Incentive Plan subject to adjustment in certain events. See “Executive Compensation—2020 Equity Incentive Plan.” Any common stock that we issue, including under our 2020 Equity Incentive Plan or other equity incentive plans that we may adopt in the future, could dilute the percentage ownership held by the investors who purchase common stock in this offering.

If you purchase our common stock in this offering, you will incur immediate and substantial dilution in the book value of your investment.

The initial public offering price of our common stock is substantially higher than the pro forma as adjusted net tangible book value per share of our outstanding common stock of $           per share as of December 31, 2019. Investors purchasing shares of our common stock in this offering will pay a price per share that substantially exceeds the book value of our tangible assets after subtracting our liabilities. As a result, investors purchasing common stock in this offering will incur immediate dilution of $           per share, based on an assumed initial public offering price of $           per share.

This dilution is due in large part to the substantially lower price paid by our investors who purchased shares prior to this offering as compared to the price offered to the public in this offering, and any previous exercise of stock options granted to our service providers. In addition, as of December 31, 2019, options to purchase 16,502,206 shares of our common stock were outstanding with a weighted-average exercise price of $1.86 per share. The exercise of any of these options would result in additional dilution. As a result of the dilution to investors purchasing shares in this offering, investors may receive less than the purchase price paid in this offering, if anything, in the event of our liquidation. See the section titled “Dilution” for more information.

We have broad discretion over the use of the net proceeds from this offering and we may not use them effectively.

We cannot specify with any certainty the particular uses of the net proceeds that we will receive from this offering. Our management will have broad discretion in the application of the net proceeds from this offering, including for any of the purposes described in “Use of Proceeds,” and you will not have the opportunity as part of your investment decision to assess whether the net proceeds are being used appropriately. Because of the number and variability of factors that will determine our use of the net proceeds from this offering, their ultimate use may vary substantially from their currently intended use. If our management fails to apply these proceeds effectively, such failure could adversely affect our business, results of operations, financial condition, and the price of our common stock. Pending their use, we may invest our proceeds in a manner that does not produce income or that loses value. Our investments may not yield a favorable return to our investors and may negatively impact the price of our common stock.

Delaware law and provisions in our amended and restated certificate of incorporation and amended and restated bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the market price of our common stock.

Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our amended and restated certificate of incorporation and amended and restated bylaws, as they will be in effect following this offering, contain provisions that may make the acquisition of our company more difficult, including the following:

 

   

our Board of Directors is classified into three classes of directors with staggered three-year terms and directors are only able to be removed from office for cause;

 

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vacancies on our Board of Directors will be able to be filled only by our Board of Directors and not by stockholders;

 

   

only the Chair of our Board of Directors, our Chief Executive Officer, or a majority of our entire Board of Directors are authorized to call a special meeting of stockholders;

 

   

certain litigation against us can only be brought in Delaware;

 

   

advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; and

 

   

any amendment of the above anti-takeover provisions in our amended and restated certificate of incorporation or amended and restated bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of our common stock.

These anti-takeover defenses could discourage, delay, or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors of their choosing and to cause us to take other corporate actions they desire, any of which, under certain circumstances, could limit the opportunity for our stockholders to receive a premium for their shares of our capital stock, and could also affect the price that some investors are willing to pay for our common stock.

Our amended and restated bylaws will designate a state or federal court located within the State of Delaware as the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to choose the judicial forum for disputes with us or our directors, officers or employees.

Our amended and restated bylaws, which will become effective immediately prior to the completion of this offering, will provide that the Court of Chancery of the State of Delaware is the exclusive forum for the following types of actions or proceedings under Delaware statutory or common law: (i) any derivative action or proceeding brought on our behalf; (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, or other employees to us or our stockholders; (iii) any action arising pursuant to any provision of the Delaware General Corporation Law, our amended and restated certificate of incorporation or our amended and restated bylaws; or (iv) any other action asserting a claim that is governed by the internal affairs doctrine shall be the Court of Chancery of the State of Delaware (or, if the Court of Chancery does not have jurisdiction, the federal district court for the District of Delaware), in all cases subject to the court having jurisdiction over indispensable parties named as defendants. The provisions would not apply to suits brought to enforce a duty or liability created by the Exchange Act. Additionally, nothing in our amended and restated bylaws precludes stockholders that assert claims under the Securities Act from bringing such claims in state or federal court, subject to applicable law.

Any person or entity purchasing or otherwise acquiring any interest in any of our securities shall be deemed to have notice of and consented to this provision. This exclusive-forum provision may limit a stockholder’s ability to bring a claim in a judicial forum of its choosing for disputes with us or our directors, officers, or other employees, which may discourage lawsuits against us and our directors, officers, and other employees. If a court were to find the exclusive-forum provision in our amended and restated bylaws to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving the dispute in other jurisdictions, which could harm our results of operations.

Our common stock market price and trading volume could decline if equity or industry analysts do not publish research or publish inaccurate or unfavorable research about our business.

The trading market for our common stock will depend in part on the research and reports that equity or industry analysts publish about us or our business. The analysts’ estimates are based upon

 

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their own opinions and are often different from our estimates or expectations. If one or more of the analysts who cover us downgrade our common stock or publish inaccurate or unfavorable research about our business, the price of our securities would likely decline. If few securities analysts commence coverage of us, or if one or more of these analysts cease coverage of us or fail to publish reports on us regularly, demand for our securities could decrease, which might cause the price and trading volume of our common stock to decline.

We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, and we intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies,” including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a non-binding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. In addition, under the JOBS Act, emerging growth companies can delay the adoption of certain new or revised accounting standards until those standards would otherwise apply to private companies. We have elected to avail ourselves of this exemption from new or revised accounting standards and, therefore, we will not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies or that have opted out of using such extended transition period, which may make comparison of our financial statements with those of other public companies more difficult. We may take advantage of these exemptions for so long as we are an “emerging growth company,” which could be as long as five years following the effectiveness of this offering. We expect, however, that we will cease being an “emerging growth company” prior to such time. We cannot predict if investors will find our common stock less attractive to the extent that we rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and the price of our common stock may be more volatile.

The requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members.

As a public company, we will be subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Act, the listing requirements of the            and other applicable securities rules and regulations. Compliance with these rules and regulations will increase our legal and financial compliance costs, make some activities more difficult, time-consuming or costly and increase demand on our systems and resources. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and results of operations. In addition, we expect that our management and other personnel will need to divert attention from operational and other business matters to devote substantial time to these public company requirements. We cannot predict or estimate the amount of additional costs we may incur as a result of becoming a public company or the timing of such costs.

We also expect that being a public company will make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage, incur substantially higher costs to obtain coverage or only obtain coverage with a significant deductible. These factors could also make it more difficult for us to attract and retain qualified executive officers and qualified members of our board of directors, particularly to serve on our audit committee and compensation committee.

 

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In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time-consuming. These laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If, notwithstanding our efforts, we fail to comply with new laws, regulations and standards or our efforts differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us, and our business may be adversely affected.

Our management team has limited experience managing a public company.

Our management team has limited or no experience managing a publicly traded company, interacting with public company investors, and complying with the increasingly complex laws pertaining to public companies. These new obligations and constituents will require significant attention from our management team and could divert their attention away from the day-to-day management of our business, which could harm our business, results of operations, and financial condition.

We do not intend to pay dividends for the foreseeable future.

We have never declared nor paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. In addition, the terms of our existing corporate debt agreements do, and any future debt agreements may, preclude us from paying dividends. As a result, capital appreciation of our common stock, if any, will be the only way for stockholders to realize any future gains on their investment for the foreseeable future.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements within the meaning of the federal securities laws about us and our industry, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “seek,” “could,” “intend,” “target,” “aim,” “project,” “contemplate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions. Forward-looking statements contained in this prospectus include statements about:

 

   

our future financial performance, including our expectations regarding our revenue, our operating expenses, our ability to determine reserves and our ability to remain profitable;

 

   

our ability to improve the effectiveness and predictiveness of our AI models and our expectations that improvements in our AI models can lead to higher approval rates and lower interest rates;

 

   

our ability to increase the volume of loans facilitated by our AI lending platform;

 

   

our ability to enter into new and maintain existing bank partnerships;

 

   

our ability to successfully maintain a diversified loan funding strategy, including bank partnerships and whole loan sales and securitization transactions;

 

   

our ability to maintain competitive interest rates offered to borrowers on our platform, while enabling our bank partners to achieve an adequate return over their cost of funding;

 

   

our ability to successfully build our brand and protect our reputation from negative publicity;

 

   

our ability to increase the effectiveness of our marketing strategies, including our direct consumer marketing initiatives;

 

   

our expectations and management of future growth, including expanding the number of potential borrowers;

 

   

our ability to successfully adjust our proprietary AI models, products and services in a timely manner in response to changing macroeconomic conditions and fluctuations in the credit market;

 

   

our compliance with applicable local, state and federal laws;

 

   

our ability to comply with and successfully adapt to complex and evolving regulatory environments, including regulation of artificial intelligence and machine learning technology;

 

   

our expectations regarding regulatory support of our approach to AI-based lending;

 

   

our ability to protect against increasingly sophisticated fraudulent borrowing and online theft;

 

   

our ability to service loans and the ability of third-party collection agents, to pursue collection of delinquent and defaulted loans;

 

   

our ability to successfully compete with companies that are currently in, or may in the future enter, the markets in which we operate;

 

   

our expectations regarding new and evolving markets and our ability enter into new markets and introduce new products and services;

 

   

our ability to effectively secure and maintain the confidentiality of the information received, accessed, stored, provided and used across our systems;

 

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our ability to successfully obtain and maintain funding and liquidity to support continued growth and general corporate purposes;

 

   

our ability to attract, integrate and retain qualified employees;

 

   

our ability to effectively manage and expand the capabilities of our operations teams, outsourcing relationships and other business operations;

 

   

our ability to maintain, protect and enhance our intellectual property;

 

   

our expectations regarding outstanding litigation and regulatory investigations;

 

   

the increased expenses associated with being a public company; and

 

   

our anticipated uses of net proceeds from this offering.

We caution you that the foregoing list may not contain all of the forward-looking statements made in this prospectus.

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this prospectus primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors, including those described in the section titled “Risk Factors” and elsewhere in this prospectus. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this prospectus. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.

Neither we nor any other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. Moreover, the forward-looking statements made in this prospectus relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this prospectus to reflect events or circumstances after the date of this prospectus or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this prospectus, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely upon these statements.

 

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INDUSTRY, MARKET AND OTHER DATA

Unless otherwise indicated, estimates and information contained in this prospectus concerning our industry and the market in which we operate, including our general expectations, market position, market opportunity, and market size, are based on industry publications and reports generated by third-party providers, other publicly available studies, and our internal sources and estimates. This information involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. Although we are responsible for all of the disclosure contained in this prospectus and we believe the information from the industry publications and other third-party sources included in this prospectus is reliable, we have not independently verified the accuracy or completeness of the data contained in such sources. The content of, or accessibility through, the below sources and websites, except to the extent specifically set forth in this prospectus, does not constitute a portion of this prospectus and is not incorporated herein, and any websites are an inactive textual reference only.

The source of certain statistical data, estimates and forecasts contained in this prospectus are the following independent industry publications or reports:

 

   

Adrian D. Garcia, Bankrate: JPM, Big Banks Spend Billions on Tech but Innovation Lags, July 2018.

 

   

Bain & Company, Inc., Evolving the Customer Experience in Banking, 2017.

 

   

Board of Governors of the Federal Reserve System, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, National Credit Union Administration and Office of the Comptroller of the Currency, Interagency Statement on the Use of Alternative Data in Credit Underwriting, December 2019.

 

   

Eldar Beiseitov, Federal Reserve Bank of St. Louis: Unsecured Personal Loans Get a Boost From Fintech Lenders, July 2019.

 

   

Consumer Financial Protection Bureau, No-Action Letter to Upstart Network, Inc. dated September 14, 2017.

 

   

Consumer Financial Protection Bureau, Policy on No-Action Letters, September 2019.

 

   

Federal Home Loan Bank of San Francisco, Cost of Funds Index, December 2019.

 

   

Federal Deposit Insurance Corporation, Statistics on Depository Institutions, December 2019.

 

   

The Federal Reserve Board, Statistical Release: Consumer Credit, December 2019.

 

   

The Federal Reserve Board, Household Debt Service and Financial Obligations Ratios, December 2019.

 

   

Forbes, citing Temkin Group Insight Report, NPS Benchmark Study, 2018, October 2018.

 

   

Kathleen L. Kraninger, Consumer Financial Protection Bureau: Director Kraninger’s Remarks at TCH-BPI Conference, November 2019.

 

   

Kirsten Wysen, Open Source Solutions: Why Credit Scores and Payday Lending Matter for Health, October 2019.

 

   

Kroll Bond Rating Agency, KBRA Surveillance Reports, December 2019.

 

   

McKinsey Global Institute, Notes From the AI Frontier: Modeling the Impact of AI on the World Economy, September 2018.

 

   

Naeem Siddiqi, Intelligent Credit Scoring: Building and Implementing Better Credit Risk Scorecards—2nd Edition, 2017.

 

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Northwestern Mutual, 2019 Planning & Progress Study: The Debt Debacle, 2019.

 

   

Patrice Ficklin and Paul Watkins, Consumer Financial Protection Bureau Blog: An Update on Credit Access and the Bureau’s First No-Action Letter, August 2019.

 

   

PricewaterhouseCoopers LLP, Experience Is Everything: Here’s How to Get It Right, 2018.

 

   

RedPoint Global and the Harris Poll, Addressing the Gaps in Customer Experience: A Benchmark Study Exploring the Ever Evolving Customer Experience and How Marketers and Consumers Are Adapting, March 2019.

 

   

Rob Kaufman, myFico Blog: The History of the FICO Score, August 2018.

References to market size estimates are based on 2017 and 2018 U.S. loan origination data obtained from TransUnion in September 2019.

As disclosed in this prospectus, the Net Promoter Scores for our bank partners’ lending programs are approximately 80, which represents the weighted average of the Net Promoter Scores of each of our bank partners in the fourth quarter of 2019. The Net Promoter Scores of our bank partners were derived through a third-party service that administers surveys to loan applicants immediately following the applicants’ acceptance of a loan on Upstart’s platform. Net Promoter Scores are calculated based on responses measured on a scale of one to ten to the survey question, “how likely is it that you would recommend us?” Responses of nine or 10 are considered “promoters,” responses of seven or eight are considered neutral or “passives,” and responses of six or less are considered “detractors.” The number of detractors is subtracted from the number of promoters, and the resulting number is divided by the total number of respondents to obtain the Net Promoter Score using the methodology developed by Bain & Company, Inc. References to our bank partners’ Net Promoter Scores are based on survey data gathered in the fourth quarter of 2019. Net Promoter Scores for other banks used for comparison were obtained from Forbes, citing the Temkin Group Insight Report, NPS Benchmark Study, 2018, October 2018. While the Net Promoter Score methodology used by Upstart’s third-party service was designed to be consistent with the methodology used in the referenced benchmark study, any differences in the timing or method in which the surveys were administered could negatively impact the comparability of such Net Promoter Scores.

