Amendment No. 2 to Form S-1
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As filed with the Securities and Exchange Commission on December 4, 2020.

 

Registration No. 333-249860

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

Amendment No. 2

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

Christopher Ing

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

  Shares
to be 
Registered(1) 
 

Proposed Maximum 

Aggregate Offering 
Price Per Share(2)

  Maximum 
Aggregate Offering 
Price(1)(2)
 

Amount of

Registration Fee(3)

Common stock, par value $0.0001 per share

 

13,818,043

 

$22.00

  $303,996,946.00   $33,166.07

 

 

(1)

Includes an additional 1,802,353 shares of our common stock that the underwriters have the option to purchase.

(2)

Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(a) 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.

(3)

The registrant previously paid $10,910 of this amount in connection with a prior filing of this registration statement.

 

 

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.

 

 

 


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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.

LOGO

Subject to Completion. Dated December 4, 2020.

12,015,690 Shares

 

 

Upstart Holdings, Inc.

Common Stock

___________________

This is the initial public offering of shares of common stock of Upstart Holdings, Inc. We are offering 9,000,000 shares of common stock. The selling stockholders identified in this prospectus are offering an additional 3,015,690 shares of common stock. We will not receive any of the proceeds from the sale of shares by the selling stockholders.

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 $20.00 and $22.00. We have been approved to list our common stock on the Nasdaq Global Select Market 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 21 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

   $        $    

Proceeds, before expenses, to the selling stockholders

   $        $    

__________

  (1)

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

 

To the extent that the underwriters sell more than 12,015,690 shares of our common stock, the underwriters have the option to purchase up to an additional 1,802,353 shares from certain selling stockholders 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
JMP Securities   Blaylock Van, LLC

___________________

Prospectus dated           , 2020.

 


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LOGO

 

Upstart

AI Powered Lending

~15B cells of performance data 1

622,079 loans transacted on platform 2

~75% reduction in loss rates 3

10x increase in conversion rates since inception 4

~70% loans fully automated 5

3 of 4 last quarters GAAP profitable 6

Data presented as of September 30, 2020 unless otherwise specified.

(1) Represents the amount of data powering our AI models, which includes model input variables and training data such as payment events. Such data is integral to our models’ continued improvement and accuracy. See the section titled “Business–Evolution of Upstart’s AI Model” for more information.

(2) 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.

(3) 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.

(4) Based on the change in Conversion Rate from May 1, 2014 to September 30, 2020. We define Conversion Rate as the Number of Loans Transacted in a period divided by the number of rate inquiries received in the same period, which we record when a borrower requests a loan offer on our platform.

(5) Percentage of Loans Fully Automated. We define Percentage of Loans Fully Automated 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.

(6) We were GAAP profitable in the fourth quarter of 2019 and the first and third quarters of 2020.


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LOGO

 

You are more than your credit score


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LOGO

 


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LOGO

 

FOUNDERS’ LETTER

I left Google in 2012 to found Upstart with Anna and Paul.

We were convinced that technology and data science could improve access to affordable credit, but we were a little fuzzy on the details. It seemed obvious that there was room for improvement: Why should a credit score invented 30 years ago, prior to the emergence of cloud computing and modern data science, decide who is approved for a loan and who isn’t?

I was confident that the types of technologies and analytics we were developing at Google for very different reasons could be useful to this vast but incredibly inefficient industry. And done properly, such a system could reduce the cost of borrowing for millions.

Why credit?

You don’t go into credit to be loved. With five thousand years of colorful history, there’s no shortage of reasons to be concerned for borrowers and suspicious of lenders. The business of lending suffers from self-inflicted reputational damage brought on by uncountable stories of borrower exploitation. For all the right reasons, it’s among the most heavily regulated industries.

We can dream about living in a world where credit isn’t necessary—where each of us has the money we need to live the life we want. But like it or not, money is a core ingredient of our lives, and the need to borrow money is a reality for virtually all Americans.

Despite its checkered past, it’s clear that credit is a cornerstone of the economy and access to affordable credit is an enabler of the American dream. Purchasing a home or car, starting a business, pursuing a college degree, relocating to a new city—these are the building blocks of life that are out of reach for those without access to affordable credit.

Simply put, credit unlocks opportunity and mobility—and thus the price of credit equals the price of the American dream.

This is why we founded Upstart.

I


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LOGO

 

Lending is broken

Considering how central lending is to the economy, it’s stunning how ineffective current approaches to credit origination are. In June of 2020, commercial banks in the US issued almost $15 trillion in loans.1 Yet the models used to predict whether a loan will be repaid are much closer to a roll of the dice than to an omniscient lending deity.

By way of example, four in five Americans have never defaulted on a loan, yet less than half have a credit score that would qualify them for the low rates that banks offer.2 The implication is eye-opening: with a smarter credit model, lenders could approve almost twice as many borrowers, with fewer defaults.

Limitations of legacy credit systems affect most of us: First, they offer loans to many people who fail to pay them back, which is harmful to both consumers and lenders. Second, they decline to offer loans to people who would successfully pay them back if given the chance, also harmful to consumers and lenders. And finally, even those who repay their loans pay too much in interest, because they subsidize borrowers who default.

It’s accepted as immutable that lending is a cyclical industry whose performance depends wholly on the macro-economic environment. A corollary of this belief holds that, aside from modest efficiency improvements, technology can’t alter the fundamentals of lending. Lenders staffed by disciplined teams with solid analytics will do fine when times are good. But like gravity, it will all come crashing down at the next recession.

These beliefs lead to an intense and ultimately fruitless effort in boardrooms across the country to predict the timing of the next recession. When the first signs of a slowdown are evident, lenders are quick to raise the drawbridge and batten down the hatches. These impulsive reactions invariably mean that access to credit for consumers and businesses dries up just when it’s needed most.

Artificial intelligence is the fix

AI has the potential to add $13 trillion to the global economy by 2030 and is broadly considered one of the most important developments in the history of technology.3 Last year, Amazon’s Jeff Bezos said “we’re at the beginning of a golden age of AI. Recent advancements have already led to invention that previously lived in the realm of science fiction.”

Credit is a compelling and obvious use case for AI. First, lending 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 improve the accuracy of credit decisions. Third, given the costs and risks associated with lending, as well as the scale of the industry, the potential economic wins from AI are dramatic.

1 Statista: Value of Loans of all Commercial Banks in the United States from March 2014 to August 2020, September 2018.

2 Based on an Upstart retrospective study completed in December 2019, which defined access to prime credit as individuals with credit reports with

VantageScores of 720 or above.

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

II


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LOGO

 

How does AI change lending? It starts by vastly expanding the information used to inform a credit decision. Then, it utilizes sophisticated machine learning algorithms that can tease out the relationships between hundreds or even thousands of variables. And finally, the system learns and improves on its own, optimizing in response to daily loan-level repayment and delinquency data. Our own AI system is trained on almost 15 billion cells of performance data and predicts the specific likelihood of default or prepayment for each month of a loan term.4

As the number of variables and volume of training data in Upstart’s model have grown over time, we’ve been able to implement increasingly sophisticated machine learning algorithms, which in turn improve the accuracy of our model and efficiency of our funnel. As good as our AI platform is today, it only scratches the surface of the accuracy gains that are possible.

Applied across the entire credit origination funnel, AI can reduce friction, eliminate costs, and mitigate risks associated with lending. The result is a superior customer experience and improved economics that can be shared between borrowers and lenders.

The wins from AI lending are compelling. Studies we completed with several large US banks suggested that Upstart’s model could approve up to three times the number of borrowers at the same loss rates as traditional models.5 Furthermore, improvements to our AI models have increased throughput of our borrower funnel by a factor of 10 since we began more than eight years ago, driving long-term reductions in acquisition cost and improvements to our unit economics. These improvements led to our first profitable quarter in Q4 2019 (and a net loss of $466,000 for the full-year 2019).

What about those ugly recessions? Lenders would do well to put away their crystal balls and instead focus on predicting which borrowers will pay them back in any environment. While the probability of default for a borrower may vary by as much as 2X6 depending on the state of the economy, our experience suggests that risk associated with two borrowers with similar credit scores can vary by at least 10X.7

Furthermore, with an AI-based system, banks can lend responsibly in any environment, with a system that responds quickly and intelligently to changes in employment levels and economic output. This isn’t just theory: during the employment shock of the recent COVID-19 pandemic, unemployment increased from about 4% to 14% in just a few weeks. While this led to a temporary decrease in loan originations and in the availability of loan funding as well as a potential for increased losses, Upstart partner banks experienced immaterial impact to the performance of their loans.8

4 Performance data is defined as a combination of payment events and model input variables.

5 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 approval rates between Upstart’s model and each of the replicated bank models, Upstart held loss 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.