The industry in which we operate is subject to a high degree of uncertainty and risk due to a variety of factors, including those described in the section titled “Risk Factors” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of shares of our common stock in this offering will be approximately $          , based upon the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters’ option to purchase additional shares of our common stock from us is exercised in full, we estimate that the net proceeds to us would be approximately $          , after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

Each $1.00 increase or decrease in the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease the net proceeds that we receive from this offering by approximately $          , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions payable by us. Similarly, each increase or decrease of 1.0 million in the number of shares of our common stock offered by us would increase or decrease the net proceeds that we receive from this offering by approximately $          , assuming the assumed initial public offering price remains the same and after deducting the estimated underwriting discounts and commissions payable by us.

The principal purposes of this offering are to increase our capitalization and financial flexibility, create a public market for our common stock, and enable access to the public equity markets for us and our stockholders.

We intend to use the net proceeds we receive from this offering for general corporate purposes, including working capital, operating expenses, and capital expenditures. Additionally, we may use a portion of the net proceeds we receive from this offering to acquire or invest in businesses, products, services, or technologies. However, we do not have agreements or commitments for any material acquisitions or investments at this time. We cannot specify with certainty the particular uses of the net proceeds that we will receive from this offering. Accordingly, we will have broad discretion in using these proceeds. Pending the use of proceeds from this offering as described above, we may invest the net proceeds that we receive in this offering in short-term, investment grade, interest-bearing instruments.

 

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DIVIDEND POLICY

We have never declared or paid any cash dividends on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our board of directors, subject to applicable laws, and will depend on a number of factors, including our financial condition, results of operations, capital requirements, contractual restrictions, general business conditions, and other factors that our board of directors may deem relevant. Additionally, our ability to pay cash dividends on our common stock is limited by restrictions under the terms of our credit facilities with Silicon Valley Bank.

 

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CAPITALIZATION

The following table sets forth our cash and capitalization as of December 31, 2019 as follows:

 

   

on an actual basis;

 

   

on a pro forma basis, giving effect to (i) the Capital Stock Conversion, as if such conversions had occurred on December 31, 2019, (ii) the automatic net exercise of an outstanding warrant to purchase up to 600,208 shares of our Series B preferred stock and the reclassification of the associated warrant liability to additional paid-in capital and (iii) the filing and effectiveness of our amended and restated certificate of incorporation in Delaware that will become effective immediately prior to the completion of this offering; and

 

   

on a pro forma as adjusted basis, giving effect to the pro forma adjustments set forth above and the sale and issuance by us of            shares of our common stock in this offering, based upon the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

The pro forma as adjusted information set forth in the table below is illustrative only and will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing. You should read this table together with our consolidated financial statements and related notes, and the sections titled “Selected Consolidated Financial and Other Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are included elsewhere in this prospectus.

 

     As of December 31, 2019  
(In thousands, except share and per share amounts)    Actual     Pro
forma
     Pro
forma as
adjusted (1)
 

Cash

   $ 44,389     $                    $                
  

 

 

   

 

 

    

 

 

 

Convertible preferred stock warrant liability

   $ 5,666     $ —        $ —    

Total borrowings

     118,609       

Convertible preferred stock, par value $0.0001 per share: 53,927,657 shares authorized, 47,349,577 issued and outstanding, actual; no shares authorized, issued and outstanding, pro forma and pro forma as adjusted

     162,546       —          —    

Preferred stock, par value $0.0001 per share: no shares authorized, issued and outstanding, actual;           shares authorized, no shares issued and outstanding, pro forma and pro forma as adjusted

     —         —          —    

Stockholders’ equity:

       

Common stock, par value $0.0001 per share: 90,000,000 shares authorized, 14,561,398 shares issued and outstanding, actual;           shares authorized,           shares issued and outstanding, pro forma; and           shares authorized,           shares issued and outstanding, pro forma as adjusted

     2       

Additional paid-in capital

     12,489       

Accumulated deficit

     (75,205     

Noncontrolling interests

     1,026       
  

 

 

   

 

 

    

 

 

 

Total stockholders’ (deficit) equity

     (61,688     
  

 

 

   

 

 

    

 

 

 

Total capitalization

   $ 225,133     $        $    
  

 

 

   

 

 

    

 

 

 

 

(1)

Each $1.00 increase or decrease in the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease the amount of our pro forma as adjusted cash, additional paid-in capital, total stockholders’ equity, and total capitalization by $          ,

 

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assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions payable by us. An increase or decrease of 1.0 million shares in the number of shares offered by us would increase or decrease, as applicable, the amount of our pro forma as adjusted cash, additional paid-in capital, total stockholders’ equity, and total capitalization by $          , assuming the assumed initial public offering price remains the same, and after deducting estimated underwriting discounts and commissions payable by us.

If the underwriters’ option to purchase additional shares of our common stock from us were exercised in full, pro forma as adjusted cash, additional paid-in capital, total stockholders’ equity, total capitalization, and shares outstanding as of December 31, 2019 would be $          , $          , $          , $          , and           , respectively.

The pro forma and pro forma as adjusted columns in the table above are based on            shares of our common stock (including shares of preferred stock issuable upon the automatic net exercise of a warrant to purchase Series B preferred stock and the Capital Stock Conversion) outstanding as of December 31, 2019, and exclude the following:

 

   

16,502,206 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock outstanding as of December 31, 2019, with a weighted-average exercise price of $1.86 per share;

 

   

319,669 shares of our common stock issuable upon the exercise of warrants outstanding as of December 31, 2019, with a weighted-average exercise price of $1.77 per share;

 

   

1,757,974 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock issued after December 31, 2019, with a weighted-average exercise price of $8.88 per share; and

 

   

           shares of our common stock reserved for future issuance under our equity compensation plans, consisting of:

 

   

           shares of our common stock to be reserved for future issuance under our 2020 Plan, which will become effective prior to the completion of this offering; and

 

   

1,319,666 shares of our common stock reserved for future issuance under our 2012 Plan, which number of shares will be added to the shares of our common stock to be reserved for future issuance under our 2020 Plan upon its effectiveness, at which time we will cease granting awards under our 2012 Plan.

Our 2020 Plan will provide for annual automatic increases in the number of shares reserved thereunder and our 2020 Plan will also provide for increases to the number of shares that may be granted thereunder based on shares under our 2012 Plan that expire, are forfeited, or otherwise repurchased by us, as more fully described in the section titled “Executive Compensation—Employee Benefit and Stock Plans.”

 

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DILUTION

If you invest in our common stock in this offering, your ownership interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock immediately after this offering. Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of shares of our common stock in this offering and the pro forma as adjusted net tangible book value per share of our common stock immediately after completion of this offering.

Our historical net tangible book value per share is determined by dividing our total tangible assets less our convertible preferred stock and our total liabilities by the number of shares of our common stock outstanding. Our historical net tangible book value as of December 31, 2019 was $           million, or $           per share. Our pro forma net tangible book value as of December 31, 2019 was $           million, or $           per share, based on the total number of shares of our common stock outstanding as of December 31, 2019, after giving effect to (i) the Capital Stock Conversion, (ii) the automatic net exercise of an outstanding warrant to purchase shares of preferred stock resulting in the issuance of shares of our common stock and the related reclassification of our convertible preferred stock warrant liability to additional paid-in capital and (iii) the filing and effectiveness of our amended and restated certificate of incorporation in Delaware that will become effective immediately prior to the completion of this offering.

After giving effect to the sale by us of            shares of our common stock in this offering at the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of December 31, 2019 would have been $          , or $           per share. This represents an immediate increase in pro forma net tangible book value of $           per share to our existing stockholders and an immediate dilution in pro forma net tangible book value of $           per share to investors purchasing shares of our common stock in this offering at the assumed initial public offering price. The following table illustrates this dilution:

 

Assumed initial public offering price per share

      $                

Pro forma net tangible book value per share as of December 31, 2019

   $                   

Increase in pro forma net tangible book value per share attributable to new investors purchasing shares of common stock in this offering

     
  

 

 

    

Pro forma as adjusted net tangible book value per share immediately after this offering

     
     

 

 

 

Dilution in pro forma net tangible book value per share to new investors in this offering

      $    
     

 

 

 

Each $1.00 increase or decrease in the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease, as applicable, our pro forma as adjusted net tangible book value per share to new investors by $          , and would increase or decrease, as applicable, dilution per share to new investors purchasing shares of common stock in this offering by $          , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. Similarly, each increase or decrease of 1.0 million shares in the number of shares of our common stock offered by us would increase or decrease, as applicable, our pro forma as adjusted net tangible book value by approximately $           per share and increase or decrease, as applicable, the dilution to new investors purchasing shares of common stock in this offering by $           per share, assuming the assumed initial public offering price remains the same, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

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If the underwriters’ option to purchase additional shares of our common stock from us is exercised in full, the pro forma as adjusted net tangible book value per share of our common stock would be $           per share, and the dilution in pro forma net tangible book value per share to new investors purchasing shares of common stock in this offering would be $           per share.

The following table presents, as of December 31, 2019, after giving effect to the automatic net exercise of an outstanding warrant to purchase shares of our Series B preferred stock and the Capital Stock Conversion, the differences between the existing stockholders and the new investors purchasing shares of our common stock in this offering with respect to the number of shares purchased from us, the total consideration paid or to be paid to us, which includes net proceeds received from the issuance of our common stock, and the average price per share paid or to be paid to us at the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us:

 

     Shares
Purchased
    Total Consideration     Average
Price
Per
Share
 
     Number      Percent     Amount      Percentage  

Existing stockholders

               $                             $                

New investors

    

            

            $    
  

 

 

    

 

 

   

 

 

    

 

 

   

Totals

        100   $          100  
     

 

 

      

 

 

   

Each $1.00 increase or decrease in the assumed initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease, as applicable, the total consideration paid by new investors and total consideration paid by all stockholders by $           million, assuming that the number of shares of our common stock offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. Similarly, each increase or decrease of 1.0 million in the number of shares of our common stock offered by us would increase or decrease the total consideration paid by new investors and total consideration paid by all stockholders by $          , assuming the assumed initial public offering price remains the same and after deducting the estimated underwriting discounts and commissions payable by us.

Except as otherwise indicated, the above discussion and tables assume no exercise of the underwriters’ option to purchase additional shares of our common stock from us. If the underwriters’ option to purchase additional shares of our common stock were exercised in full, our existing stockholders would own           % and our new investors would own           % of the total number of shares of our common stock outstanding upon completion of this offering.

The number of shares of our common stock that will be outstanding after this offering is based on            shares of our common stock (including the preferred stock issuable upon the automatic net exercise of a warrant to purchase Series B preferred stock and the Capital Stock Conversion) outstanding as of December 31, 2019, and excludes:

 

   

16,502,206 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock outstanding as of December 31, 2019, with a weighted-average exercise price of $1.86 per share;

 

   

319,669 shares of our common stock issuable upon the exercise of warrants outstanding as of December 31, 2019, with a weighted-average exercise price of $1.77 per share;

 

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1,757,974 shares of common stock issuable upon the exercise of options to purchase shares of our common stock issued after December 31, 2019, with a weighted-average exercise price of $8.88 per share; and

 

   

           shares of our common stock reserved for future issuance under our equity compensation plans, consisting of:

 

   

           shares of our common stock to be reserved for future issuance under our 2020 Plan, which will become effective prior to the completion of this offering; and

 

   

1,319,666 shares of our common stock reserved for future issuance under our 2012 Plan, which number of shares will be added to the shares of our common stock to be reserved for future issuance under our 2020 Plan upon its effectiveness, at which time we will cease granting awards under our 2012 Plan.

Our 2020 Plan will provide for annual automatic increases in the number of shares reserved thereunder, and our 2020 Plan will also provide for increases to the number of shares that may be granted thereunder based on shares under our 2012 Plan that expire, are forfeited, or otherwise repurchased by us, as more fully described in the section titled “Executive Compensation—Employee Benefit and Stock Plans.”

To the extent that any outstanding options to purchase our common stock are exercised, or new awards are granted under our equity compensation plans, there will be further dilution to investors participating in this offering.

 

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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

The following selected consolidated statements of operations data for the years ended December 31, 2017, 2018 and 2019 and the consolidated balance sheet data as of December 31, 2018 and 2019 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results that may be expected in the future. You should read the following selected consolidated financial and other data below in conjunction with the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

Consolidated Statements of Operations Data

 

     Year Ended December 31,  
(In thousands, except share and per share amounts)    2017     2018     2019  

Revenue:

      

Revenue from fees, net

   $ 51,161     $ 88,482     $ 159,847  

Interest income and fair value adjustments, net

     6,128       10,831       4,342  
  

 

 

   

 

 

   

 

 

 

Total revenue

     57,289       99,313       164,189  
  

 

 

   

 

 

   

 

 

 

Operating expenses:

      

Sales and marketing(1)

     33,838       63,633       93,175  

Customer operations(1)

     10,232       15,416       24,947  

Engineering and product development(1)

     5,324       8,415       18,777  

General, administrative, and other(1)

     15,431       19,820       31,865  
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     64,825       107,284       168,764  
  

 

 

   

 

 

   

 

 

 

Loss from operations

     (7,536     (7,971     (4,575

Other income

     330       487       1,036  

Expense on warrants and convertible notes, net

     (1,649     (3,734     (1,407
  

 

 

   

 

 

   

 

 

 

Net loss before income taxes

     (8,855     (11,218     (4,946

Provision for income taxes

     6       —         74  
  

 

 

   

 

 

   

 

 

 

Net loss before attribution to noncontrolling interests

     (8,861     (11,218     (5,020

Net (loss) income attributable to noncontrolling interests

     (1,144     1,101       (4,554
  

 

 

   

 

 

   

 

 

 

Net loss attributable to Upstart Holdings, Inc. common stockholders

   $ (7,717   $ (12,319   $ (466
  

 

 

   

 

 

   

 

 

 

Net loss per common share attributable to Upstart Holdings, Inc. common stockholders, basic and diluted(2)

   $ (0.56   $ (0.87   $ (0.03
  

 

 

   

 

 

   

 

 

 

Weighted-average number of shares outstanding used in computing net loss per share attributable to Upstart Holdings, Inc. common stockholders, basic and diluted(2)

     13,873,810       14,128,183       14,335,611  
  

 

 

   

 

 

   

 

 

 

Pro forma net loss per share attributable to Upstart Holdings, Inc. common stockholders, basic and diluted (unaudited)(2)

       $    
      

 

 

 

Weighted-average number of shares used to compute pro forma net loss per share attributable to Upstart Holdings, Inc. common stockholders, basic and diluted (unaudited)(2)

       $    
      

 

 

 

 

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(1)

Includes stock-based compensation expense as follows:

     Year ended December 31,  
(In thousands)    2017      2018      2019  

Sales and marketing

   $ 32      $ 183      $ 278  

Customer operations

     124        178        433  

Engineering and product development

     574        753        1,803  

General, administrative, and other

     560        931        1,292  
  

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 1,290      $ 2,045      $ 3,806  
  

 

 

    

 

 

    

 

 

 

 

(2)

See Note 16 to our consolidated financial statements for an explanation of the calculations of our basic and diluted net loss per share attributable to Upstart Holdings, Inc. common stockholders, pro forma net loss per share attributable to Upstart Holdings, Inc. common stockholders and the weighted-average number of shares used in the computation of the per share amounts.

Consolidated Balance Sheet Data

 

     As of December 31,  
(In thousands)    2018     2019  

Cash

   $ 73,038     $ 44,389  

Loans (at fair value)

     502,666       232,305  

Notes receivable and residual certificates (at fair value)

     8,314       34,116  

Total assets

     645,908       393,462  

Borrowings

     74,983       118,609  

Payable to securitization note holders and residual certificate holders (includes $353,292 and $89,672 at fair value, and $61,439 and $41,343 payable to related parties as of December 31, 2018 and 2019, respectively)

     373,068       96,107  

Total liabilities

     542,655       292,604  

Convertible preferred stock

     157,923       162,546  

Accumulated deficit

     (75,078     (75,205

Total Upstart Holdings, Inc. stockholders’ deficit

     (66,671     (62,714

Noncontrolling interests

     12,001       1,026  

Total stockholders’ deficit

     (54,670     (61,688

Total liabilities, convertible preferred stock and stockholders’ deficit

     645,908       393,462  

Key Operating Metrics

We review a number of operating and financial metrics, including the following key metrics to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions.

 

     Year Ended December 31,  
     2017      2018      2019  

Number of Loans Transacted

     70,457        114,125        215,122  

Conversion Rate

     8.1%        9.1%        13.1%  

Percentage of Loans Fully Automated

     34%        53%        66%  

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Operating Metrics” for a description of Number of Loans Transacted, Conversion Rate and Percentage of Loans Fully Automated.

 

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Non-GAAP Financial Measures

 

     Year Ended December 31,  
(In thousands)    2017     2018     2019  

Contribution Profit

   $ 9,265     $ 13,098     $ 48,940  

Adjusted EBITDA

   $ (4,679   $ (6,226   $ 5,595  

Contribution Profit

We define Contribution Profit as our revenue from fees, net less certain costs that we consider to be variable and closely correlated to our fee revenue. Our revenue from fees, net consists of platform and referral fees, net and servicing fees, net. Platform fees and referral fees are contracted for and charged separately, although they are generally combined for accounting purposes as they usually represent a single performance obligation. To derive Contribution Profit, we subtract from revenue from fees, net our borrower acquisition costs as well as our borrower verification and servicing costs. Borrower acquisition costs consist of our sales and marketing expenses adjusted to exclude costs not directly attributable to attracting a new borrower, such as payroll related expenses for our business development and marketing teams, as well as other operational, brand awareness and marketing activities. Our borrower verification and servicing costs consist of payroll and other personnel related expenses for personnel engaged in loan onboarding, verification and servicing, as well as servicing system costs. It excludes payroll and personnel related expenses and stock-based compensation for certain members of our customer operations team whose work is not directly attributable to onboarding and servicing loans.

The following table provides a calculation of Contribution Profit for the years ended December 31, 2017, 2018 and 2019:

 

     Year Ended December 31,  
(In thousands)    2017     2018     2019  

Referral fees, net

   $ 30,921     $ 53,869     $ 90,672  

Platform fees, net

     17,146       29,512       53,383  

Servicing fees, net

     3,094       5,101       15,792  
  

 

 

   

 

 

   

 

 

 

Revenue from fees, net

     51,161       88,482       159,847  

Borrower acquisition costs

     (32,777     (61,658     (89,569

Borrower verification and servicing costs

     (9,119     (13,726     (21,338
  

 

 

   

 

 

   

 

 

 

Total direct expenses

     (41,896     (75,384     (110,907
  

 

 

   

 

 

   

 

 

 

Contribution Profit

   $ 9,265     $ 13,098     $ 48,940  

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for a reconciliation of loss from operations to Contribution Profit.

Adjusted EBITDA

We calculate Adjusted EBITDA as net loss attributable to Upstart Holdings, Inc. stockholders adjusted to exclude stock-based compensation expense, depreciation and amortization, expense on warrants and convertible notes, net and provision for income taxes. Adjusted EBITDA does include interest expense from corporate debt and warehouse credit facilities which is incurred in the course of earning corresponding interest income.

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for a reconciliation of net loss attributable to Upstart Holdings, Inc. common stockholders to Adjusted EBITDA.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the section titled “Selected Consolidated Financial and Other Data” and the consolidated financial statements and related notes thereto included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Factors that could cause or contribute to such differences include those identified below and those discussed in the section titled “Risk Factors” and other parts of this prospectus. Our historical results are not necessarily indicative of the results that may be expected for any period in the future.

Overview

Upstart applies modern data science and technology to the process of underwriting consumer credit. By providing our bank partners with a proprietary AI-based origination platform, we help them originate credit with higher approval rates, lower loss rates and a high degree of automation. As our technology continues to improve and additional banks adopt our platform, consumers benefit from improved access to affordable and frictionless credit.

Since our inception, we have facilitated the origination of almost 450,000 personal loans that have generated more than 5.5 million repayment events. Our key milestones include:

 

 

LOGO

We believe that banks will continue to be at the forefront of consumer lending in the United States. We believe AI lending will become increasingly critical as this industry continues to undergo a broad digital transformation. Our strategy is to partner with banks, providing them with a best-in-class AI lending platform that they can configure as they originate consumer loans under their own brand, according to their own business and regulatory requirements.

Consumers can obtain Upstart-powered loans in one of two ways: either by referral from Upstart.com to one of our bank partners, or directly through our bank partners’ own websites, where our lending technology and experience is white-labeled. Our direct bank partner channel represents a small but growing portion of our overall volume, and we believe this portion will continue to grow over time as we onboard new bank partners. Consumers on our platform are generally offered unsecured

 

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personal loans ranging from $1,000 to $50,000 in size, at APRs typically ranging from approximately 6.5% to 35.99%, for terms typically ranging from three to five years, with a monthly repayment schedule and no prepayment penalty. These loans are used for a variety of purposes, including credit card consolidation, refinancing of existing debt, home improvements and other personal uses.

Our bank partners can retain loans that align with their business and risk objectives. We then help our bank partners diversify the funding of their remaining loans to a broad base of approximately 70 institutional investors that fund or invest in Upstart-powered loans. In the fourth quarter of 2019, 21% of the loans funded through our platform were retained by the originating bank (up from 15% in the fourth quarter of 2018). 72% of loans were purchased by institutional investors through our loan funding programs in the fourth quarter of 2019 (down from 80% in the fourth quarter of 2018), and the remaining 7% were funded through our balance sheet (compared to 5% in the fourth quarter of 2018). Over the last few years, the percentage of loans retained by bank partners has generally increased while the percentage of loans funded through our balance sheet has generally decreased and the percentage of loans purchased by institutional investors has remained high and relatively stable.

Our approach has allowed us to achieve rapid growth in recent years while simultaneously improving our margin profile. The Number of Loans Transacted on our platform increased 88% from 114,125 in 2018 to 215,122 in 2019. Over the same period, revenue increased 65% from $99.3 million to $164.2 million. Net loss decreased from $12.3 million in 2018 to $0.5 million in 2019.

Our Economic Model

Upstart’s revenues are primarily earned in the form of three separate usage-based fees, which can be either dollar or percentage based depending on the contractual arrangement. We charge our bank partners a referral fee of 3% to 4% of the loan principal amount each time we refer a borrower who obtains a loan. Separately, we charge bank partners a platform fee of approximately 2% of loan value each time they originate a loan using our platform. These fees are contracted for and charged separately, although they are generally combined for accounting purposes as they usually represent a single performance obligation. We do not charge the borrowers on our platform any referral, platform or other similar fees for our loan matching services.

We also charge the holder of the loan (either a bank or institutional investor) an ongoing 0.5% to 1% annualized servicing fee based on the outstanding principal over the lifetime of the loan for ongoing servicing of the loan. Taken together, these fees represented 97% of our revenue in 2019. In addition, we earn a small portion of our revenue from interest income and our securitization activities.

The below table summarizes the dollar value of our economics on an average-sized loan, based on our contractual rates that were in effect as of December 31, 2019.

 

     Paid By   Fees per Loan

Referral Fees

  Bank partner  

$400-$500

on origination

   

Platform Fees

  Bank partner  

$200-$300

on origination

   

Servicing Fees

 

Bank partner or

institutional investor

 

0.5%-1%

per year

 

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Loans fall into one of two different economic profiles, depending on their source. For loans that are referred to banks through Upstart.com (98% of all loans in the fourth quarter of 2019) we incur variable costs in the form of borrower acquisition costs and borrower verification and servicing costs; in the fourth quarter of 2019 this category of loans generated a 38% contribution margin on average. Borrower acquisition cost and borrower verification and servicing cost are highly correlated with the Number of Loans Transacted on our platform and trended upwards on an annual basis. The remaining 2% of loans in the fourth quarter of 2019 were sourced directly through bank partners and thus, we received no referral fee and incurred no acquisition cost; in the fourth quarter of 2019 this category of loans generated a 74% contribution margin. In 2017, 2018 and 2019, the average contribution margin per loan of all Upstart-powered loans was 18%, 15% and 31%, respectively. To the extent we are able to increase the number of loans sourced directly through our bank partners, our contribution margin would be positively impacted. The rising level of automation and continued improvements to our Conversion Rate achieved through our increasingly sophisticated risk models and our evolving channel mix have contributed to continually improving loan unit economics over time.

The below table summarizes the contribution economics for loans originated by our bank partners in the fourth quarter of 2019:

 

 

LOGO

Factors Affecting Our Performance

Continued Improvements to Our AI Models

Much of our historical growth has been driven by improvements to our AI models. These models benefit over time from a flywheel effect that is characteristic of machine learning systems: accumulation of repayment data leads to improved accuracy of risk and fraud predictions, which results in higher approval rates and lower interest rates, leading to increased volume, and consequently greater accumulation of repayment data. This virtuous cycle describes an important mechanism by which our business grows simply through model learning and recalibration. We expect to continue to invest significantly in the development of our AI models and platform functionalities.

Beyond the ongoing accumulation of repayment data used to train our models, we also frequently make discrete improvements to model accuracy by upgrading algorithms and incorporating new variables, both of which have historically resulted in higher approval rates, more competitive loan offers, increased automation, and faster growth. As a second order effect, the impact of these improvements on our conversion funnel also allow us to unlock new marketing channels over time that have previously been unprofitable.

 

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We believe that ongoing improvements to our technology in this manner will allow us to further expand access and lower rates for creditworthy borrowers, which will continue to fuel our growth. Should the pace of these improvements slow down or cease, or should we discover forms of model upgrades which improve accuracy at the expense of volume, our growth rates could be adversely affected.

Bank and Market Adoption

Banks play two key roles in Upstart’s ecosystem: funding loans and acquiring new customers. Banks tend to enjoy among the most efficient sources of funding due to their expansive base of deposits. As they adopt our technology and fund a growing proportion of our platform transactions, offers made to borrowers will typically improve, generally leading to higher conversion rates and faster growth for our platform. The number of loans funded and retained by originating banks in 2019 was 48,674, up from 11,714 in 2018. Historically, we have observed that each 100 basis point reduction in APR has led to an approximate 15% increase in our conversion rate.49

New bank partners also represent additional acquisition channels through which we can reach and source prospective new borrowers, as these banks develop and implement their own digital and in-branch campaigns to drive traffic from their existing customer base to our platform. We view this emerging growth channel to be additive to the marketing acquisition programs we currently run at Upstart.

To provide funding support for our bank partners, we have built a broad network of institutional investors that can fund Upstart-powered loans through secondary loan purchasing, issuance of pass-through certificates and investment in asset-backed securitizations. This diverse network of capital helps to minimize our reliance on any one funding source. However, any trend towards reduced participation by banks will generally erode the overall competitiveness of the offers on our platform, and any declining trend in the participation of broader institutional investment markets with respect to funding availability for Upstart-powered loans could adversely affect our business.

Product Expansion and Innovation

We intend to continue developing new financial products that address a broader set of consumer needs over time. We believe that significant growth opportunities exist to apply our evolving technology to additional segments of credit, such as auto loans, student loans, credit cards, point-of-sale loans, and home equity lines of credit. In addition, we aim to serve a broader role of technology enablement for banks, which we believe will seek more comprehensive technology solutions from their suppliers. For example, we intend to offer an application programming interface product to banks that would allow them to utilize our AI underwriting models to support their loan origination process for personal, auto, and student loans. We will incur expenses and opportunity cost to develop and launch these products. Their monetization prospects are uncertain, and costs associated with developing and marketing new products might not be recovered, which could weigh on our top-line growth and profitability.

Impact of Macroeconomic Cycles

Economic cycles can impact our financial performance and related metrics, including consumer demand for loans, conversion rates and the interest rates our bank partners and institutional investors are willing to accept. In a potential downturn, we believe consumer lending will generally contract,

 

49 

In an internal study, Upstart replicated three bank models using their respective underwriting policies and evaluated their hypothetical loss rates and approval rates using Upstart’s applicant base in late 2017. Such result represents the average rate of improvement exhibited by Upstart’s platform against each of the three respective bank models.

 

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including the volume transacted on our own platform. However, the performance of Upstart-powered loans through an economic downturn will be important in further validating our AI models with banks and institutional investors. If we are able to demonstrate the resilience of Upstart-powered loans through a macroeconomic cycle relative to general consumer credit, it could strengthen our competitive positioning as we emerge from such a downturn.

Key Operating Metrics

We focus on several key operating metrics to measure the performance of our business and help determine strategic direction.

 

     Year Ended December 31,  
     2017      2018      2019  

Number of Loans Transacted

     70,457        114,125        215,122  

Conversion Rate

     8.1%        9.1%        13.1%  

Percentage of Loans Fully Automated

     34%        53%        66%  

Number of Loans Transacted

We define the Number of Loans Transacted as the transaction volume, measured by number of loans facilitated on our platform, between a borrower and originating bank. We believe this metric to be a good proxy for our overall scale and reach as a platform. The Number of Loans Transacted in 2019 was 215,122, up 88% from 114,125 in 2018.

Conversion Rate

We define Conversion Rate as the Number of Loans Transacted in a period divided by the number of rate inquiries received, which we record when a borrower requests a loan offer on our platform. We track this metric to understand the impact of improvements to the efficiency of our borrower funnel on our overall growth. Historically, our Conversion Rate has benefitted from improvements to our technology, which have made our evaluation of risk more accurate and our verification process more automated, or from the addition of bank partners that have made our offers more competitive. Our Conversion Rate was 13.1% in 2019, up 4% from 9.1% in 2018. Our ability to continue to improve our Conversion Rate depends in part on our ability to continue to improve our AI models and Percentage of Loans Fully Automated and the mix of marketing channels in any given period.