6 Based on a comparison of loss rates on 60 day past due credit card accounts from 2004-2006 and 2009 using data obtained from Canals-Cerda and Kerr, Working Paper No. 15-08 Credit Risk Modeling in Segmented Portfolios: An Application to Credit Cards, Federal Reserve Bank of Philadelphia, February 2015.

7 Based on an internal Upstart study conducted in June 2020 comparing annualized loss rates of all Upstart-powered loans originated in 2018 by segments based on the borrower’s FICO credit score and the risk tier assigned by Upstart at origination.

8 Bureau of Labor Statistics, U.S. Department of Labor, News Release: The Employment Situation - August 2020, September 2020.


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LOGO

 

We don’t expect every future cycle to behave the same in terms of government stimulus and consumer dynamics. And while our model has not yet been extensively tested in a down-cycle economy or recession without significant government assistance, we do expect the relative strengths of AI demonstrated during this cycle to persist. Nevertheless, it will take time for banks and capital markets to develop confidence necessary to continue lending through cycles, as evidenced by the fact that the COVID-19 pandemic led to a significant but temporary reduction in bank lending and loan funding on our platform.

While we expect AI to disrupt virtually all forms of credit globally, Upstart is focused today on the US consumer market (and on personal loans in particular). There were more than $4.2 trillion in credit outstanding in December 2019 across mortgages, HELOCs, auto loans, credit cards, personal loans, and student loans - and virtually all could have been improved with AI.9

In June 2020, we announced the expansion of our AI platform into auto lending, and the first Upstart-powered auto loan was originated in September 2020. The auto lending market is both large - at least five times the size of the personal loan market - and inefficient, with millions of borrowers paying interest rates that don’t reflect their true risk. 10 This is an ideal next opportunity for Upstart.

Why now, why Upstart?

History is littered with companies who claimed to have built a “better mousetrap” in credit only to fail the test of time. 11 So it’s fair to ask what’s changed and why now is the time for AI lending.

First, the building blocks for this transformation came into place only in the last decade or so. The science underpinning AI has gone from research labs to mainstream in just a few years. And cloud computing has unlocked the ability to apply the enormous power of computation required by AI to a single credit decision in just a few seconds.

Second, change is hard, and change at the core of credit is really hard. The data science, the regulatory hurdles, the financial risk-add these up and it’s no secret why the pre-eminent lending institutions in the US (banks) have yet to take on the challenge of building an AI model.

At Upstart, we built the right team to take on this challenge and paired it with the right mission to inspire us. Every single day, we focus maniacally on helping our bank partners approve more borrowers at lower rates while eliminating every bit of friction associated with the process. With our eight-year head start, we believe our AI lending platform is well-positioned to help power one of the largest transformations facing the financial services industry.

6 Based on a comparison of loss rates on 60 day past due credit card accounts from 2004-2006 and 2009 using data obtained from Canals-Cerda and Kerr, Working Paper No. 15-08 Credit Risk Modeling in Segmented Portfolios: An Application to Credit Cards, Federal Reserve Bank of Philadelphia, February 2015.

7 Based on an internal Upstart study conducted in June 2020 comparing annualized loss rates of all Upstart-powered loans originated in 2018 by segments based on the borrower’s FICO credit score and the risk tier assigned by Upstart at origination.

8 Bureau of Labor Statistics, U.S. Department of Labor, News Release: The Employment Situation - August 2020, September 2020.

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

10 Based on an internal Upstart study conducted in July 2020. Market size data obtained from Matt Komos, TransUnion: Consumer Credit Origination, Balance and Delinquency Trends: Q1 2020, June 2020.

11 Hansell, Saul, Technology; U.S. Seizes Bank Business of Web Credit Card Issuer, The New York Times, February 2002.


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LOGO

 

A partner to banks

While many Fintech companies aspire to become the bank of the future, we’re not one of them. Instead of competing with banks, we decided to partner with them, helping banks navigate and thrive through one of the most foundational technology transformations in history.

For our first four years, we worked with a single bank partner, Cross River Bank, to build our models and refine our processes. We decided at that point to partner with banks rather than to become one, so began to work with other banks. As of today, there are 10 banks on our platform, though Cross River Bank still originated 89% of our volume in 2019 and 72% in the first three quarters of 2020.

While a handful of our country’s largest banks may aspire to build an AI-powered lending platform, thousands of others will look to form strong and reliable technology partnerships in order to secure their future. We aim to partner with them.

What motivates us

Eight years in, it’s unusual for three founders to continue to lead a company day in and day out. But Paul, Anna and I are still here. We’re different people, from different backgrounds and even different generations. But we figured out how to work together to build a company that none of us could have built alone. We do have some things in common-we each come from a modest background, where affordable credit was central to our unique pursuit of the American dream.

We have a “true north” at Upstart-to bring more people into the world where the credit system works, to unlock opportunity and mobility for them so that money isn’t a daily concern, and to write a story about lending of which we can all be proud.

Dave on behalf of Paul and Anna


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TABLE OF CONTENTS

Prospectus

 

     Page  

Prospectus Summary

     1  

Risk Factors

     21  

Special Note Regarding Forward-Looking Statements

     85  

Industry, Market and Other Data

     87  

Use of Proceeds

     89  

Dividend Policy

     90  

Capitalization

     91  

Dilution

     93  

Selected Consolidated Financial and Other Data

     96  

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

     99  

Business

     136  

Management

     166  

Executive Compensation

     177  

Certain Relationships and Related Party Transactions

     193  

Principal and Selling Stockholders

     199  

Description of Capital Stock

     202  

Shares Eligible for Future Sale

     208  

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

     211  

Underwriting

     216  

Validity of Common Stock

     222  

Experts

     222  

Where You Can Find Additional Information

     222  

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, the selling stockholders 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, the selling stockholders 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, the selling stockholders 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.


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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 over 620,000 personal loans that have generated more than 9 million repayment events. In the nine months ended September 30, 2020, 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.12 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.13

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 eight years. We have discrete AI

 

12 

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

13 

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 1,600 variables and benefit from a rapidly growing training dataset that currently contains more than 9 million repayment events.14 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.15 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.16 Third, for pools of securitized loans, our realized loss rates were only approximately half of those predicted by Kroll, a prominent credit rating agency; over that same time period, realized losses for the same pool of loans were on average only 5% different than our internal forecasts.17 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.18

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 100 institutional investors and buyers that invest in Upstart-powered loans or funded by Upstart’s balance sheet. In the third quarter of 2020, 22% of the loans funded through our platform were retained by the originating bank and 76% of loans were purchased by

 

14 

References to variables in this prospectus refer to all raw variables and certain combined variables considered in our AI models.

15 

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

16 

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.

17 

In an internal study, Upstart compared the actual realized loss rates of Upstart loans securitized in five securitization transactions between June 2017 and September 2019 and the loss rate predictions for those loans obtained from KBRA Surveillance Reports published by Kroll Bond Rating Agency in December 2019. As compared to Kroll’s loss predictions, actual realized losses were approximately 31% to 71% lower, with an average deviation across all five securitization transactions of -48%. As compared to our internal forecasts, actual realized losses ranged from approximately 35% higher (for the earliest securitization transaction) to approximately 17% lower (for the most recent securitization transaction), with an average absolute deviation across all of five securitization transactions of approximately 13%.

18 

Upstart compares on a monthly basis its AI models to (i) a FICO-only model and (ii) a “FICO+” model, which considers loan amount, debt-to-income ratio, monthly income, number of inquiries and number of trade accounts in addition to FICO score, which we believe is representative of the model many of our sophisticated competitors would use. To conduct a comparison of the Upstart AI models to the models described in (i) and (ii), we run applicant information through the Upstart AI models, the FICO-only model, and FICO+ model, comparing performance by analyzing five commonly-used statistical metrics, each of which measures the deviation between predicted losses and actual losses for each model. These metrics include: the root mean square error of net present value of losses, normalized logistic loss, ratio of the gini coefficients of predicted to observed rankings, the area under the receiver operating characteristics curve, and the Kolmogorov-Smirnov statistic.