Percentage of Loans Fully Automated

A key driver of our contribution margin and operating efficiency is the Percentage of Loans Fully Automated, which is defined as the total number of loans in a given period originated end-to-end (from initial rate request to final funding) with no human involvement divided by the Number of Loans Transacted in the same period. The Percentage of Loans Fully Automated in 2019 was 66%, up from 34% in 2017, with fraud rates during the same period remaining generally flat or slightly declining, from an average of 0.25% in 2017 to an average of 0.23% in 2019. We believe our growth over the last several years has been driven in part by our ability to rapidly streamline and automate the loan application and origination process on our platform. We expect the Percentage of Loans Fully Automated to level off and remain relatively constant in the long term, and to the extent we expand our loan offerings beyond unsecured personal loans, we expect that such percentage may decrease in the short term.

 

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Components of Results of Operations

Revenue from Fees, Net

Platform and Referral Fees, Net

We charge our bank partners platform fees in exchange for usage of our AI lending platform, which includes collection of loan application data, underwriting of credit risk, verification and fraud detection, and the delivery of electronic loan offers and associated documentation. We also charge referral fees to our bank partners in exchange for the referral of borrowers from Upstart.com. Referral fees are charged to bank partners on a per borrower basis upon origination of a loan. For bank partners that use our loan funding capabilities, these fees are charged net of any fees the bank partner charges Upstart. For the loans Upstart purchases from bank partners after the completion of the minimum holding periods, Upstart pays bank partners a one-time loan premium fee at the time the loan is sold by such bank partner to Upstart. Upstart also pays bank partners monthly loan trailing fees based on the amount and timing of principal and interest payments made by borrowers of the underlying loans.50

Servicing Fees, Net

Servicing fees are calculated as a percentage of outstanding principal and are charged monthly to any entities holding loans facilitated through our platform, to compensate us for activities we perform throughout the loan term, including collection, processing and reconciliations of payments received, investor reporting and borrower customer support. Servicing fees are recorded net of any gains, losses or changes to fair value recognized in the underlying servicing rights and obligations, which are carried as assets and liabilities on our consolidated balance sheet. Upstart acts as loan-servicer for substantially all outstanding loans facilitated through the Upstart platform.

Interest Income and Fair Value Adjustments, Net

Interest income and fair value adjustments, net is comprised of interest income, interest expense and net changes in the fair value of financial instruments held on our consolidated balance sheets as part of our ongoing operating activities, excluding loan servicing assets and liabilities, common stock warrant liabilities and convertible preferred stock warrant liabilities. Interest income and fair value adjustments, net also includes the full amount of net interest income and expense incurred by consolidated variable interest entities, or VIEs, the majority of which has been historically allocated to third parties in the line item net (loss) income attributable to noncontrolling interests on our consolidated statements of operations and comprehensive loss. Interest income and fair value adjustments, net can fluctuate based on the fair value of financial instruments held on our consolidated balance sheet. This amount has historically been a small percentage of our total revenue, and we do not manage our business with a focus on growing this component of revenue.

Sales and Marketing

Sales and marketing expenses primarily consist of costs incurred across various advertising channels, including expenses for partnerships with third parties providing borrower referrals, direct mail and digital advertising campaigns, as well as other expenses associated with building overall brand awareness and experiential marketing costs. Sales and marketing expenses also include payroll and other personnel-related costs, including stock-based compensation expense. These costs are recognized in the period incurred. We expect that our sales and marketing expenses will increase in

 

50 

See Note 2 to our consolidated financial statements for more information about loan premium fees and trailing fees.

 

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absolute dollars and may fluctuate as a percentage of our total revenue from period to period as we hire additional sales and marketing personnel, increase our marketing activities and build greater brand awareness.

Customer Operations

Customer operations expenses include payroll and other personnel-related expenses, including stock-based compensation expense, for personnel engaged in borrower onboarding, loan servicing, customer support and other operational teams. These costs also include systems, third-party services and tools we use as part of loan servicing, information verification, fraud detection and payment processing activities. These costs are recognized in the period incurred. We expect that our customer operations expenses will increase in absolute dollars and may fluctuate as a percentage of our total revenue over time, as we expand our portfolio and increase the Number of Loans Transacted.

Engineering and Product Development

Engineering and product development expenses primarily consist of payroll and other personnel-related expenses, including stock-based compensation expense, for the engineering and product development teams as well the costs of systems and tools used by these teams. These costs are recognized in the period incurred. We expect that our engineering and product development expenses will increase in absolute dollars and may increase as a percentage of our total revenue over time, as we expand our engineering and product development team to continue to improve our AI models and develop new products and product enhancements.

General, Administrative and Other

General, administrative and other expenses consist primarily of payroll and other personnel-related expenses, including stock-based compensation expense, for legal and compliance, finance and accounting, human resources and facilities teams, as well as depreciation and amortization of property, equipment and software, professional services fees, facilities and travel expenses. These costs are recognized in the period incurred. Following the completion of this offering, we expect to incur additional general, administrative and other expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC, additional insurance expenses, investor relations activities and other administrative and professional services. We also expect to increase the size of our general and administrative function to support the growth of our business. As a result, we expect that our general, administrative and other expenses will increase in absolute dollars but may fluctuate as a percentage of our total revenue from period to period.

Other Income

Other income primarily consists of dividend income earned on our unrestricted cash balances and sublease income. Other income is recognized in the period earned.

Expense on Warrants and Convertible Notes, Net

Expense on warrants and convertible notes, net is primarily comprised of the net changes in the fair value of our common and convertible preferred stock warrant liabilities, as well as interest expense on convertible notes outstanding in 2017 and 2018.

 

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Results of Operations

The following table summarizes our historical consolidated statements of operations data:

 

     Year Ended December 31,  
(In thousands)    2017     2018     2019  

Revenue:

      

Revenue from fees, net

   $ 51,161     $ 88,482     $ 159,847  

Interest income and fair value adjustments, net

     6,128       10,831       4,342  
  

 

 

   

 

 

   

 

 

 

Total revenue

     57,289       99,313       164,189  
  

 

 

   

 

 

   

 

 

 

Operating expenses:

      

Sales and marketing(1)

     33,838       63,633       93,175  

Customer operations(1)

     10,232       15,416       24,947  

Engineering and product development(1)

     5,324       8,415       18,777  

General, administrative, and other(1)

     15,431       19,820       31,865  
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     64,825       107,284       168,764  
  

 

 

   

 

 

   

 

 

 

Loss from operations

     (7,536     (7,971     (4,575

Other income

     330       487       1,036  

Expense on warrants and convertible notes, net

     (1,649     (3,734     (1,407
  

 

 

   

 

 

   

 

 

 

Net loss before income taxes

     (8,855     (11,218     (4,946

Provision for income taxes

     6       —         74  
  

 

 

   

 

 

   

 

 

 

Net loss before attribution to noncontrolling interests

     (8,861     (11,218     (5,020

Net (loss) income attributable to noncontrolling interests

     (1,144     1,101       (4,554
  

 

 

   

 

 

   

 

 

 

Net loss attributable to Upstart Holdings, Inc. common stockholders

   $ (7,717   $ (12,319   $ (466
  

 

 

   

 

 

   

 

 

 

 

(1)

Includes stock-based compensation expense as follows:

     Year ended December 31,  
(In thousands)      2017          2018          2019    

Sales and marketing

   $ 32      $ 183      $ 278  

Customer operations

     124        178        433  

Engineering and product development

     574        753        1,803  

General, administrative, and other

     560        931        1,292  
  

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 1,290      $ 2,045      $ 3,806  
  

 

 

    

 

 

    

 

 

 

Revenue

Revenue from Fees, Net

The following table set forth our revenue from fees, net in the periods shown:

 

    

 

Year Ended December 31,

     2017 to 2018
% Change
    2018 to 2019
% Change
 
(In thousands)    2017      2018      2019  

Platform and referral fees, net

   $ 48,067      $ 83,381      $ 144,055        73     73

Servicing fees, net

     3,094        5,101        15,792        65     210
  

 

 

    

 

 

    

 

 

      

Total revenue from fees, net

   $ 51,161      $ 88,482      $ 159,847        73     81
  

 

 

    

 

 

    

 

 

      

2018 Compared to 2019

Revenue from fees, net increased $71.4 million, or 81%, in the year ended December 31, 2019, compared to the prior year. The increase was primarily due to an increase of $60.7 million in revenue

 

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from platform and referral fees, net. This increase was primarily driven by an 88% increase in the Number of Loans Transacted from 114,125 in 2018 to 215,122 in 2019. Servicing fees, net increased by $10.7 million due to a doubling in average outstanding loan principal, as well as a downward revaluation to the net liability of our servicing obligation.

2017 Compared to 2018

Revenue from fees, net increased $37.3 million, or 73%, in the year ended December 31, 2018 compared to the prior year, comprised primarily of an increase of $35.3 million in revenue from platform and referral fees, net. This increase was primarily due to an 62% increase in the Number of Loans Transacted from 70,457 in 2017 to 114,125 in 2018.

Interest Income and Fair Value Adjustments, Net

 

    Year Ended December 31,     2017 to 2018
% Change
    2018 to 2019
% Change
 
(In thousands)   2017     2018     2019  

Interest income and fair value adjustments, net

  $ 6,128     $ 10,831     $ 4,342       77     (60 )% 

2018 Compared to 2019

Interest income and fair value adjustments, net decreased $6.5 million, or 60%, in the year ended December 31, 2019 compared to the prior year. The decrease was primarily driven by a decline in interest income due to a reduction of consolidated loan balances from securitization-related VIEs in the year ended December 31, 2019. This decrease was partially offset by a lower amount of fair value adjustments to consolidated assets held by securitization-related VIEs.

2017 Compared to 2018

Interest income and fair value adjustments, net increased $4.7 million, or 77%, in the year ended December 31, 2018 compared to the prior year. The increase was primarily driven by a rise in interest income due to growth in consolidated loan balances from securitization-related VIEs in the year ended December 31, 2018. The increase in the outstanding balance of loans on our consolidated balance sheets was primarily attributable to our securitization program, which launched in June of 2017 and increased during 2018.

Operating Expenses

Sales and Marketing

 

     Year Ended December 31,      2017 to 2018
% Change
    2018 to 2019
% Change
 
(In thousands)    2017      2018      2019  

Sales and marketing

   $ 33,838      $ 63,633      $ 93,175        88     46

2018 Compared to 2019

Sales and marketing expenses increased by $29.5 million, or 46%, in the year ended December 31, 2019 compared to the prior year. The increase was primarily due to increased spending of $26.8 million for partnerships with parties providing borrower referrals and a $1.6 million increase in payroll and other personnel-related expenses driven by increased headcount, as well as a $1.1 million increase in advertising and other traffic acquisition costs. As a percentage of total revenue, sales and marketing expenses decreased from 64% to 57%.

 

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2017 Compared to 2018

Sales and marketing expenses increased by $29.8 million, or 88%, in the year ended December 31, 2018 compared to the prior year. The increase was primarily due to increased spending of $14.6 million in digital and direct mail advertising campaigns, as well as an increase of $13.5 million in spending for partnerships with parties providing borrower referrals. As a percentage of total revenue, sales and marketing expenses increased from 59% to 64%.

Customer Operations

 

     Year Ended December 31,      2017 to 2018
% Change
    2018 to 2019
% Change
 
(In thousands)    2017      2018      2019  

Customer operations

   $ 10,232      $ 15,416      $ 24,947        51     62

2018 Compared to 2019

Customer operations expenses increased by $9.5 million, or 62%, in the year ended December 31, 2019 compared to the prior year. The increase was primarily due to an increase of $5.0 million in payroll and other personnel-related expenses due to increases in headcount, as well as increased spending of $4.4 million in information verification and platform operations due to a growing volume of loans facilitated through our platform. As a percentage of total revenue, customer operations expenses decreased from 16% to 15%.

2017 Compared to 2018

Customer operations expenses increased by $5.2 million, or 51%, in the year ended December 31, 2018 compared to the prior year. The increase was primarily due to an increase of $2.7 million in payroll and other personnel-related expenses due to increases in headcount, as well as increased spending of $2.3 million related to information verification and platform operations due to a growing volume of loans facilitated through our platform. As a percentage of total revenue, customer operations expenses decreased from 18% to 16%.

Engineering and Product Development

 

     Year Ended December 31,      2017 to 2018
% Change
    2018 to 2019
% Change
 
(In thousands)    2017      2018      2019  

Engineering and product development

   $ 5,324      $ 8,415      $ 18,777        58     123

2018 Compared to 2019

Engineering and product development expenses increased by $10.4 million, or 123%, in the year ended December 31, 2019 compared to the prior year. The increase was primarily due to an increase of $8.9 million in payroll and other personnel-related expenses driven by an increase in headcount, as well as a $1.5 million increase in spending on consultants and other engineering services. As a percentage of total revenue, engineering and product development expenses increased from 8% to 11%.

2017 Compared to 2018

Engineering and product development expenses increased by $3.1 million, or 58%, in the year ended December 31, 2018 compared to the prior year. The increase was primarily due to an increase of $2.4 million in payroll and other personnel-related expenses driven by an increase in headcount, as

 

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well as a $0.7 million increase in spending on consultants and other engineering services. As a percentage of total revenue, engineering and product development expenses decreased from 9% to 8%.

General, Administrative, and Other

 

     Year Ended December 31,      2017 to 2018
% Change
    2018 to 2019
% Change
 
(In thousands)    2017      2018      2019  

General, administrative, and other

   $ 15,431      $ 19,820      $ 31,865        28     61

2018 Compared to 2019

General, administrative, and other expenses increased by $12.0 million, or 61%, in the year ended December 31, 2019 compared to the prior year. The increase was primarily due to an increase of $6.0 million in personnel-related costs as a result of increased headcount; an increase of $2.6 million in office rent and other facility-related expenses due to the opening of our second office in Columbus, Ohio, and relocation of our headquarters from San Carlos, California to San Mateo, California; an increase of $1.1 million in legal and compliance-related expenses; and an increase of $1.0 million in professional services fees. As a percentage of total revenue, general, administrative, and other expenses decreased from 20% to 19%.

2017 Compared to 2018

General, administrative, and other expenses increased by $4.4 million, or 28%, in the year ended December 31, 2018 compared to the prior year. The increase was primarily due to an increase of $3.4 million in personnel-related costs as a result of increased headcount; an increase of $2.0 million in office and administrative related expenses; and an increase of $0.7 million in legal and compliance-related expenses. This increase was partially offset by a $2.2 million decrease in professional fees. As a percentage of total revenue, general, administrative, and other expenses decreased from 27% to 20%.

Other Income

 

     Year Ended December 31,      2017 to 2018
% Change
    2018 to 2019
% Change
 
(In thousands)      2017          2018          2019    

Other income

   $ 330      $ 487      $ 1,036        48     113

2018 Compared to 2019

Other income increased by $0.5 million, or 113%, in the year ended December 31, 2019 compared to the prior year. The increase was primarily due to an increase in unrestricted cash balances held in interest-bearing deposit accounts throughout the year at commercial banks.

2017 Compared to 2018

Other income increased by $0.2 million, or 48%, in the year ended December 31, 2018 compared to the prior year. The increase was primarily due to an increase in unrestricted cash balances held in interest-bearing deposit accounts at commercial banks.

Expense on Warrants and Convertible Notes, Net

 

    Year Ended December 31,     2017 to 2018
% Change
    2018 to 2019
% Change
 
(In thousands)   2017     2018     2019  

Expense on warrants and convertible notes, net

  $ 1,649     $ 3,734     $ 1,407       126     (62 )% 

 

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2018 Compared to 2019

Expense on warrants and convertible notes decreased by $2.3 million, or 62%, in the year ended December 31, 2019 compared to the prior year. The decrease was primarily due to a decrease of $2.1 million in the fair value of outstanding convertible preferred stock warrants as a result of warrants exercised or repurchased and retired during the year, and a decrease in interest expense on convertible notes of $0.7 million as the convertible notes were converted into convertible preferred stock in 2018. The decrease was partially offset by an increase of $0.5 million in the fair value of common stock warrants.

2017 Compared to 2018

Expense on warrants and convertible notes increased by $2.1 million, or 126%, in the year ended December 31, 2018 compared to the prior year. The increase was primarily due to an increase of $1.5 million in the fair value of outstanding convertible preferred stock warrants as well as an increase in interest expense on convertible notes of $0.4 million, which were issued in September and October 2017 and converted into Series C-1 convertible preferred stock in June 2018.

Reconciliation of Non-GAAP Financial Measures

To supplement our consolidated financial statements prepared and presented in accordance with GAAP, we use the non-GAAP financial measures Contribution Profit and Adjusted EBITDA to provide investors with additional information about our financial performance and to enhance the overall understanding of our past performance and future prospects. We are presenting these non-GAAP financial measures because we believe they provide an additional tool for investors to use in comparing our core financial performance over multiple periods with the performance of other companies.

However, non-GAAP financial measures have limitations in their usefulness to investors because they have no standardized meaning prescribed by GAAP and are not prepared under any comprehensive set of accounting rules or principles. In addition, non-GAAP financial measures may be calculated differently from, and therefore may not be directly comparable to, similarly titled measures used by other companies. As a result, non-GAAP financial measures should be viewed as supplementing, and not as an alternative or substitute for, our consolidated financial statements prepared and presented in accordance with GAAP.

To address these limitations, we provide a reconciliation of Contribution Profit and Adjusted EBITDA to loss from operations and net loss attributable to Upstart Holdings, Inc. common stockholders, respectively. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure and to view Contribution Profit and Adjusted EBITDA in conjunction with their respective related GAAP financial measures.

Contribution Profit

We use Contribution Profit as part of our overall assessment of our performance, including the preparation of our annual operating budget and quarterly forecasts, to evaluate the effectiveness of our business strategies, and to communicate with our board of directors concerning our financial performance. We believe Contribution Profit is useful to investors for period-to period comparisons of our business and in evaluating and understanding our operating results and ability to scale. Contribution Profit is also useful to investors because our management uses Contribution Profit, in conjunction with financial measures prepared in accordance with GAAP, to evaluate our operating results and financial performance and the effectiveness of our strategies.

 

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Contribution Profit has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Contribution Profit is not a GAAP financial measure of, nor does it imply, profitability. Even if our revenue exceeds variable expenses over time, we may not be able to achieve or maintain profitability, and the relationship of revenue to variable expenses is not necessarily indicative of future performance. Contribution Profit does not reflect all of our variable expenses and involves some judgment and discretion around what costs vary directly with loan volume. Other companies that present contribution profit calculate it differently and, therefore, similarly titled measures presented by other companies may not be directly comparable to ours.

The following table presents a reconciliation of loss from operations to Contribution Profit:

 

     Year Ended December 31,  
(In thousands)    2017     2018     2019  

Loss from operations

   $ (7,536   $ (7,971   $ (4,575

Sales and marketing, net of borrower acquisition costs(1)

     1,061       1,975       3,606  

Customer operations, net of borrower verification and servicing costs(2).

     1,113       1,690       3,609  

Engineering and product development

     5,324       8,415       18,777  

General, administrative, and other

     15,431       19,820       31,865  

Interest income and fair value adjustments, net

     (6,128     (10,831     (4,342
  

 

 

   

 

 

   

 

 

 

Contribution Profit

   $ 9,265     $ 13,098     $ 48,940  
  

 

 

   

 

 

   

 

 

 

 

(1)

Borrower acquisition costs were $32.8 million, $61.7 million and $89.6 million in 2017, 2018 and 2019, respectively. Borrower acquisition costs consist of our sales and marketing expenses adjusted to exclude costs not directly attributable to attracting a new borrower, such as payroll-related expenses for our business development and marketing teams, as well as other operational, brand awareness and marketing activities.

 

(2)

Borrower verification and servicing costs were $9.1 million, $13.7 million and $21.3 million in 2017, 2018 and 2019, respectively. Borrower verification and servicing costs consist of payroll and other personnel-related expenses for personnel engaged in loan onboarding, verification and servicing, as well as servicing system costs. It excludes payroll and personnel-related expenses and stock-based compensation for certain members of our customer operations team whose work is not directly attributable to onboarding and servicing loans.

Adjusted EBITDA

We believe that Adjusted EBITDA is useful for investors to use in comparing our financial performance with the performance of other companies for the following reasons:

 

   

Adjusted EBITDA is widely used by investors and securities analysts to measure a company’s operating performance without regard to items such as stock-based compensation expense, depreciation and interest expense, that can vary substantially from company to company depending upon their financing and capital structures, and the method by which assets were acquired; and

 

   

Adjusted EBITDA provides consistency and comparability with our past financial performance, and facilitates comparisons with other companies, many of which use similar non-GAAP financial measures to supplement their GAAP results.

Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider this measure in isolation or as a substitute for analysis of our financial results as reported under GAAP. Some of these limitations are as follows:

 

   

Although depreciation expense is a non-cash charge, the assets being depreciated may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;

 

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Adjusted EBITDA excludes stock-based compensation expense, which has been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy;

 

   

Adjusted EBITDA does not reflect: (1) changes in, or cash requirements for, our working capital needs; (2) interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces cash available to us; or (3) tax payments that may represent a reduction in cash available to us; and

 

   

the expenses and other items that we exclude in our calculation of Adjusted EBITDA may differ from the expenses and other items, if any, that other companies may exclude from Adjusted EBITDA when they report their operating results.

Because of these limitations, Adjusted EBITDA should be considered along with other operating and financial performance measures presented in accordance with GAAP. The following table provides a reconciliation of net loss attributable to Upstart Holdings, Inc. common stockholders to Adjusted EBITDA:

 

     Year Ended December 31,  
(In thousands)    2017     2018     2019  

Net loss attributable to Upstart Holdings, Inc. common stockholders

   $ (7,717   $ (12,319   $ (466

Adjusted to exclude the following:

      

Stock-based compensation

     1,290       2,045       3,806  

Depreciation and amortization

     93       314       774  

Expense on warrants and convertible notes, net(1)

     1,649       3,734       1,407  

Provision for income taxes

     6       —         74  
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ (4,679   $ (6,226   $ 5,595  
  

 

 

   

 

 

   

 

 

 

 

(1)

Consists of fair value adjustments to our warrant liability and interest expense on convertible notes.

Liquidity and Capital Resources

Since inception, we have financed our operations, corporate investments, and capital expenditures primarily through the sale of convertible preferred stock, term loans and draws on our revolving credit facilities, and cash generated from operations. We have also periodically issued convertible promissory notes, none of which were outstanding as of December 31, 2019.

Our outstanding debt consists of borrowings from term loan agreements, advances on our revolving credit facilities, including our warehouse credit facilities, and amounts borrowed under loan and security agreements to finance risk retention balances for certain unconsolidated securitizations we sponsor. As of December 31, 2019, we had an aggregate principal balance of $118.7 million outstanding, of which $7.7 million is due within the next 12 months. See “Note 7. Borrowings” to our consolidated financial statements included elsewhere in this prospectus for further information.

As of December 31, 2019, our primary source of liquidity was cash of $44.4 million. Changes in the balance of cash are generally a result of working capital fluctuations or the timing of purchases of loans facilitated through our platform. To finance purchases of certain loans facilitated through our platform, we rely on our warehouse credit facilities, which allow us to borrow up to an aggregate of $252.0 million through special-purpose trusts, or warehouse trusts. Loans purchased by us are classified as held-for-investment and can be sold to third-party investors or in securitization transactions to generate additional liquidity. As of December 31, 2019, the outstanding principal amount of these loans was $109.7 million.

 

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We believe that our cash on hand, funds available from our revolving credit facilities, amounts borrowed under our term loans, and our cash flow from operations will be sufficient to meet our liquidity needs for at least the next 12 months. Our future capital requirements will depend on multiple factors, including our revenue growth, working capital requirements, volume of loan purchases for product development purposes and our capital expenditures. Payments made to securitization notes and residual certificates holders have no material impact on our liquidity as borrower repayments of loans included as collateral in the related securitization are closely related to the payments made to holders of these instruments.

To the extent our cash balances, cash generated by operations, revolving credit facilities, term loans and the proceeds from this offering are insufficient to satisfy our liquidity needs in the future, we may need to raise additional capital through equity or debt financing and may not be able to do so on terms acceptable to us or at all. If we are unable to raise additional capital when needed, our results of operations and financial condition would be materially and adversely impacted.

Term Loans

In 2016, we, along with our wholly owned subsidiary, Upstart Network, Inc., or UNI, as the co-borrower, entered into a loan and security agreement, or LSA, with a third-party lender to obtain a term loan of $5.5 million. The term loan matures on December 1, 2020 and is payable in monthly installments of principal and interest. The loan bears a floating interest of prime rate plus 1.75% per annum. In 2018, we entered into a mezzanine loan and security agreement with the same lender to obtain a second term loan of up to $15.0 million, or the Mezzanine Loan. The Mezzanine Loan bears interest at the greater of prime rate plus 5.25% or 10.00% per annum and matures on October 1, 2021. As of December 31, 2019, the outstanding principal balance of these loans was $17.2 million.

Revolving Credit Facility

As of December 31, 2019, our revolving credit facility has an aggregate credit limit of $5.5 million and we were fully drawn on such facility. The outstanding principal and any accrued and unpaid interest is due and payable in full on June 1, 2020. Our revolving credit facility bears floating interest rates, payable on a monthly basis, and contains certain financial covenants. Failure to comply with these covenants may result in an acceleration of payment on the outstanding principal and accrued interest. Borrowings under the revolving credit facility are secured by all assets of the company, excluding assets of consolidated securitizations and cash and restricted cash related to other borrowing arrangements. As of December 31, 2018 and 2019, we were in compliance with all applicable covenants under our revolving credit facility.

Warehouse Credit Facilities

We have entered into two warehouse credit facilities with separate third-party lenders through our warehouse trusts, which are consolidated VIEs. As of December 31, 2019, the warehouse credit facilities have an aggregate credit limit of $252.0 million, the entire amount of which is limited to be used to fund purchases of personal whole loans originated by certain bank partners on our platform; the assets of the warehouse trusts secure the facilities provided by the warehouse lenders and are not available to settle claims of our general creditors. As of December 31, 2019, we have borrowed an aggregate of $79.1 million under the warehouse facilities. We may borrow under these warehouse credit facilities until May 2020. Repayment of any outstanding principal, together with any accrued and unpaid interest, is due and payable in May 2021. Our warehouse credit facilities bear floating interest rates, payable on a monthly basis, and contain certain financial covenants. Failure to comply with these covenants may result in an acceleration of payment on outstanding principal and accrued interest. As of December 31, 2018 and 2019, we were in compliance with all applicable covenants under the warehouse credit facilities.

 

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Risk Retention Funding Loans

We obtained financing under two loan and security agreements to fund the purchase of securitization notes and residual certificates issued by certain of our consolidated VIEs in our sponsored securitization transactions. These purchases were made in the amounts required to satisfy the requirements of U.S. risk retention regulations. The loans under these agreements bear interest at rates of 4.00% and 4.33% per annum. Interest is paid using cash distributions received monthly on the related securitization notes and residual certificates held by these entities. As of December 31, 2019, the aggregate outstanding principal amount of these loans was $17.0 million. These borrowings are solely obligations of these consolidated VIEs and are not available to satisfy potential claims of our creditors.

Cash Flows

The following table summarizes our cash flows during the periods indicated:

 

     Year ended December 31,  
(In thousands)    2017     2018     2019  

Net cash provided by operating activities

   $ 10,357     $ 50,338     $ 31,582  

Net cash (used in) provided by investing activities

     (393,421     (137,237     45,433  

Net cash provided by (used in) financing activities

     412,715       135,766       (119,190
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and restricted cash

   $ 29,651     $ 48,867     $ (42,175
  

 

 

   

 

 

   

 

 

 

Net Cash from Operating Activities

Our main sources of cash provided by operating activities are our revenue from fees earned under contracts with bank partners and loan investors and interest income we receive for loans held-for-investment.

Our main uses of cash in our operating activities include payments to marketing partners, vendor payments, payroll and other personnel-related expenses, payments for facilities, and other general business expenditures.

Net cash provided by operating activities was $31.6 million in 2019, which primarily consisted of a net loss before attribution to noncontrolling interests of $5.0 million, offset by a change in fair value of financial instruments of $34.7 million. The change in fair value of financial instruments was primarily related to a $42.1 million decrease in the fair value of loans held-for-investment, partially offset by a $6.1 million decrease in the fair value of payable to securitization note holders and residual certificate holders.

Net cash provided by operating activities was $50.3 million in 2018, which primarily consisted of a net loss before attribution to noncontrolling interests of $11.2 million, offset by a change in fair value of financial instruments of $42.3 million and a $14.0 million change in net operating assets and liabilities. The change in fair value of financial instruments was primarily related to a $45.8 million decrease in the fair value of loans held-for-investment. The change in net operating assets and liabilities was mainly related to a $14.1 million increase in payable to investors.

Net cash provided by operating activities was $10.4 million in 2017, which primarily consisted of a net loss before attribution to noncontrolling interests of $8.9 million and a change in fair value of financial instruments of $5.2 million, offset by a $21.0 million change in net operating assets and liabilities. The change in fair value of financial instruments was primarily related to a $12.3 million decrease in the fair value of payable to securitization note holders and residual certificate holders,

 

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partially offset by a $9.5 million decrease in the fair value of loans held-for-investment. The change in net operating assets and liabilities was mainly related to a $23.5 million increase in payable to investors.

Net Cash from Investing Activities    

Our primary sources of cash from investing activities are principal repayments received on loans held-for-investment through credit facilities and held by consolidated securitizations, proceeds from the sale of loans and payments on residual certificates held for risk retention purposes in sponsored securitizations.