 

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institutional investors through our loan funding programs. Our institutional investors and buyers that participate in our loan funding programs, which include Goldman Sachs, PIMCO and funds managed by Morgan Stanley Investment Management, 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 securitizations, or ABS, under which our ABS investors benefit from our loan servicing capabilities.19 The remaining 2% of loans funded through our platform in the third quarter of 2020 were funded through our balance sheet.

Our revenue is primarily comprised of fees paid by banks. We charge banks referral fees for each loan referred through Upstart.com and originated by a bank partner, platform fees for each loan originated (regardless of its source) and loan servicing fees as consumers repay their loans. Our agreements with our bank partners are nonexclusive, generally have 12-month terms that automatically renew, 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 September 30, 2020, we had 10 bank partners. In the nine months ended September 30, 2020, Cross River Bank originated 72% of the loans facilitated on our platform and fees received from Cross River Bank accounted for 65% of our total revenue.20 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, and 30% from 136,468 in the nine months ended September 30, 2019 to 176,983 over the same period in 2020. Our revenue for the nine months ended September 30, 2019 and 2020 was $101.6 million and $146.7 million, respectively, representing an increase of 44%. For the nine months ended September 30, 2019 and 2020, our net income (loss) was $(6.5) million and $5.0 million, respectively.21

Industry Overview

Affordable Credit is Critical to Unlocking Upward Mobility and Opportunity

With $3.6 trillion of consumer credit originated between April 2019 and March 2020,22 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.23 The average American has approximately $29,800 in personal debt.24 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

 

19 

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.

20 

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

21 

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

22 

Based on loan origination dollar amounts published by TransUnion; see the section titled “Industry, Market and Other Data.”.

23 

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

24 

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



 

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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.25 In addition, 16% of Americans spend 50% to 100% of their monthly income repaying debt.26

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.27 The FICO score is used by over 90% of lenders to determine who is approved for credit and at what interest rate.28 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 30.29 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.30 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.

 

LOGO

 

25 

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

26 

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

27 

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

28 

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

29 

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

30 

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



 

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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.31 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.32 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 institutions33 that are at risk of falling behind. Despite holding over $8 trillion in deposits,34 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.35 A 2017 Bain survey found that approximately 50% of the U.S. population would be comfortable buying financial products from technology companies.36 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.

We believe that these trends have been accelerated by the COVID-19 pandemic, as the lack of access to physical bank branches has increased the banking industry’s focus on digital capabilities. The performance of our platform through this crisis has also given existing and prospective bank partners an important new data point to underpin their growing confidence in our solution.

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.37 In December 2019, these agencies issued an inter-agency report in support of the use of alternative data in lending decisions.38 Additionally, in November 2019, the CFPB director noted that despite external uncertainty regarding how AI will fit into

 

31 

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

32 

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

33 

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

34 

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.”

35 

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.

36 

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

37 

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.

38 

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



 

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regulatory frameworks, the CFPB is focused on ensuring a path to regulatory clarity because it recognizes the value AI lending products can offer consumers.39 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.40 This no-action letter expired on December 1, 2020. On November 30, 2020, the CFPB issued a new no-action letter to Upstart under the CFPB’s revised 2018 policy on no-action letters. This new no-action letter, which will expire on November 30, 2023, covers the use of our Al model to underwrite and price unsecured closed-end loans, and is conditional on our implementation of a Model Risk Assessment Plan that was developed with the CFPB.

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.41 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.42 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 eight-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, one of the fastest-growing segment of consumer credit.43 From April 2019 to March 2020, there were $118 billion44 in U.S. unsecured personal loan originations, representing 8% growth over the prior year. In the same period, we facilitated the origination of $3.5 billion in unsecured personal loans, or less than 5% of the total market.45 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 U.S. auto loan, credit card and mortgage markets. From April 2019 to March 2020, there were $625 billion in U.S. auto loan originations, $363 billion in U.S. credit card originations and $2.5 trillion in U.S. mortgage originations.46 In June 2020, we began offering auto loans on our platform, and in September 2020, the first auto loan was originated through the Upstart platform. Over time, we believe we are also capable of capturing market share in student loans, point-of-sales loans and Home Equity Lines of Credit, or HELOCs.

 

39 

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

40 

Consumer Financial Protection Bureau, No-Action Letter to Upstart Network, Inc. dated September 14, 2017, and as modified on September 11, 2020, or the CFPB No-Action Letter.

41 

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

42 

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

43 

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

44 

Based on loan origination dollar amounts published by TransUnion; see the section titled “Industry, Market and Other Data.”

45 

Based on loan origination dollar amounts published by TransUnion; see the section titled “Industry, Market and Other Data.”

46 

Based on loan origination dollar amounts published by TransUnion; see the section titled “Industry, Market and Other Data.”



 

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Our AI Lending Platform

Our AI models are central to our value proposition and unique position in the industry. Our models incorporate more than 1,600 variables, which are analogous to the columns in a spreadsheet. They have been trained by more than 9 million repayment events, analogous to rows of data in a spreadsheet. Interpreting these almost 15 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.

Upstart’s AI Flywheel

 

 

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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.

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.47 Our analyses suggest that our loan offers have improved significantly over time relative to those of competitors.48

 

47 

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

48 

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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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 third quarter of 2020, 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 79, well above published benchmarks for the largest banks.49

 

   

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 in the third quarter of 2020 was 28 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.50

 

   

New product offering—Personal loans are one of the fastest-growing segment of credit in the U.S.51 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 eight years, and they have led directly to our growth and profitability. Our models currently incorporate more than 1,600 variables and are trained by more than 9 million repayment events. Beyond the advantages accrued by our constantly growing volume of training data, our data science team continues to update our modeling

 

49 

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 third quarter of 2020. 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.”

50 

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.

51 

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



 

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techniques regularly. Model and technology improvements have increased our conversion rate from the initial rate inquiry to funded loan by a factor of ten since inception. 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 the third quarter of 2020, we generated 96% 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 third quarter of 2020, driving operating leverage and improving unit economics.

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.52

In September 2017, we received the CFPB’s first no-action letter.53 The CFPB issues no-action letters to reduce potential regulatory uncertainty for innovative products that may offer significant consumer benefit.54 On November 30, 2020, at the expiration of our first no-action letter, we received a new no-action letter from the CFPB, which expires on November 30, 2023. 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.

 

 

52 

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

53 

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

54 

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



 

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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%.55 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.

New Products

Personal loans are one of the fastest-growing segment of consumer credit in the U.S., but they are far from the largest.56 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, mortgages, student loans, point-of-sale loans and HELOCs. In June 2020, we began offering auto loans on our platform, and in September 2020, the first auto loan was originated through the Upstart platform.

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.

 

   

The COVID-19 pandemic has harmed and could continue to harm our business, financial condition and results of operations.

 

   

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.

 

 

55 

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.

56 

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



 

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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 and one other bank partner account 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 extensively tested during 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.

 

   

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.

 

   

Substantially all of our revenue is derived from a single loan product, and we are thus particularly susceptible to fluctuations in the unsecured personal loan market. We also 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.



 

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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.

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

9,000,000 shares

 

Common stock offered by the selling stockholders

3,015,690 shares

 

Common stock to be outstanding after this offering

72,460,881 shares

 

Option to purchase additional shares of common stock from certain selling stockholders

Certain selling stockholders have granted the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to 1,802,353 additional shares.

 

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 $166.9 million, based upon the assumed initial public offering price of $21.00 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. We will not receive any of the proceeds from the sale of common stock by the selling stockholders in this offering.

 

  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 62.7% 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.

 

Nasdaq Global Select Market 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 63,460,881 shares of our common stock outstanding as of September 30, 2020, and reflects:

 

   

15,044,707 shares of common stock outstanding;

 

   

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;

 

   

600,208 shares of our Series B preferred stock issued in November 2020 upon the exercise of a warrant that was outstanding as of September 30, 2020, which will automatically convert into shares of common stock in the Capital Stock Conversion; and

 

   

466,389 shares of our common stock to be issued upon exercise of options to purchase shares of our common stock by certain selling stockholders in connection with the sale of such shares by such selling stockholders in this offering.

The shares of our common stock outstanding after this offering exclude the following:

 

   

18,889,653 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock outstanding as of September 30, 2020, with a weighted-average exercise price of $3.17 per share;

 

   

319,669 shares of our common stock issuable upon the exercise of warrants outstanding as of September 30, 2020, with a weighted-average exercise price of $1.77 per share;

 

   

1,540,938 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock issued after September 30, 2020, with a weighted-average exercise price of $15.16 per share; and

 

   

10,765,271 shares of our common stock reserved for future issuance under our equity compensation plans, consisting of:

 

   

5,520,000 shares of our common stock 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;

 

   

3,865,271 shares of our common stock reserved for future issuance under our 2012 Stock Plan, or our 2012 Plan, provided that we will cease granting awards under our 2012 Plan upon the effectiveness of the 2020 Plan; and

 

   

1,380,000 shares of our common stock reserved for future issuance under our 2020 Employee Stock Purchase Plan, or our ESPP, which will become effective prior to the completion of this offering.

Each of our 2020 Plan and our ESPP provides for annual automatic increases in the number of shares reserved thereunder, and our 2020 Plan also provides for increases to the number of shares that may be granted thereunder based on awards 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;



 

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no exercise or cancellation of outstanding stock options subsequent to September 30, 2020 (other than shares to be issued upon exercise of options to purchase common stock by certain selling stockholders in connection with the sale of such shares by such selling stockholders in this offering); and

 

   

no exercise by the underwriters of their option to purchase an additional 1,802,353 shares of our common stock from certain selling stockholders.



 

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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 from our audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated statements of operations data for the nine months ended September 30, 2019 and 2020 and the consolidated balance sheet data as of September 30, 2020 have been derived from our unaudited interim 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,     Nine Months Ended September 30,  
(In thousands, except share and per
share amounts)
   2017     2018     2019     2019     2020  

Revenue:

          

Revenue from fees, net

   $ 51,161     $ 88,482     $ 159,847     $ 98,699     $ 144,179  

Interest income and fair value adjustments, net

     6,128       10,831       4,342       2,918       2,527  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     57,289       99,313       164,189       101,617       146,706  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

          

Sales and marketing(1)

     33,838       63,633       93,175       61,236       65,113  

Customer operations(1)

     10,232       15,416       24,947       16,593       24,792  

Engineering and product development(1)

     5,324       8,415       18,777       11,480       24,651  

General, administrative, and other(1)

     15,431       19,820       31,865       20,399       30,778  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     64,825       107,284       168,764       109,708       145,334  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from operations

     (7,536     (7,971     (4,575     (8,091     1,372  

Other income

     330       487       1,036       832       5,497  

Expense on warrants and convertible notes, net

     (1,649     (3,734     (1,407     (2,626     (2,317
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income before income taxes

     (8,855     (11,218     (4,946     (9,885     4,552  

Provision for income taxes

     6       —         74       —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income before attribution to noncontrolling interests

     (8,861     (11,218     (5,020     (9,885     4,552  

Net (loss) income attributable to noncontrolling interests

     (1,144     1,101       (4,554     (3,368     (404
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income attributable to Upstart Holdings, Inc. common stockholders

   $ (7,717   $ (12,319   $ (466   $ (6,517   $ 4,956  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 


 

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     Year Ended December 31,     Nine Months Ended September 30,  
(In thousands, except share and per
share amounts)
   2017     2018     2019     2019     2020  

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

   $ (0.56   $ (0.87   $ (0.03   $ (0.46   $ —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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       14,313,262       14,663,623  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net income per share attributable to Upstart Holdings, Inc. common stockholders, basic(2)

       $ 0.06       $ 0.11  
      

 

 

     

 

 

 

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

         62,249,893         62,613,408  
      

 

 

     

 

 

 

Pro forma net income per share attributable to Upstart Holdings, Inc. common stockholders, diluted(2)

       $ 0.05       $ 0.09  
      

 

 

     

 

 

 

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

         71,497,924         71,733,580  
      

 

 

     

 

 

 

 

(1)

Includes stock-based compensation expense as follows:

 

     Year Ended December 31,      Nine Months Ended
September 30,
 
(In thousands)      2017          2018          2019          2019          2020    

Sales and marketing

   $ 32      $ 183      $ 278      $ 157      $ 1,136  

Customer operations

     124        178        433        252        625  

Engineering and product development

     574        753        1,803        932        3,181  

General, administrative, and other

     560        931        1,292        863        2,160  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 1,290      $ 2,045      $ 3,806      $ 2,204      $ 7,102  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(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 income 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.



 

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Consolidated Balance Sheet Data

 

     As of September 30, 2020  
(In thousands)    Actual     Pro
Forma(1)
    Pro Forma
as
Adjusted (2) (3)(4)
 

Cash

   $ 53,234     $ 53,240     $ 224,608  

Loans (at fair value)

     122,708       122,708       122,708  

Total assets

     309,804       309,810       476,293  

Borrowings

     100,588       100,588       100,588  

Total liabilities

     194,591       187,134       187,134  

Convertible preferred stock

     162,546       —         —    

Accumulated deficit

     (70,249     (70,249     (75,134

Total stockholders’ (deficit) equity

     (47,333     122,676       289,159  

Total liabilities, convertible preferred stock and stockholders’ (deficit) equity

   $ 309,804     $ 309,810     $ 476,293  

 

(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 September 30, 2020, (b) the preferred stock issued in November 2020 upon the exercise of a warrant to purchase Series B 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 $21.00 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 and (c) the issuance of 466,389 shares of common stock upon the exercise of options held by certain selling stockholders in connection with the sale of such shares by such selling stockholders in this offering.

(3)

Each $1.00 increase or decrease in the assumed initial public offering price of $21.00 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 $8.4 million, 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 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, working capital, total assets, and total stockholders’ equity by $19.5 million assuming the assumed initial public offering price remains the same, and after deducting estimated underwriting discounts and commissions payable by us.

(4)

Pro forma as adjusted cash and total assets each excludes $4.2 million of deferred offering costs that had been paid as of September 30, 2020.

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,      Nine Months Ended
September 30,
 
     2017      2018      2019        2019          2020    

Number of Loans Transacted

     70,457        114,125        215,122        136,468        176,983  

Conversion Rate

     8.1%        9.1%        13.1%        12.2%        14.0%  

Percentage of Loans Fully Automated

     34%        53%        66%        64%        69%  


 

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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,      Nine Months Ended
September 30,
 
(In thousands)    2017     2018     2019        2019         2020    

Contribution Profit

   $ 9,265     $ 13,098     $ 48,940      $ 25,560     $ 63,697  

Adjusted EBITDA

   $ (4,679   $ (6,226   $ 5,595      $ (1,363   $ 16,006  

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

Investing in our common stock involves a high degree of risk because our business is subject to numerous risks and uncertainties, as fully described below. The principal factors and uncertainties that make investing in our common stock risky include, among others:

 

   

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.

 

   

The COVID-19 pandemic has harmed and could continue to harm our business, financial condition and results of operations.

 

   

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 and one other bank partner account 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 extensively tested during 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.

 

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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.

 

   

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, or if loan aggregators begin offering competing products, our business could be adversely affected.

 

   

Substantially all of our revenue is derived from a single loan product, and we are thus particularly susceptible to fluctuations in the unsecured personal loan market. We also do not currently offer a broad suite of products that bank partners may find desirable.

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. For the nine months ended September 30, 2019 and 2020, our revenue was $101.6 million and $146.7 million, respectively, representing a period-over-period growth rate of 44%. 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 2019.57 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.

The COVID-19 pandemic has harmed and could continue to harm our business, financial condition and results of operations.

The COVID-19 pandemic has caused extreme societal, economic, and financial market volatility, resulting in business shutdowns, an unprecedented reduction in economic activity and significant dislocation to businesses, the capital markets, and the broader economy. In particular, the impact of the COVID-19 pandemic on the finances of borrowers on our platform has been profound, as many have been, and will likely continue to be, impacted by unemployment, reduced earnings and/or elevated economic disruption and insecurity.

 

57 

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.

 

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The magnitude and duration of the resulting decline in business activity cannot currently be estimated with any degree of certainty and has had several effects on our business and results of operations, including, among other things:

 

   

decreased origination volumes on our platform;

 

   

the potential for increased losses for new and existing originations using our AI models resulting from a rapid rise in U.S. unemployment;

 

   

a temporary reduction in the availability of loan funding from institutional investors and the capital markets; and

 

   

restricted sales operations and marketing efforts, and a reduction in the effectiveness of such efforts in some cases.