The primary use of cash for investing activities includes purchases of loans held-for investment, including loans collateralized in consolidated securitizations, as well as purchases of securitization notes and residual certificates to fulfill risk retention requirements in securitizations we have sponsored in the past.

Net cash provided by investing activities was $45.4 million in 2019 as a result of $207.0 million of principal payments received on loans and $100.7 million in net proceeds from the sale of loans, which were partially offset by $265.3 million in purchase of loans.

Net cash used in investing activities was $137.2 million in 2018 as a result of $421.1 million in purchases of loans, which was partially offset by $238.0 million in principal payments received on loans and $45.7 million in net proceeds from the sale of loans.

Net cash used in investing activities was $393.4 million in 2017 as a result of $513.9 million in purchases of loans, which was partially offset by $76.2 million in principal payments received on loans and $45.1 million in net proceeds from the sale of loans.

Net Cash from Financing Activities

The main sources of cash from financing activities include proceeds from issuance of securitization notes and residual certificates from consolidated securitizations, proceeds from borrowings, and proceeds from the issuance of convertible preferred stock, notes payable and convertible notes.

The primary uses of cash for financing activities include payments made to holders of securitization notes and residual certificates for consolidated securitizations and repayments of notes payable and borrowings.

Net cash used in financing activities was $119.2 million in 2019 as a result of $199.4 million in payment on notes payable and securitization notes and certificates, which was partially offset by $43.6 million in net proceeds from borrowings and $39.9 million in proceeds from issuance of notes payable.

Net cash provided by financing activities was $135.8 million in 2018 as a result of $285.0 million in proceeds from issuance of notes payable and securitization notes and certificates, $51.1 million in net proceeds from borrowings and $49.9 million in proceeds from the issuance of convertible preferred stock, net of issuance costs, which were partially offset by $248.2 million in payment on notes payable and securitization notes and certificates.

Net cash provided by financing activities was $412.7 million in 2017, primarily driven by $432.3 million in proceeds from the issuance of notes payable and securitization notes and certificates.

 

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Contractual Obligations and Off-Balance Sheet Arrangements

Contractual Obligations

Our principal commitments consist of obligations under our loan purchase agreements, debt obligations related to our revolving credit facilities, term loans and risk retention funding loans, and operating leases for office spaces. The following table summarizes our contractual obligations as of December 31, 2019 and the timing and effect that such commitments are expected to have on our liquidity and capital requirements in future periods:

 

(In thousands)    Total      Less than 1
year
     1 to 3 years      3 to 5 years      More than 5
years
 

Loan purchase obligations(1)

   $ 51,854      $ 51,854      $ —        $ —        $ —    

Term loans

     17,200        2,200        15,000        —          —    

Interest payments on term loans

     3,089        1,727        1,362        —          —    

Warehouse and revolving credit facilities

     84,596        5,500        79,096        —          —    

Risk retention funding loans

     16,941        —          3,167        13,774        —    

Operating lease obligations

     19,566        4,117        8,593        5,959        897  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 193,246      $ 65,398      $ 107,218      $ 19,733      $ 897  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Represents loans facilitated through our platform of which certain of our originating banks retain ownership for the duration of the holding period required by our contracts with the banks. This period is generally equal to three business days. We have committed to purchase the loans for the unpaid principal balance, plus accrued interest, at the conclusion of the required period.

For a discussion of our long-term debt obligations, operating lease obligations and loan repurchase agreement as of December 31, 2019, see “Note 7. Borrowings,” “Note 12. Leases,” and “Note 13. Commitments and Contingencies,” respectively, to our consolidated financial statements included elsewhere in this prospectus for further information.

Off-Balance Sheet Arrangements

In the ordinary course of business, we engage in activities that are not reflected on our consolidated balance sheets, generally referred to as off-balance sheet arrangements. These activities involve transactions with unconsolidated VIEs, including our sponsored and co-sponsored securitization transactions, which we contractually service. We use these transactions to provide a source of liquidity to finance our business and to diversify our investor base. When required by law, we retain at least 5% of the credit risk of the securities issued in these securitizations. We also engaged in activities with a personal loan trust entity created to facilitate fractional loan transactions. As of December 31, 2019, the fractional loan program was closed to new investments. We provide additional information regarding transactions with unconsolidated VIEs in “Note 3. Securitizations and Variable Interest Entities” to our consolidated financial statements included elsewhere in this prospectus.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from our estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

 

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Our significant accounting policies are described in “Note 1. Description of Business and Significant Accounting Policies” to our consolidated financial statements included elsewhere in this prospectus. We believe that the accounting policies described below reflect our most critical accounting policies and estimates, which represent those that involve a significant degree of judgment and complexity. Accordingly, we believe these policies are critical in fully understanding and evaluating our reported financial condition and results of operations.

Variable Interest Entities

A legal entity is considered a VIE if it either has a total equity investment that is insufficient to finance its operations without additional subordinated financial support or whose equity holders lack the characteristics of a controlling financial interest. Our variable interest arises from contractual, ownership, or other monetary interests in the entity. We consolidate a VIE when we are deemed to be the primary beneficiary. We determine whether we are the primary beneficiary if we have the power to direct activities that significantly impact the VIE’s economic performance and we have the obligation to absorb losses or receive benefits of the VIE that could be potentially significant to the VIE.

We are required to apply judgment in performing this assessment, including in identifying the activities that most significantly impact a VIE’s economic performance and determining significance of our obligation to absorb losses or receive benefits. Factors considered in assessing the significance include: the design of the VIE, including its capitalization structure; subordination of interests; payment priority; relative share of interests held within the VIE’s capital structure; and the nature of or reason behind our interest in the entity.

We also apply judgment to determine whether decision-maker or service-provider fees are variable interests. Decision-maker or service-provider fees are not considered variable interests when the arrangement does not expose Upstart to risks of loss that a potential VIE was designed to pass on to its variable interest holders, the fees are commensurate, the arrangement is at market, and we do not have any other interests (including direct interests and certain indirect interests held through related parties) that absorb more than an insignificant amount of a VIE’s potential variability. Changes in our level of other interests in a potential VIE, such as those resulting from disposals of investments in securitization trusts serviced by us subsequent to the expiration of applicable risk retention requirements, can affect whether a decision-maker or service-provider fee is deemed a variable interest. This determination can have a significant impact on our consolidation conclusions, as it could affect whether a legal entity is a VIE and whether Upstart is the primary beneficiary of a VIE.

At a VIE’s inception, we determine whether we are the primary beneficiary based on the facts and circumstances. We assess whether or not we are the primary beneficiary of a VIE on an ongoing basis.

Upstart has an ongoing contractual relationship with two of its VIEs, Upstart Loan Trust and Upstart Warehouse Trust, or the Warehouse Trusts, both of which are bankruptcy-remote special purpose borrowing entities. Upstart, from time to time and as-desired, sells loans to each Warehouse Trust pursuant to a loan sale agreement, and services those loans from the time of transfer to the applicable Warehouse Trust until such loans are either charged-off or mature pursuant to a loan servicing agreement. Each Warehouse Trust borrows from a bank group pursuant to a revolving credit and security agreement in order to finance the purchases of the loans from Upstart.

Upstart has also established a VIE special purpose trust, Upstart Loan Trust 2, that holds loans that are the result of repurchases by the Company following breaches of loan-level representations and warranties, loans that are ineligible to finance via the Warehouse Trusts or loans that are held by Upstart for research purposes. Upstart services the loans held by Upstart Loan Trust 2 until the loans are either charged-off or mature pursuant to a loan servicing agreement.

 

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Upstart has also established VIEs and grantor trusts pursuant to its sponsored securitization transactions involving the issuance of asset-backed securities, or ABS. Such VIEs or grantor trusts are respectively referred to elsewhere in this registration statement with the nomenclature Upstart Securitization Trust [Year]-[Number] and Upstart Funding Grantor Trust [Year]-[Number]. For each such securitization transaction, we (along with certain other loan contributors that have previously purchased whole loans from us) sold Upstart-powered loans via a bankruptcy-remote intermediate entity to the issuing trust and then to the grantor trust. For each transaction, the grantor trust holds legal title to the loans and issues a collateral certificate representing the beneficial interest in such loans to the issuing trust. The issuing trust in turn issues various tranches of asset-backed securitization notes and certificates, which are purchased by an investment bank initial purchaser for resale to qualified institutional buyers and backed by the payments from the grantor trust to the issuing trust reflecting payments on the underlying securitized loans. Upstart, in addition to being party to various loan transfer agreements that facilitate the contribution of loans to the grantor trust, also services the loans held by each grantor trust from the time of transfer to the trust until the loans are charged off or mature pursuant to a loan servicing agreement.

In connection with each securitization transaction, Upstart facilitated the creation of a majority-owned affiliate, or MOA, which is a limited liability company and VIE. The purpose of these MOAs is to enable Upstart’s compliance with its risk retention obligations as a securitization sponsor pursuant to Regulation RR. Each MOA has held the requisite amount of ABS to comply with these obligations for the length of time required by the regulation. Upstart is party to the limited liability company agreement establishing each MOA.

Upstart has also established Upstart Network Trust, a special purpose entity that purchases loans from Upstart in which individual accredited investors in turn have purchased securities representing fractional interests in such purchased loans. Upstart, in addition to being party to a transfer agreement that facilitates the contribution of loans to Upstart Network Trust, services the loans held by Upstart Network Trust from the time of transfer until the loans are charged off or mature pursuant to a loan servicing agreement. Upstart Network Trust was closed to new investments as of the end of 2019.

Fair Value of Loans, Notes Receivable and Residual Certificates, Payable to Securitization Note Holders and Residual Certificate Holders, and Notes Payable

We have elected the fair value option for loans, notes payable to investors who participate in the legacy fractional loan-related securities program, and financial instruments related to securitization transactions, including notes receivable and residual certificates representing required risk retention for sponsored non-consolidated securitizations, and amounts payable to note holders and residual certificate holders in consolidated securitizations. We believe the estimate of fair value of these financial instruments requires significant judgment. We use a discounted cash flow model to estimate the fair value of these financial instruments based on the present value of estimated future cash flows. This model uses both observable and unobservable inputs and reflects our best estimates of the assumptions a market participant would use to calculate fair value. Primary inputs that require significant judgment include discount rates, credit risk rates, and expected prepayment rates. These inputs are based on historical performance of loans facilitated through our platform, as well as the consideration of market participant requirements. See “Note 4. Fair Value Measurementto our consolidated financial statements included elsewhere in this prospectus for additional information.

Fair Value of Loan Servicing Assets and Liabilities

We also record loan servicing assets and liabilities at estimated fair value when we transfer loans which qualify as sales under Topic 860, Transfers and Servicing with servicing rights retained or when we enter into servicing agreements with banks partners that retain Upstart-powered loans. Loan

 

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servicing assets and liabilities are reported in other assets and other liabilities on our consolidated balance sheets. The gain or loss on loan sale, as well as changes in the fair value of loan servicing assets and liabilities are reported in revenue from fees, net, on our consolidated statements of operations and comprehensive loss in the period in which the changes occur. We use a discounted cash flow model to estimate the fair values of loan servicing assets and liabilities. The cash flows in the valuation model represent the difference between the servicing fees charged to loan investors and an estimated market servicing fee. Since servicing fees are generally based on the monthly unpaid principal balance of the underlying loans, the expected cash flows in the model incorporate estimated credit risk and expected prepayments on the loans. These inputs are consistent with the assumptions used in the valuation of loans held-for-investment and related securitization notes and residual certificates. See “Note 4. Fair Value Measurement” to our consolidated financial statements included elsewhere in this prospectus for additional information.

Revenue Recognition

Our revenue consists of two components: revenue from fees, net and interest income and fair value adjustments, net.

Revenue From Fees, Net

The revenue from fees, net line item on the consolidated statements of operations is primarily comprised of platform and referral fees, net, which are recognized based on Accounting Standards Update, or ASU, 2014-09, Revenue from Contracts with Customers (Topic 606). Income historically recognized under Topic 860, Transfers and Servicing and Topic 310, Receivables is excluded from the scope of the standard; as such, we have concluded that interest income and fair value adjustments, net and income from servicing fees will not change under the standard. We adopted Topic 606 as of January 1, 2019, using the modified retrospective method for all contracts not completed as of the date of adoption. The adoption of Topic 606 had no material impact on our consolidated balance sheet, consolidated statement of operations and comprehensive loss and consolidated statement of cash flows as of the adoption date or for the year ended December 31, 2019.

Topic 606 outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers. The core principle, involving a five-step process, of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

Our arrangements for platform and referral services typically consist of an obligation to provide one or both of these services to customers on a when and if needed basis (a stand-ready obligation), and we recognize revenue as such services are performed, which coincides with the amount billable to the customer. Additionally, the services have the same pattern and period of transfer, and when provided individually or together, are accounted for as a single combined performance obligation representing a series of distinct days of service.

Our platform and referral fees represent variable consideration. Since the variable fees relate directly to the day the service is provided, they generally meet the criteria for allocating variable consideration entirely to one or more, but not all, performance obligations in a contract. Accordingly, when the requisite criteria are met, variable fees are allocated to and recognized on the day the services are provided.

We also charge an ongoing loan servicing fee to the holder of the loan (either a bank or institutional investor) based on a predetermined percentage of the outstanding principal balance. Loan

 

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servicing fees are recognized in the period the services are provided. Servicing fees, net also includes gains and losses on assets and liabilities recognized under loan servicing arrangements for loans retained by bank partners or loans sold to institutional investors. Such gains or losses are recognized based on whether the benefits of servicing are expected to more than adequately compensate us for carrying out our servicing obligations. Servicing fees also include changes in fair value of loan servicing assets and liabilities in the periods presented.

Interest Income and Fair Value Adjustments, Net

Interest income and fair value adjustments, net is comprised of interest income, interest expense and net changes in fair value of financial instruments from our normal course of business held at fair value, including loans, notes receivable and residual certificates, payable to securitization note holders and residual certificate holders, and notes payable. We record these adjustments in earnings in the period incurred and include both realized and unrealized adjustments to the value of related assets and liabilities. See the subsection titled “Fair Value of Loans, Notes Receivable and Residual Certificates, Payable to Securitization Note Holders and Residual Certificate Holders, and Notes Payable” above for further details on the estimates of fair value of these assets and liabilities.

Stock-Based Compensation

We estimate the grant date fair value of stock options granted to employees and nonemployees using the Black-Scholes option-pricing model. The fair value of stock options that is expected to vest is recognized as compensation expense on a straight-line basis over the requisite service period, which is typically the vesting period of the respective awards.

The Black-Scholes option-pricing model considers several variables and assumptions in estimating the grant date fair value of stock-based awards. These assumptions include:

 

   

Fair Value of Common Stock—See the subsection titled “Common Stock Valuations” below.

 

   

Expected Term—The expected term represents the period that the stock-based awards are expected to be outstanding. We determined the expected term for employee stock options based on historical terminations and exercise behavior, which factors in an extended post-termination exercise provision for vested awards for certain employees who provide more than three years of service. We use the contractual term for all nonemployee awards.