The COVID-19 pandemic may lead to a continued economic downturn, which is expected to decrease technology spending generally and could adversely affect demand for our platforms and services, in addition to prolonging the foregoing challenges in our business.

In response to the impact of the COVID-19 pandemic, we have undertaken a number of initiatives to support borrowers on our platform who have suffered income loss or other hardships as a result of the pandemic. We worked with our bank partners to offer revised hardship and temporary relief plans to support borrowers impacted by the COVID-19 pandemic and adjust credit and underwriting processes and standards. While these changes to our hardship and temporary relief plans were designed to help borrowers impacted by the COVID-19 pandemic, the changes were implemented quickly and may not have had all the intended effects or desired impact. We continue to actively monitor the situation, assess possible implications to our business and take appropriate actions in an effort to mitigate the adverse consequences of the COVID-19 pandemic. However, there can be no assurances that the initiatives we take will be sufficient or successful.

We have also taken precautionary measures intended to reduce the risk of the virus spreading to our employees, partner banks, vendors, and the communities in which we operate, including temporarily closing our offices and virtualizing, postponing, or canceling partner bank, employee, or industry events, which may negatively impact our business. Furthermore, as a result of the COVID-19 pandemic, we have required all employees who are able to do so to work remotely through the end of the first quarter of 2021. It is possible that widespread remote work arrangements may have a negative impact on our operations, the execution of our business plans, the productivity and availability of key personnel and other employees necessary to conduct our business, and on third-party service providers who perform critical services for us, or otherwise cause operational failures due to changes in our normal business practices necessitated by the outbreak and related governmental actions. If a natural disaster, power outage, connectivity issue, or other event occurred that impacted our employees’ ability to work remotely, it may be difficult or, in certain cases, impossible, for us to continue our business for a substantial period of time. The increase in remote working may also result in increased consumer privacy, data security, and fraud risks, and our understanding of applicable legal and regulatory requirements, as well as the latest guidance from regulatory authorities in connection with the COVID-19 pandemic, may be subject to legal or regulatory challenge, particularly as regulatory guidance evolves in response to future developments.

Further, in response to the market conditions caused by the COVID-19 pandemic, we made certain operational changes, including increases to the fees we charge our bank partners and reductions in our sales and marketing activities and certain operational expenses. We continue to evaluate market and other conditions and may make additional changes to our fees or marketing activities, or implement additional operational changes, in the future.

 

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The extent to which the COVID-19 pandemic continues to impact our business and results of operations will also depend on future developments that are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the disease, the duration and spread of the outbreak, the scope of travel restrictions imposed in geographic areas in which we operate, mandatory or voluntary business closures, the impact on businesses and financial and capital markets, and the extent and effectiveness of actions taken throughout the world to contain the virus or treat its impact. An extended period of economic disruption as a result of the COVID-19 pandemic could have a material negative impact on our business, results of operations, and financial condition, though the full extent and duration is uncertain. To the extent the COVID-19 pandemic continues to adversely affect our business and financial results, it is likely to also have the effect of heightening many of the other risks described in this “Risk Factors” section.

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%. The Number of Loans Transacted on our platform increased from 136,468 to 176,983 in the nine months ended September 30, 2019 and 2020, respectively, representing a growth rate of 30%.58 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. From time to time, we rely on temporary independent contractor programs to scale our operations team. Failure to effectively implement and manage such programs could result in misclassification or other employment related claims or inquiries by governmental agencies. 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. For the nine months ended September 30, 2019 and 2020, we have experienced net losses of $6.5 million and net income of $5.0 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. For example, increases in our common stock price could cause us to incur significant losses related to our liability-classified warrants, which would negatively impact our profitability. 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

 

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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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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, including due to the economic impact of the COVID-19 pandemic;

 

   

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;

 

   

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

 

   

the number and extent of loans facilitated on our platform that are subject to loan modifications and/or temporary assistance due to disasters or emergencies;

 

   

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

 

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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 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 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 any person 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.

 

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For example, an upgrade to our AI models in the fourth quarter of 2018 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 the nine months ended September 30, 2020, approximately 98% 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, Customers Bank, FinWise Bank, First Federal Bank of Kansas City, First National Bank of Omaha, KEMBA Financial Credit Union, TCF Bank, Apple Bank for Savings and Ridgewood Savings 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 nonexclusive, generally have 12-month terms that automatically renew, 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 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 generally increasingly retained loans for their own customer base and balance sheet. In the third quarter of 2020, approximately 22% of Upstart-powered loans were retained by the originating bank, while about 76% of Upstart-powered loans were purchased by institutional investors through our loan funding programs. The percentage of Upstart-powered loans retained by the originating banks has fluctuated from quarter-to-quarter, but generally increased over 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 by the originating bank generally carry lower interest

 

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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 and one other bank partner account 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 the year ended December 31, 2019 and the nine months ended September 30, 2020, CRB originated approximately 89% and 72%, respectively, of the loans facilitated on our platform. CRB also accounts for a large portion of our revenues. In the year ended December 31, 2019 and the nine months ended September 30, 2020, fees received from CRB accounted for 81% and 65%, respectively, 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 or one of our other bank partners 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.

In the nine months ended September 30, 2020, one of our other bank partners originated approximately 19% of the loans facilitated on our platform. In the nine months ended September 30, 2020, the fees received from this bank partner accounted for 15% of our total 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 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 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.

 

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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 our 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, in response to the COVID-19 pandemic, bank partners tightened their credit requirements or paused originations, and investors in our loan funding programs temporarily suspended making investments in Upstart-powered loans, which resulted in a decrease in the Number of Loans Transacted by 71% and a decrease in our revenue of 47%, each, in the second quarter of 2020 compared to the same period of the prior year. Furthermore, 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 of these circumstances, bank partners, investors and borrowers may be discouraged 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, such as the disruption and uncertainty caused by the COVID-19 pandemic. 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.

For example, the COVID-19 pandemic and other related adverse economic events led to a significant increase in unemployment, comparable, and at times surpassing, the unemployment rates during the peak of the financial crisis in 2008. There can be no assurance that levels of unemployment or underemployment will improve in the near term. The increase in the unemployment rate could increase the delinquency rate of borrowers of Upstart-powered loans or increase the rate of borrowers declaring bankruptcy, any of which could adversely affect the attractiveness of Upstart-powered loans to the investors in our loan funding programs. If we are unable to improve our AI platform to account for events like the COVID-19 pandemic and the resulting rise in unemployment, or if our AI platform is unable to more successfully predict the creditworthiness of potential borrowers compared to other lenders, then our business, financial condition and results of operations could be adversely affected.

Furthermore, the COVID-19 pandemic has caused some borrowers on our platform to request a temporary extension or modification of the payment schedules of their loans under the temporary relief

 

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or loan modification programs, or hardship programs, offered by our bank partners and investors in our loan funding programs. If a large number of borrowers seek to participate in such hardship programs, the investment returns of our bank partners and investors in our loan funding programs could decline. Further, if the rate of borrowers that participate in such hardship programs is greater than those experienced by our competitors, then our bank partners and the investors in our loan funding programs may become less interested in purchasing or investing in Upstart-powered loans, which could negatively impact our diversified loan funding strategy or significantly increase the cost of obtaining loan funding. Any of the foregoing could 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, or if we are unable to address and mitigate the risks associated with any of the foregoing, our business, financial condition and results of operations could be adversely affected.

Our AI models have not yet been extensively tested during 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. While our AI models have been refined and updated to account for the COVID-19 pandemic, the bulk of the data gathered and the development of our AI models have largely occurred during a period of sustained economic growth, and our AI models have not been extensively tested during a down-cycle economy or recession and have not been tested at all during a down-cycle economy or recession without significant levels of government assistance. There is no assurance that our AI models can continue to 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.

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.