 

   

Expected Volatility—Since we are not yet a public company and do not have any trading history for our common stock, the expected volatility is estimated based on the average historical volatilities of common stock of comparable publicly traded entities over a period equal to the expected term of the stock option grants. We will continue to apply this process until a sufficient amount of historical information regarding the volatility of our own stock price becomes available.

 

   

Risk-Free Interest Rate—The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant for zero-coupon U.S. Treasury notes with maturities approximately equal to the expected term of the stock option award.

 

   

Expected Dividend—We have never paid dividends on our common stock since our inception, nor do we expect to pay dividends in the foreseeable future. Therefore, we used an expected dividend yield of zero.

See “Note 11. Equity Incentive Plans” of our consolidated financial statements included elsewhere in this prospectus for information concerning certain of the specific assumptions we used in applying the Black-Scholes option-pricing model to determine the estimated fair value of our stock

 

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options granted in the years ended December 31, 2018 and 2019. Such assumptions involved inherent uncertainties and the application of significant judgment. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our stock-based compensation could be materially different.

Stock-based compensation expense was $1.3 million, $2.0 million and $3.8 million during the years ended December 31, 2017, 2018 and 2019, respectively. As of December 31, 2019, we had $15.3 million of total unrecognized stock-based compensation costs which we expect to recognize over a weighted-average period of 2.5 years. These amounts reflect our reassessment of the fair value of our common stock in the year ended December 31, 2019.

The intrinsic value of all outstanding options as of December 31, 2019 was approximately $           million, based on the initial public offering price of $           per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, fair value estimated by the board of directors as of that date, of which approximately $           million is related to vested options and approximately $           million is related to unvested options.

Common Stock Valuations

Historically, for all periods prior to this initial public offering, since there has been no public market of our common stock to date, the fair value of the shares of common stock underlying our share-based awards was estimated on each grant date by our board of directors. In order to determine the fair value of our common stock underlying option grants, our board of directors considered, among other things, input from management, valuations of our common stock prepared by unrelated third-party valuation firms in accordance with the guidance provided by the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, and our board of directors’ assessment of additional objective and subjective factors that it believed were relevant, and factors that may have changed from the date of the most recent valuation through the date of the grant. These factors include, but are not limited to:

 

   

our results of operations and financial position, including our levels of available capital resources;

 

   

our stage of development and material risks related to our business;

 

   

our business conditions and projections;

 

   

the valuation of publicly traded companies in the financial technology sectors, as well as recently completed mergers and acquisitions of peer companies;

 

   

the lack of marketability of our common stock as a private company;

 

   

the prices at which we sold shares of our convertible preferred stock to outside investors in arms-length transactions;

 

   

the rights, preferences, and privileges of our convertible preferred stock relative to those of our common stock;

 

   

the likelihood of achieving a liquidity event for our securityholders, such as an initial public offering or a sale of our company, given prevailing market conditions;

 

   

the hiring of key personnel and the experience of management;

 

   

trends and developments in our industry; and

 

   

external market conditions affecting the financial technology industry sector.

 

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Our board of directors considered the fair value of our common stock by first determining the equity value of our company, and then allocating that value among the various classes of our equity securities to derive a per share value of our common stock.

The equity value of our company was determined using the market approach by reference to the closest round of equity financing, if any, preceding the date of valuation and analysis of the trading values of publicly traded companies deemed comparable to us.

In allocating the equity value of our company among various classes of stock, for our valuations performed on and prior to June 30, 2019, we used the option pricing method, or OPM, backsolve method. In an OPM framework, the backsolve method for inferring the equity value implied by a recent financing transaction involves making assumptions for the expected time to liquidity, volatility and risk-free rate and then solving for the value of equity such that value for the most recent financing equals the amount paid. This method was selected as management concluded that the contemporaneous financing transaction was an arms-length transaction. Furthermore, as of June 30, 2019, we were at an early stage of development and future liquidity events were difficult to forecast.

For our valuations performed subsequent to June 30, 2019, we used a hybrid method of the OPM and the Probability-Weighted Expected Return Method, or PWERM. PWERM considers various potential liquidity outcomes. Our approach included the use of different timing of initial public offering scenarios and a scenario assuming continued operation as a private entity. Under the hybrid OPM and PWERM method, the per share value calculated under the OPM and PWERM are weighted based on expected exit outcomes and the quality of the information specific to each allocation methodology to arrive at a final estimated fair value per share value of the common stock before a discount for lack of marketability is applied.

In the course of preparing our consolidated financial statements with a retrospective view, we have reassessed the fair value of our common stock in 2019 solely for accounting purposes. For purposes of this determination, we determined that the reassessed fair value of our common stock increased on a linear basis between the dates of our third-party valuation reports. We believe that linear interpolation between these is appropriate as no single event caused the valuation of our common stock to increase.

Following the closing of this offering, our board of directors will determine the fair market value of our common stock based on its closing price as reported on the date of grant on the primary stock exchange on which our common stock is traded.

Recent Accounting Pronouncements

See “Note 1. Description of Business and Significant Accounting Policies” to our consolidated financial statements included in this prospectus for recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted as of the date of this prospectus.

Emerging Growth Company Status

We are an emerging growth company, as defined in the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, these

 

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consolidated financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates. The JOBS Act does not preclude an emerging growth company from early adopting a new or revised accounting standard earlier than the time that such standard applies to private companies. We early adopted ASU 2016-02, Leases (Topic 842) effective January 1, 2019 and have elected not to restate comparative periods presented in the consolidated financial statements. We expect to use the extended transition period for any other new or revised accounting.

Quantitative and Qualitative Discussions of Market Risk

We are exposed to market risks in the ordinary course of our business, which primarily relate to fluctuations in market discount rates, credit risks, and interest rates. We are exposed to market risk directly through loans and securities held on our consolidated balance sheets, access to the securitization markets, investor demand for unsecured personal loans facilitated through our platform, and availability of funding under our current credit facilities and term loans. Such fluctuations to date have not been significant.

Discount Rate Risk

Discount rate sensitivity refers to the risk of loss to future earnings, values or future cash flows that may result from changes in market discount rates.

Loans at Fair Value—As of December 31, 2019, we were exposed to market discount rate risk on $141.6 million of loans held-for-investment in our consolidated balance sheet, excluding collateralized loans in consolidated securitizations which are subject to the measurement alternative. The fair value of these loans is estimated using a discounted cash flow methodology, where the discount rate represents an estimate of the required rate of return by market participants. The discount rates for loans facilitated through our platform may change due to changes in expected loan performance or changes in the expected returns of similar financial instruments available in the market. Any gains and losses from discount rate changes are recorded in earnings. As of December 31, 2019, a hypothetical 100 basis point and 200 basis point increase in discount rate would result in a $1.9 million and $3.8 million decrease, respectively, in the fair value of these loans.

Assets and Liabilities related to Securitization Transactions—As of December 31, 2019, we were exposed to discount rate risk on $34.1 million of notes receivable and residual certificates and $89.7 million of payable to securitization note holders and residual certificate holders. We assess the sensitivity of securitization notes and residual certificates by reviewing the average impact across all securitization transactions. As of December 31, 2019, a hypothetical 100 basis point and 200 basis point increase in discount rates would result in a decrease in fair value of these securities of 1.40% and 2.77%, respectively, on average across all securitizations.

Credit Risk

Credit risk refers to the risk of loss arising from individual borrower default due to inability or unwillingness to meet their financial obligations. The performance of certain financial instruments, including loans, securitization notes and residual certificates, on our consolidated balance sheets are dependent on the credit performance of loans facilitated by us. To manage this risk, we monitor borrower payment performance through our lending platform and utilize our AI capabilities to price loans in a manner that we believe is reflective of their credit risk.

The fair values of these loans, securitization notes, and residual certificates are estimated based on a discounted cash flow model which involves the use of significant unobservable inputs and assumptions. These instruments are sensitive to changes in credit risk.

 

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Loans, at Fair Value—As of December 31, 2019, we were exposed to credit risk on $141.6 million of loans in held-for-investment in our consolidated balance sheet, excluding collateralized loans in consolidated securitizations, which are subject to the measurement alternative. These loans bear fixed interest rates and are carried on our consolidated balance sheets at fair value. As of December 31, 2019, a hypothetical 10% and 20% increase in credit risk would result in a $2.3 million and $4.7 million decrease, respectively, in the fair value of loans held-for-investment (excluding loans held as collateral by consolidated securitizations).

Assets and Liabilities related to Securitization Transactions—As of December 31, 2019, we were exposed to credit risk on $34.1 million of notes receivable and residual certificates and $89.7 million of payable to securitization note holders and residual certificate holders.

The securities issued in the securitizations are senior or subordinated based on the waterfall criteria of loan payments to each security class, with the residual interest, or the residual certificates, issued being the first to absorb credit losses in accordance with the waterfall criteria. Accordingly, the residual certificates are the most sensitive to adverse changes in credit risk rates. Depending on the specific securitization, a hypothetical increase in the credit risk rate of 10% to 20% would result in significant decreases in the fair value of the residual certificates. On average, a hypothetical increase in the credit risk rate of 20% would result in a 25% decrease in the fair value of the residual certificates. The remaining classes of securities, with the exception of those in the August 2018 securitization transaction, are all overcollateralized such that changes in credit risk rates are not expected to have significant impacts on their fair values.

As of December 31, 2019, we are exposed to credit risk of $80.1 million related to cash and restricted cash held in business checking accounts and interest-bearing deposit accounts at various financial institutions in the United States. We are exposed to credit risk in the event of default by these financial institutions to the extent the amount recorded on our consolidated balance sheets exceeds the insured amounts by the Federal Deposit Insurance Corporation, or FDIC. We reduce credit risk by placing our cash and restricted cash in reputable institutions.

Interest Rate Risk

The interest rates charged on the loans that our bank partners originate are determined based upon a margin above a market benchmark at the time of onboarding. Increases in the market benchmark would result in increases in the interest rates on new loans. Increased interest rates may adversely impact the spending levels of our individual borrowers and their ability and willingness to borrow money. Higher interest rates often lead to higher payment obligations, which may reduce the ability of individual borrowers to remain current on their obligations to our bank partners and, therefore, lead to increased delinquencies, defaults, customer bankruptcies and charge-offs, and decreasing recoveries, all of which could have a material adverse effect on our business.

Term Loans, Warehouse Credit Facilities and Revolving Credit Facility—As of December 31, 2019, we are exposed to interest rate risk on $101.8 million under the term loans and revolving credit facility arrangements which bear floating interest rates. Changes in interest rates may impact our cost of borrowing. Future funding activities under the revolving credit facilities may increase our exposure to interest rate risk, as the interest rates payable on such funding are tied to short-term market rates. From time to time, we enter into interest rate hedges in connection with our warehouse credit facilities.

Our inability or failure to manage market risks could harm our business, financial condition or results of operations.

 

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BUSINESS

Overview

Our mission is to enable effortless credit based on true risk.

We are a leading, cloud-based AI lending platform. AI lending enables a superior loan product with improved economics that can be shared between consumers and lenders. Our platform aggregates consumer demand for high-quality loans and connects it to our network of Upstart AI-enabled bank partners. Consumers on our platform benefit from higher approval rates, lower interest rates, and a highly automated, efficient, all-digital experience. Our bank partners benefit from access to new customers, lower fraud and loss rates, and increased automation throughout the lending process. Since inception, our bank partners have originated almost 450,000 personal loans that have generated more than 5.5 million repayment events. In the fourth quarter of 2019, approximately 70% of Upstart-powered loans were entirely automated.

Credit is a cornerstone of the U.S. economy, and access to affordable credit is central to unlocking upward mobility and opportunity. The FICO score was invented in 1989 and remains the standard for determining who is approved for credit and at what interest rate.51 While FICO is rarely the only input in a lending decision, most banks use simple rules-based systems that consider only a limited number of variables. Unfortunately, because legacy credit systems fail to properly identify and quantify risk, millions of creditworthy individuals are left out of the system, and millions more pay too much to borrow money.52

The first generation of online lenders focused on bringing credit online. Analogous to earlier internet pioneers, these companies made shopping for and accessing credit simpler and easier for consumers and businesses. It was no longer necessary to stand in line at a bank branch, to sit across the desk from a loan officer and to wait weeks or months for a decision. These lenders enabled the emergence of personal loan products that were previously unprofitable for banks to offer. While they brought the credit process online, they inherited the decision frameworks that banks had used for decades and did not address the more rewarding and challenging opportunity of reinventing the credit decision.

We leverage the power of AI to more accurately quantify the true risk of a loan. Our AI models have been continuously upgraded, trained and refined for more than seven years. We have discrete AI models that target fee optimization, income fraud, acquisition targeting, loan stacking, prepayment prediction, identity fraud and time-delimited default prediction. Our models incorporate more than 1,500 variables and benefit from a rapidly growing training dataset that currently contains more than 5.5 million repayment events. The network effects generated by our constantly improving AI models provide a significant competitive advantage—more training data leads to higher approval rates and lower interest rates at the same loss rate.

We have been able to demonstrate through several studies that AI lending works. First, in 2019 the CFPB reported that a study by Upstart of its data using a methodology specified by the CFPB showed that our AI model approves 27% more borrowers than a high-quality traditional model, with a 16% lower average APR for approved loans.53 Second, when compared to credit models from several large banks, our AI models approve approximately 2.7 times as many borrowers at the same loss

 

51 

Kaufman; see the section titled “Industry, Market and Other Data.”

52 

Ficklin and Watkins; see the section titled “Industry, Market and Other Data.”

53 

Ficklin and Watkins; see the section titled “Industry, Market and Other Data.”

 

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rate.54 Third, for pools of securitized loans, our realized loss rates were approximately half of those predicted by Kroll, a prominent credit rating agency.55 And finally, we regularly monitor the accuracy of our AI models in comparison with simple credit score-based models and have observed higher model accuracy for our AI models across a variety of statistical measures relating to each model’s predictive accuracy.56

Our AI models are provided to bank partners within a consumer-facing cloud application that streamlines the end-to-end process of originating and servicing a loan. We have built a configurable, multi-tenant cloud application designed to integrate seamlessly into a bank’s existing technology systems. Our highly configurable platform allows each bank to define its own credit policy and determine the significant parameters of its lending program. Our AI models use and analyze data from all of our bank partners. As a result, these models are trained by every Upstart-powered loan, and each bank partner benefits from participating in a shared AI lending platform.

Consumers can discover Upstart-powered loans in one of two ways: either via Upstart.com or through a white-labeled product on our bank partners’ own websites.

Loans issued through our platform can be retained by our originating bank partners, distributed to our broad base of approximately 70 institutional investors and buyers that fund or invest in Upstart-powered loans or funded by Upstart’s balance sheet. In the fourth quarter of 2019, 21% of the loans funded through our platform were retained by the originating bank and 72% of loans were purchased by institutional investors through our loan funding programs. Our institutional investors and buyers that participate in our loan funding programs, which include                     ,                      and                     , fund or invest in Upstart-powered loans through whole loan purchases, issuances of pass-through certificates and investments in asset-backed securitizations. We enter into nonexclusive agreements with our whole loan purchasers and each of the grantor trust entities in our asset-backed securitizations, or ABS, under which our ABS investors benefit from our loan servicing capabilities.57 The remaining 7% of loans funded through our platform in the fourth quarter of 2019 were funded through our balance sheet, primarily for purposes of testing and validating newer aspects of our model.

Our revenue is primarily comprised of fees paid by banks. We charge banks referral fees for each loan originated through Upstart.com, platform fees for each loan originated and loan servicing fees as consumers repay their loans. Our agreements with our bank partners are nonexclusive, have initial terms ranging from one to three years, are subject to certain early termination provisions and minimum fee amounts, and do not include any minimum origination obligation or origination limits. As a usage-based platform, we target positive unit economics on each transaction, resulting in a cash efficient business model that features both high growth rates and profitability. As of March 31, 2020, we had eight bank partners. In 2019, Cross River Bank originated 89% of the loans facilitated on our platform

 

54 

In an internal study, Upstart replicated three bank models using their respective underwriting policies and evaluated their hypothetical loss rates and approval rates using Upstart’s applicant base in late 2017. Such result represents the average rate of improvement exhibited by Upstart’s platform against each of the three respective bank models.

55 

In an internal study, Upstart compared the actual realized loss rates of Upstart loans securitized between June 2017 and September 2019 and the realized loss rate predictions for those loans obtained from KBRA Surveillance Reports published by Kroll Bond Rating Agency in December 2019.

56 

In an internal study in March 2020, Upstart compared the performance of its AI model with that of hypothetical lending models formulated using Upstart’s approximation of credit score variables used in traditional simple rules-based lending models and additional variables including loan amount, debt-to-income ratio, monthly income, number of credit inquiries and number of trade accounts.

57 

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Term loans and revolving loan facilities” and Note 7 to our consolidated financial statements for more information about our loan funding programs, including the role of our warehouse credit facilities and special purpose entities. See “Note 3. Securitizations and Variable Interest Entities” to our consolidated financial statements for additional information regarding transactions with our VIEs.

 

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and fees received from Cross River Bank accounted for 80% of our total revenue.58 Our current agreement with Cross River Bank began on January 1, 2019 and has an initial four year term, with a renewal term for an additional two years following the initial four year term.

We have achieved rapid growth while improving our margin profile in recent years. The number of loans facilitated on our platform increased by 88% from 114,125 in 2018 to 215,122 in 2019. Over the same period, revenue increased 65% from $99.3 million to $164.2 million. Net loss decreased from $12.3 million in 2018 to $0.5 million in 2019.

Industry Overview

Affordable Credit is Critical to Unlocking Upward Mobility and Opportunity

With $4.2 trillion of consumer credit outstanding as of December 2019,59 credit is a cornerstone of the U.S. economy. Access to affordable credit is central to unlocking upward mobility and opportunity. Reducing the price of borrowing for consumers has the potential to dramatically improve the quality of life for millions of people. Studies have demonstrated a strong statistical link among access to affordable credit, personal well-being and income growth.60 The average American has approximately $29,800 in personal debt.61 While access to affordable credit has allowed Americans to purchase and improve their homes, buy cars, pay for college tuition and cover emergency expenses, high interest rates can negatively impact a consumer’s financial health. The U.S. Federal Reserve reports that on average, 10% of household disposable personal income is spent on debt repayment.62 In addition, 16% of Americans spend 50% to 100% of their monthly income repaying debt.63

Affordable Credit Is Inaccessible for Millions because Existing Systems Fail to Accurately Quantify Risk

The FICO score was invented in 1989 and has not fundamentally changed since that time.64 The FICO score is used by over 90% of lenders to determine who is approved for credit and at what interest rate.65 While FICO is rarely used in isolation, many credit models are simple rules-based systems. A leading expert found that bank credit models commonly incorporate eight to 15 variables, with the more sophisticated models using as many as 30.66 Unsurprisingly, the world is more complicated than can be represented by these models, so they are limited in their ability to reliably estimate the probability of default.

Many borrowers suffer from the effects of inaccurate credit models. Many are approved for a loan that they ultimately will be unable to repay, negatively impacting both the consumer and the lender. Many others may be declined for a loan that they could have successfully repaid if given the opportunity—again doing harm to both consumer and lender. According to an Upstart retrospective study completed in December 2019, four out of five Americans who have taken out a loan have never defaulted, yet less than half of Americans have access to prime credit.67 Even consumers with high credit scores tend to pay too much for loans because the rates they pay effectively subsidize the losses from borrowers who default.

 

58 

See the section titled “—Bank Partnerships” for more information about our arrangements with CRB and other bank partners.

59 

Federal Reserve Consumer Credit; see the section titled “Industry, Market and Other Data.”

60 

Wysen; see the section titled “Industry, Market and Other Data.”

61 

Northwestern Mutual; see the section titled “Industry, Market and Other Data.”

62 

Federal Reserve Household Debt; see the section titled “Industry, Market and Other Data.”

63 

Northwestern Mutual; see the section titled “Industry, Market and Other Data.”

64 

Kaufman; see the section titled “Industry, Market and Other Data.”

65 

Kaufman; see the section titled “Industry, Market and Other Data.”

66 

Siddiqi; see the section titled “Industry, Market and Other Data.”

67 

The study defined access to prime credit as individuals with credit reports with VantageScores of 720 or above.

 

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LOGO

Banks Will Continue to be at the Forefront of Consumer Lending

Banks have been at the forefront of consumer lending in the U.S. for more than a century. They benefit from long-term structural advantages, including a low cost of funding, a unique regulatory framework, and high levels of consumer trust. Through large and reliable deposit bases, banks are able to maintain a very low cost of funds—approximately 1% on average.68 These cost savings are passed through to borrowers in the form of lower interest rates, a significant competitive advantage over non-depository lending institutions. Banks also benefit from a regulatory framework that allows them to create nation-wide lending programs that are largely uniform. Given these advantages, we believe that a partnership-based bank enablement approach will be more successful than a disruption strategy.

Banks Must Undergo a Digital Transformation to Remain Competitive

The largest four U.S. banks spend an estimated $38 billion on technology and innovation annually.69 These four banks may attempt to build AI lending models over time, once general market acceptance has been achieved. However, outside the largest four banks, there are approximately 5,200 FDIC insured institutions70 that are at risk of falling behind. Despite holding over $8 trillion in deposits,71 we believe these banks, particularly small to medium-sized banks, have outdated technology and lack the technical resources of larger banks to fund the digitization process.

At the same time, consumers are increasingly seeking digital, personalized and automated experiences.72 A 2017 Bain survey found that approximately 50% of the U.S. population would be comfortable buying financial products from technology companies.73 We believe that as consumers, both young and old, move their financial lives online, small and medium-sized banks will be increasingly ill-equipped to serve them.

Increasing Recognition from Regulators

Many regulators including the FDIC, the OCC, the Federal Reserve and the CFPB increasingly recognize the opportunity to modernize techniques used in lending.74 In December 2019, these

 

68 

Federal Home Loan Bank of San Francisco; see the section titled “Industry, Market and Other Data.”

69 

Garcia; see the section titled “Industry, Market and Other Data.”

70 

FDIC; see the section titled “Industry, Market and Other Data.”

71 

The dollar amount of deposits held by banks, other than the four largest banks, was aggregated by Upstart using data provided by the FDIC; see the section titled “Industry, Market and Other Data.”

72 

Bain, PwC and RedPoint Global; see the section titled “Industry, Market and Other Data.”

73 

Bain; see the section titled “Industry, Market and Other Data.”

74 

FDIC Interagency Statement; see the section titled “Industry, Market and Other Data.”

 

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agencies issued an inter-agency report in support of the use of alternative data in lending decisions.75 Additionally, in November 2019, the CFPB director noted that despite external uncertainty regarding how AI will fit into regulatory frameworks, the CFPB is focused on ensuring a path to regulatory clarity because it recognizes the value AI lending products can offer consumers.76 In fact, in 2017, in response to a request by Upstart, the CFPB issued Upstart the first no-action letter, which provides that the CFPB has no present intention to recommend enforcement action with regard to the application of the Equal Credit Opportunity Act against Upstart for its use of alternative variables and AI and machine learning in credit decision-making.77 Such no-action letter expires on September 14, 2020.

The AI Opportunity

AI has the potential to add $13 trillion to the current global economic output by 2030, a 16% increase over today’s output.78 According to the McKinsey Global Institute, AI will be slowly adopted in its early stages, followed by steep acceleration as the technology matures and companies learn how to best deploy it.79 We believe the lending industry will follow this path.

Lending is a compelling application for AI. First, it involves sophisticated decisioning for events that occur millions of times each day. Second, there is an almost unlimited supply of data that has the potential to be predictive and improve the accuracy of credit decisions. Third, given the costs and risks associated with lending, the economic wins from AI are dramatic for both banks and consumers. This means that the significant investment required to overcome the technical and regulatory hurdles is well worth the effort.

With our seven-year head start, our AI lending platform is well-positioned to power a significant portion of the U.S. credit market. To date, we have focused on the unsecured personal loan market, the fastest-growing segment of consumer credit.80 In 2018, there were $88 billion81 in U.S. unsecured personal loan originations, representing 20% growth over the prior year. In 2019, we facilitated the origination of $2.7 billion in unsecured personal loans, or less than 5% of the total market.82 We not only have a large opportunity to capture market share in unsecured personal loans, but by applying our AI models and technology to adjacent opportunities, we believe we are well-positioned to address the approximately $899 billion83 opportunity in U.S. auto loans, credit cards, student loans, point-of-sale loans and HELOCs. Over the longer term, we believe we are also capable of capturing market share in mortgage and small business lending.

Our AI Lending Platform

Our AI models are central to our value proposition and unique position in the industry. Our models incorporate more than 1,500 variables, which are analogous to the columns in a spreadsheet. They have been trained by more than 5.5 million repayment events, analogous to rows of data in a spreadsheet. Interpreting these more than 8 billion cells of data are increasingly sophisticated machine learning algorithms that enable a more predictive model.

 

75 

FDIC Interagency Statement; see the section titled “Industry, Market and Other Data.”

76 

Kraninger; see the section titled “Industry, Market and Other Data.”

77 

CFPB No-Action Letter; see the section titled “Industry, Market and Other Data.”

78 

McKinsey; see the section titled “Industry, Market and Other Data.”

79 

McKinsey; see the section titled “Industry, Market and Other Data.”

80 

Beiseitov; see the section titled “Industry, Market and Other Data.”

81 

Based on 2018 loan origination dollar amounts and 2017 loan origination dollar amounts provided by TransUnion.

82 

Based on 2018 loan origination dollar amounts provided by TransUnion.

83 

Based on 2018 loan origination dollar amounts provided by TransUnion.

 

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These elements of our model are co-dependent; the use of hundreds or thousands of variables is impractical without sophisticated machine learning algorithms to tease out the interactions between them. And sophisticated machine learning depends on large volumes of training data. Over time, we have been able to deploy and blend more sophisticated modeling techniques, leading to a more accurate system. This co-dependency presents a challenge to others who may aim to short-circuit the development of a competitive model. While incumbent lenders may have vast quantities of historical repayment data, their training data lacks the hundreds of columns, or variables, that power our model. For more details regarding the variables, training data, and algorithms in our models, please see “Business—Evolution of Upstart’s AI Model.”

Despite their sophistication, our AI models are delivered to banks in the form of a simple cloud application that shields consumers from the underlying complexity. Additionally, our platform allows banks to tailor lending applications based on their policies and business needs. Our bank partners can configure many aspects of their lending programs, including factors such as loan duration, loan amount, minimum credit score, maximum debt-to-income ratio and return target by risk grade. Within the construct of each bank’s self-defined lending program, our platform enables the origination of conforming and compliant loans at a low per-loan cost.

Our platform benefits from powerful flywheel effects that drive continuous improvements as our business scales. Our platform benefits first from increasingly sophisticated models, variable expansion and rapid growth of training data. Upgrades to our platform allow us to offer higher approval rates and lower interest rates to consumers, which increases the number of borrowers on our platform. Upgrades to our platform also lead to better borrower selection, which lowers losses and lowers interest rates to borrowers. The flywheel effect created by self-reinforcing AI increases the economic opportunity that can be shared by borrowers and lenders over time.

Upstart’s AI Flywheel

 

 

LOGO

Our Ecosystem

Our platform connects consumers, banks and institutional investors through a shared AI lending platform. Because AI is a new and disruptive technology, and banking is a traditionally conservative industry, we have brought our technology to market in a way that allows us to grow rapidly and improve on our AI models, while allowing banks to take a prudent and responsible approach to assessing and adopting our platform.

 

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On the consumer side, we aggregate demand on Upstart.com, where consumers are presented with bank-branded offers from our bank partners. In this way, we benefit banks who have adopted our AI lending technology. Bank partners can also offer Upstart-powered loans through a white-labeled interface on their own website or mobile application.

On the funding side, our bank partners can retain loans that align with their business and risk objectives, while the remainder can be sold to our network of institutional investors, which have far broader and more diverse capacity to absorb and distribute risk. This flexible approach allows banks to adopt AI lending at their own pace, while we continue to grow and improve our platform.

Upstart’s Ecosystem

 

LOGO

Value Proposition to Consumers

 

   

Higher approval rates and lower interest rates—The CFPB reported that a study by Upstart of its data using a methodology specified by the CFPB, showed that our AI model approves 27% more borrowers than high-quality traditional lending models with a 16% lower average APR for approved loans.84 Our analyses suggest that our loan offers have improved significantly over time relative to those of competitors.85

 

   

Superior digital experience—Whether consumers apply for a loan through Upstart.com or directly through a bank partner’s website, the application experience is streamlined into a single application process and the loan offers provided are firm. In the fourth quarter of 2019, approximately 70% of Upstart-powered loans were instantly approved with no document upload or phone call required, an increase from 0% in late 2016. Such automation improvements were due in large part to improvements to our AI models and the application of such models to different aspects of the loan process, including data verification and fraud detection.

 

84 

Ficklin and Watkins; see the section titled “Industry, Market and Other Data.”

85 

Since 2017, Upstart has used a third-party service to perform quarterly comparative studies of the interest rates offered for Upstart-powered loans versus the interest rates offered by six other companies offering personal loans online.

 

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Value Proposition to Bank Partners

 

   

Competitive digital lending experience—We provide regional banks and credit unions with a cost effective way to compete with the technology budgets of their much larger competitors. The NPS for our bank partners’ lending programs are approximately 80, well above published benchmarks for the largest banks.86

 

   

Expanded customer base—We refer customers that apply for loans through Upstart.com to our bank partners, helping them grow both loan volumes and number of customers. The most common age of Upstart-referred borrowers is 27 years old, a compelling demographic that is often challenging for banks to access.

 

   

Lower loss rates—An internal study comparing our model to that of several large U.S. banks found that our model could enable these banks to lower loss rates by almost 75% while keeping approval rates constant.87

 

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