Since we launched our AI lending platform, we have been proactively working with the federal government and regulatory bodies to ensure that our AI lending platform and other services are in compliance with applicable laws and regulations. For example, after significant collaboration with the Consumer Financial Protection Bureau, or CFPB, the CFPB issued Upstart the first no-action letter in 2017 and, upon its expiration, we received a second no-action letter regarding the use of our Al model to underwrite and price unsecured closed-end loans. The current no-action letter expires on

 

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November 30, 2023, unless terminated by the CFPB earlier for one of the bases provided for by the no-action letter, and we can provide no assurance that the CFPB will continue to permit us to operate under its current no-action letter policies beyond that date, or will not change its position regarding supervisory or enforcement action against us in the future. Further, this no-action letter does not extend to other credit products offered on Upstart’s platform. 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 five members of the U.S. Senate asking questions in connection with claims of discriminatory lending made by an advocacy group. We responded to this inquiry, and in July 2020, three of the Senators issued their findings from this inquiry, writing a letter to the Director of the CFPB recommending the CFPB further review Upstart’s use of educational variables in its model and requesting that the CFPB stop issuing no-action letters related to the Equal Credit Opportunity Act, or ECOA. We have been subject to other governmental inquiries on this topic including an inquiry in June 2020 from the North Carolina Department of Justice. See the section titled “—We have been in the past and may in the future be subject to federal and state regulatory inquiries regarding our business” for more information. 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.

Substantially all of our revenue is derived from a single loan product, and we are thus particularly susceptible to fluctuations in the unsecured personal loan market. We also do not currently offer a broad suite of products that bank partners may find desirable.

While we recently expanded the type of loan products offered on our platform to include auto loans, the vast majority of loan originations facilitated through our platform are 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

 

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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.

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. For example, the economic downcycle resulting from the COVID-19 pandemic may cause borrowers to incur additional debt. 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 recently began offering auto loans and a credit decision application programming interface to allow our bank partners to utilize our AI underwriting models to support their loan origination process for personal, auto, and student loans. We are continuing to invest in developing new loan products and service offerings, such as credit cards, mortgages, student loans, point-of-sale loans and HELOCs. 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 accurately 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

 

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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.

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,

 

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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.

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 five members of the U.S. Senate asking questions in connection with claims of discriminatory lending made by an advocacy group. We responded to this inquiry, and in July 2020, three of the Senators issued their findings from this inquiry, writing a letter to the Director of the CFPB recommending the CFPB further review Upstart’s use of educational variables in its model and requesting that the CFPB stop issuing no-action letters related to ECOA. On December 1, 2020, in connection with these inquiries, we entered into an agreement with the NAACP Legal Defense and Education Fund, or LDF, and the Student Borrower Protection Center, or SBPC, in which we agree to participate in fair lending reviews of our AI model, including, but not limited to, its use of educational variables. The agreement provides for our engagement of a neutral third-party firm to perform periodic fair lending assessments over a two year period. Under the agreement, we have agreed to cooperate with, and provide data to, the third-party firm to conduct fair lending testing of our underwriting model, and we, the LDF and the SBPC will provide input to the third-party firm on, among other things, the testing methodologies to be employed. The fair lending testing will be designed to assess lending outcomes from our underwriting model to determine if the model causes or results in a disparate impact on any protected class, and if so, whether there are less discriminatory alternative practices that maintain the model’s predictiveness. We have also agreed to implement the auditor’s recommendations, for modifications to our AI model that may promote more equitable outcomes while maintaining the model’s predictiveness and meet any other legitimate business needs of Upstart. The third-party firm will also prepare and make public periodic reports that summarize any general findings, recommendations and best practices, as well as any aspects of our AI model that raise particular fair lending concerns or implicate novel insights on educational equity that serve the public interest. While we will have input on these reports, and the agreement provides that the third-party firm and the parties to the agreement will collaborate to reach agreement on any recommendations, we could become involved in disagreements with the third-party firm, the LDF or the SBPC regarding the contents of the reports or particular recommendations that may be made, the manner in which they should be implemented, if at all, and whether they would maintain the predictiveness of our AI model. It is possible, however, that changes implemented in our AI model could negatively impact its predictiveness. In addition, if we are not able to reach agreement in a timely manner, or at all, with the third-party firm to perform the audit, or we do not implement any recommendation, the LDF and/or the SBPC could terminate the agreement with us. Although we believe that this agreement will support our objective of providing visibility into AI and related emerging technologies and the potential benefits such technologies can have for the consumer lending industry, if reports under the agreement were to raise significant fair lending concerns, or the third-party firm

 

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terminates its agreement with us and/or the agreement with the LDF and/or the SBPC is terminated for any reason, our brand and reputation and the overall market acceptance of, and trust in, our AI lending platform could suffer, and we could be subject to increased regulatory and litigation risk. In addition, the publication of information arising from our agreement with the LDF or the SBPC could lead to additional regulatory scrutiny for our bank partners.

We have been subject to other governmental inquiries on this topic including an inquiry in June 2020 from the North Carolina Department of Justice. See the section titled “—We have been in the past and may in the future be subject to federal and state regulatory inquiries regarding our business” for more information. 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 capital, interest rates and fees (and other financing terms) available to consumers from our bank

 

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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 expenditures 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.

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

 

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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 one of 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. Further, as a result of the COVID-19 pandemic, a large and increasing number of companies have adopted permanent work-from-home policies, which further increases the challenges associated with hiring and retaining qualified personnel. We may not be able to hire or retain such personnel at compensation or flexibility levels consistent with our existing compensation and salary structure and policies. 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, 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

 

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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. Further, our shift to a remote working environment due to the COVID-19 pandemic could increase the risk of a security breach. Significant disruptions of our, our bank partners and third-party vendors’ and/or other 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 our bank partners or other 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 our bank partners and other third parties to lose trust in us or we could be subject to claims by our bank partners and other 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.

The vast majority of 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

 

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delinquencies and charge-offs on the loans, which could decrease fees payable to us, cause our bank partners to 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.

While auto loans issued through our new auto lending platform will be secured by collateral, auto loans are inherently risky, as they are often secured by assets that may be difficult to locate and can depreciate rapidly. We generally begin the repossession process for auto loans that become 90 days past due. As our volume of auto loans increases, we plan to engage a third-party auto repossession vendor to handle all repossession activity. Following a repossession, if a borrower fails to redeem their vehicle or reinstate their loan agreement, the repossessed vehicle is sold at an auction and the proceeds are applied to the unpaid balance of the loan and related expenses. If the proceeds do not cover the unpaid balance of the loan and any related expenses, the deficiency would be charged-off. Further, if a vehicle cannot be located, repossession and sale of the vehicle would not be possible, which could also lead to delinquencies and charge-offs. A significant number of delinquencies and charge-offs could decrease fees payable to us, cause our bank partners to decrease the volume of Upstart-powered auto loans kept on their balance sheets, erode trust in our platform and increase the costs of our loan funding programs.

Additionally, if such repossession vendors do not perform consistent with agreements entered into with us, or if vendors act unprofessionally or 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. We may also become subject to regulatory scrutiny and potential litigation based on the conduct of our repossession vendors.

In addition, loan servicing is a highly manual process and an intensely regulated activity. Errors in our servicing activities, or failures to comply with our servicing obligations, could affect our internal and external reporting of the loans that we service, adversely affect our business and reputation and expose us to liability to borrowers, bank partners or investors in our loan funding programs. In addition, the laws and regulations governing these activities are subject to change. For example, during the COVID-19 pandemic certain states prohibited or restricted collection activities. 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 three collection agencies 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.

 

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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, 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.

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. These claims, lawsuits, and proceedings could involve labor and employment, discrimination and harassment, commercial disputes, intellectual property rights (including patent, trademark, copyright, trade secret, and other proprietary rights), class actions, general contract, tort, defamation, data privacy rights, antitrust,

 

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common law fraud, government regulation, or compliance, alleged federal and state securities and “blue sky” law violations or other investor claims, and other matters. 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 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. In addition, the recent inquiries related to our model’s use of education variables in assessing credit risk could prompt potential litigation and government enforcement claims based on perceived violations of ECOA. See—“We have been in the past and may in the future be subject to federal and state regulatory inquiries regarding our business” 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.

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 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;

 

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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.

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, epidemics, pandemics, cyber-attacks, computer viruses, internal or external system failures, telecommunications failures, power outages or increased risk of cybersecurity breaches due to a swift transition to remote work brought about by a catastrophic event, could have an adverse effect on our business, results of operations and financial condition. For example, the outbreak of the COVID-19 pandemic beginning 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. In addition, it is possible that continued widespread remote work arrangements may have a negative impact on our operations, the execution of our business plans, the productivity and availability of key personnel and other

 

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employees necessary to conduct our business, or otherwise cause operational failures due to changes in our normal business practices necessitated by the outbreak and related governmental actions. There is no guarantee that we will be as effective while working remotely because our team is dispersed, employees may have less capacity to work due to increased personal obligations (such as childcare, eldercare, or caring for family members who become sick), may become sick themselves and be unable to work, or may be otherwise negatively affected, mentally or physically, by the COVID-19 pandemic and prolonged social distancing. Additionally, remote work arrangements may make it more difficult to scale our operations efficiently, as the recruitment, onboarding and training of new employees may be prolonged or delayed. If a natural disaster, power outage, connectivity issue, or other event occurred that impacted our employees’ ability to work remotely, it may be difficult or, in certain cases, impossible, for us to continue our business for a substantial period of time. The increase in remote working may also result in privacy, data protection, data security, and fraud risks. Further, one of our headquarters is located in the San Francisco Bay Area, a region known for seismic activity and wildfires, and our other headquarters 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 civil, political and 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

 

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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.

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 Nasdaq Global Select Market. 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 and 2020, 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 this time have been fully implemented and such enhancements to our internal controls are operating effectively. Due to our remediation efforts in 2019, we have concluded 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

 

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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 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 Nasdaq Global Select Market. 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

 

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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 INTELLECTUAL PROPERTY AND PLATFORM DEVELOPMENT

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, contractual provisions and our information security infrastructure 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.

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.

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

 

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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 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, incorrectly displayed interest rates to applicants or borrowers, or incorrectly charged interest to borrowers or fees to bank partners or institutional investors, 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.

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.

 

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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.

 

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RISKS RELATED TO OUR DEPENDENCE ON THIRD PARTIES

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, or if loan aggregators begin offering competing products, 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 and the nine months ended September 30, 2020, 38% and 52%, respectively, of loan originations were derived from traffic from Credit Karma. Our most recent agreement with Credit Karma dated November 6, 2020 provides that 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. In this regard, Credit Karma recently began directing more customer traffic to a program that hosts and aggregates the credit models of other loan providers directly on its platform for the purpose of giving credit offers. To date, Upstart has opted not to participate in this program. In November 2020, we experienced a reduction in the number of loan applicants directed to the Upstart platform by Credit Karma and a corresponding decrease in the number of loans originated on our platform, and we may experience additional reductions in traffic from Credit Karma in the future. If traffic from Credit Karma continues to decrease in the future as a result of this program or for other reasons, our loan originations and results of operations would be adversely affected. 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 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

 

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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.

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, data received from credit bureaus, 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 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.

 

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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.

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.

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

 

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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.

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

 

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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 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. For example, the Colorado Administrator of the Colorado Uniform Consumer Credit Code, or the UCCC, reached a settlement with respect to 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 included, 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. Under the settlement, these banks and nonbank partners committed to, among other things, limit the annual percentage rates, or APR, on loans to Colorado consumers to 36% and take other actions to ensure that the banks were in fact the true lenders. The nonbanks also agreed to obtain and maintain a Colorado lending license. In Colorado, this settlement should provide a helpful model for what constitutes an acceptable bank partnership model. However, the settlement may also invite other states to initiate their own actions, and set their own regulatory standards through enforcement.

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-JJM (W.D.N.Y. June 6, 2019)) and Cohen, et al. v. Capital One Funding, LLC et al., (No. 19-03479 (E.D.N.Y. June 12, 2019)). In Petersen, the plaintiffs sought class action status 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 sought 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. Cohen was a materially similar claim against a separate

 

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national bank. 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). On September 21, 2020, the District Court accepted the magistrate’s recommendation and dismissed all claims. The District Court found that the usury claims were expressly preempted by the National Bank Act and referenced the OCC’s recent rulemaking (discussed further below) that “[i]nterest on a loan that is permissible under [the National Bank Act] shall not be affected by the sale, assignment, or other transfer of the loan.” Among other things, the Court deferred to the “OCC’s reasoned judgment that enforcing New York’s usury laws against the Chase defendants would significantly interfere with [the bank’s] exercise of its [National Bank Act] powers.” The Cohen case was dismissed on September 29, 2020 and plaintiffs in both Cohen and Petersen have filed appeals to the second circuit.

As noted above, federal prudential regulators have also taken actions to address the Madden decision. On May 29, 2020, the OCC issued a final rule clarifying that, when a national bank or savings association sells, assigns, or otherwise transfers a loan, interest permissible before the transfer continues to be permissible after the transfer. That rule took effect on August 3, 2020. As discussed further below, the OCC also has issued a rule pertaining to the “true lender” issue. Similarly, the FDIC finalized on June 25, 2020 its 2019 proposal declaring that the interest rate for a loan is determined when the loan is made, and will not be affected by subsequent events. On July 29, 2020, California, New York and Illinois filed suit in the U.S. District Court for the Northern District of California to enjoin enforcement of the OCC rule (Case No. 20-CV-5200) and, similarly in the same court, on August 20, 2020 California, Illinois, Massachusetts, Minnesota, New Jersey, New York, North Carolina, and the District of Columbia sought to enjoin enforcement of the FDIC rule (Case No. 20-CV-5860), in each case related to permissible interest rates post-loan transfer on the grounds that the OCC and FDIC exceeded their authority when promulgating those rules.

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 settlement, 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.

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.

 

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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. As noted above, the Colorado Administrator has entered into a settlement agreement with certain banks and nonbanks that addresses this true lender issue. Specifically, the settlement agreement sets forth a safe harbor indicating that a bank is the true lender if certain specific terms and conditions are met. However, other states could also bring lawsuits based on these types of relationships. For example, on June 5, 2020, the Washington, DC Attorney General filed a lawsuit against online lender Elevate for allegedly deceptively marketing high-cost loans with interest rates above the Washington, DC usury cap. The usury claim is based on an allegation that Elevate, which was not licensed in Washington, DC, and not its partner bank, originated these loans, and were therefore in violation of the state’s usury laws.

We note that the OCC issued on October 27, 2020, a final rule to address the “true lender” issue for lending transactions involving a national bank. For certain purposes related to federal banking law, including the ability of a national bank to “export” interest-related requirements from the state from which they lend, the rule would treat a national bank as the “true lender” if it is named as the lender in the loan agreement or funds the loan. It remains possible that the rule could be challenged by state regulators or private parties, or rescinded or otherwise limited by a future administration. In addition, the OCC rule does not apply to state-chartered banks and there can be no assurance that the FDIC will issue a similar rule applicable to state-chartered banks.

We, bank partners, securitization vehicles and similarly situated parties could become subject to challenges like that presented by the Colorado settlement 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). However, we are also taking steps to confirm that our business model conforms with the requirements of the Colorado safe harbor.

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.

 

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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).

 

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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 a class action lawsuit 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;

 

   

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

 

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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, California has enacted legislation to create a “mini-CFPB,” which could increase its oversight over bank partnership relationships and 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 and may not always be allowed under state law.

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 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

 

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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.

For auto loans issued under our new auto lending platform, certain state laws may not allow for electronic lien and title transfer, which would require us to use a paper-based title process to secure title to the underlying collateral. While this process may help mitigate some of the risks associated with online processes, because it is outside of our usual practices and titling rules can vary by state, we may encounter greater difficulty complying with the proper procedures. If we fail to effectively follow such procedures we may, among other things, be limited in our ability to secure the collateral associated with loans issued under our auto lending platform.

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. States also maintain licensing requirements pertaining to the transmission of money, and certain states may broadly interpret such licensing requirements to cover loan servicing and the transmission of funds to investors. 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, 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

 

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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 strategies and priorities, including in both its examination and enforcement processes, will impact our business and our results of operations going forward. Our current no-action letter expires on November 30, 2023, unless terminated by the CFPB earlier for one of the bases provided for by the no-action letter, and there is no assurance that the CFPB will permit us to continue to operate under its current no-action letter policies or that it will not change its position regarding supervisory or enforcement action against us in the future. Further, this no-action letter does not extend to other credit products offered on Upstart’s platform. In addition, evolving views regarding the use of alternative variables and machine learning in assessing credit risk could result in the CFPB taking actions that result in requirements to alter or cease offering affected financial products and services, making them less attractive and restricting our ability to offer them. For example, in response to a February 2020 inquiry, three members of the U.S. Senate recommended as part of their findings, that the CFPB further review Upstart’s use of educational variables in its model. The CFPB could also implement rules that restrict our effectiveness in servicing our financial products and services.

Although we have committed resources to enhancing our compliance programs, future actions by the CFPB (or other regulators) against us, our bank partners or our competitors could discourage the use of our services or those of our bank partners, which could result in reputational harm, a loss of bank partners, borrowers or investors in our loan funding programs, or discourage the use of our or their services 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. This is particularly true with respect to the application of ECOA and Regulation B to credit risk models that rely upon alternative variables and machine learning, an area of law where regulatory guidance is currently uncertain and still evolving, and for which there are not well-established regulatory norms for establishing compliance. 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, or another regulator, were to issue a consent decree or other similar order against us, this could also directly or indirectly affect our results of operations.

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

 

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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 ECOA as it pertains to the use of our AI model to underwrite applicants for unsecured non-revolving credit. Under the terms of the 2020 no-action letter, we are required to continue to share certain information with the CFPB regarding the updates to our model and the variables it considers, loan performance reports, the results of fair lending tests we conduct, and research we conduct to identify less discriminatory alternatives, as well as information on how our AI models expand access to credit for traditionally underserved populations. We must also update the CFPB of material changes to information included in our no-action letter application or if our products or services are not performing as expected in a material way. Such no-action letter expires on November 30, 2023, unless terminated by the CFPB earlier for one of the bases provided for by the no-action letter. We can provide no assurance that the CFPB will continue to provide such relief, and it is possible the CFPB will change its position regarding supervisory or enforcement action against us in the future. Further, this no-action letter does not extend to other credit products offered on Upstart’s platform. Moreover, were we determined to be conducting business contrary to the facts presented to, and relied 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 an inquiry from the North Carolina Department of Justice regarding our role in facilitating the origination of loans for educational purposes. We are providing information in response to that inquiry, and cannot provide any assurances regarding the outcome of that inquiry.

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.

 

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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 the California Attorney General approved final regulations on August 14, 2020. Although the regulations will bring some clarity regarding compliance with the CCPA, 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. In addition, California voters approved Proposition 24 in the November 2020 election to create the California Privacy Rights Act, which amends and purports to strengthen the CCPA and will create a state agency to enforce privacy laws. 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 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. In general, an “investment company” is a company that holds itself out as an investment company or holds more than 40% of the total value of its assets (minus cash and government securities) in “investment securities.” We believe we are not an investment company. We do not hold ourselves out as an investment company. We understand, however, that the loans held on our balance sheet could be viewed by the SEC or its staff as “securities,” which could in turn cause the SEC or its staff to view Upstart Holdings, Inc., Upstart Network, Inc., or an affiliate as an “investment company” subject to regulation under the Investment Company Act. To provide clarity on this issue, we applied for and, on December 1, 2020,

 

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received an exemptive order from the SEC exempting us from regulation under the Investment Company Act, subject to certain conditions. Notwithstanding the exemptive order, we believe that we have never been an investment company because, among other reasons, we are primarily engaged in the business of providing an AI-based lending platform to banks.

Exemptive orders provided by the SEC under the Investment Company Act may cease to be effective if the facts and analysis upon which they are based materially change or the recipient of the order fails to comply with conditions outlined in the order. Although not currently anticipated, 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, either because the facts of how we conduct our business change or because we no longer meet the conditions outlined in the order. If the exemptive order ceases to apply to our business, we could be deemed an investment company and may be required to institute burdensome compliance requirements, restricting our activities in a way that could 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 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.

 

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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 have relied on 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.

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.

 

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Anti-money laundering, anti-terrorism financing, anti-corruption 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. We are also subject to anti-corruption and anti-bribery and similar laws, such as the U.S. Foreign Corrupt Practices Act of 1977, as amended, or the FCPA, the U.S. domestic bribery statute contained in 18 U.S.C. § 201, and the U.S. Travel Act, which prohibit companies and their employees and agents from promising, authorizing, making, or offering improper payments or other benefits to government officials and others in the private sector in order to influence official action, direct business to any person, gain any improper advantage, or obtain or retain business. We have implemented an anti-corruption policy to ensure compliance with these anti-corruption and anti-bribery laws. 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 and anti-corruption 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 credit facilities, 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 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 warehouse trust SPEs, which loan sales are partially financed with associated warehouse credit facilities from banks. Concurrently, each securitization SPE issues notes or certificates pursuant to the terms of indentures and trust agreements, or in the case of the warehouse facilities, the warehouse trust SPE 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 a certain proportion of the 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 periods of financial disruption, such as the financial crisis that began in 2008 and the COVID-19 pandemic that began in early 2020, the securitization market has constrained, and this could continue or occur again in the future. In addition, other matters, such as (i) accounting standards

 

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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, the Investment Company Act and the so-called “Volcker Rule,” may affect the type of securitizations that we are able to complete.

If it is not possible or economical for us to securitize loans in the future, 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 that of 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 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 practices related to 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 losses that result from economic downturns, may also reduce the price we receive on future loan sales.

 

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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 regulation under federal law, and banks and other regulated financial institutions acquiring and holding asset-based securities, including asset-backed securities sponsored by us, are subject to capital and leverage requirements. 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 five 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 “investment companies” if they wish to continue selling to banking entities. 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.

 

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RISKS RELATED TO LOAN FUNDING AND INDEBTEDNESS

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 third quarter of 2020, approximately 22% of Upstart-powered loans were retained by the originating bank while approximately 76% 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. For example, at the start of the COVID-19 pandemic, the availability of most of our loan funding sources was significantly reduced. In the event of another 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.

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 September 30, 2020, the number of repurchased Upstart-powered loans as a result of inaccurate representations and warranties represents less than 0.30% of all Upstart-powered loans. While only a small number of Upstart-powered loans have been historically repurchased by us, 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.

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 or co-sponsored by us are

 

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currently rated by a limited number of 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.

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 September 30, 2020, we had $21.0 million outstanding principal under the term loans and revolving credit facilities. These 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. We have in the past, and may in the future, fail to comply with certain operating or financial covenants in our credit agreements, requiring a waiver from our lenders. 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, through 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 through 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. As of September 30, 2020, outstanding borrowings under these warehouse credit facilities were $70.2 million, and $109.2 million of aggregate fair value of loans purchased were pledged as collateral.59 On November 2, 2020, we repaid all outstanding borrowings under one of our warehouse credit facilities in the amount of $4.0 million and terminated the corresponding warehouse credit facility.

Under our remaining warehouse credit facility, we may borrow up to $100.0 million until May 2021, and any outstanding principal, together with any accrued and unpaid interest, are due and payable by the warehouse trust special purpose entity in May 2022. As of September 30, 2020, the amount borrowed under this credit facility was $52.7 million.

 

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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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Our warehouse credit facility imposes operating and financial covenants on the warehouse trust special purpose entity, and under certain events of default, the lender could require that all outstanding borrowings become immediately due and payable or terminate their agreement with us. We have in the past, and may in the future, fail to comply with certain operating or financial covenants in our warehouse credit facility, requiring a waiver from our lenders. 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.

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.

 

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RISKS RELATED TO TAXES

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.

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

 

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approximately $61.3 million and $53.0 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.

 

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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 have been approved to list our common stock on the Nasdaq Global Select Market 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, the selling stockholders 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;

 

   

other events or factors, including those resulting from war, incidents of terrorism, political unrest, natural disasters, pandemics or responses to these events; 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 63,460,881 shares of our common stock (after giving effect to the Capital Stock Conversion, the exercise of a preferred stock warrant in November 2020 and the exercise of options to purchase common stock by certain selling stockholders in connection with the sale by such selling stockholders in this offering) outstanding as of September 30, 2020, we will have 72,460,881 shares of our common stock outstanding immediately

 

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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 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:

 

   

beginning on the date of this prospectus, all 12,015,690 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), all remaining shares of our common stock will be eligible for sale in the public market from time to time thereafter, subject in some cases to the volume and other restrictions of Rule 144, as described below.

Upon completion of this offering, stockholders owning an aggregate of up to 47,949,785 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 627,539,119 shares of common stock authorized but unissued, and our amended and restated

 

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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 5,520,000 shares 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 $3.73 per share as of September 30, 2020. 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 $17.27 per share, based on an assumed initial public offering price of $21.00 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 September 30, 2020, options to purchase 18,889,653 shares of our common stock were outstanding with a weighted-average exercise price of $3.17 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

 

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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;

 

   

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, unless we consent in writing to the selection of an alternative forum, to the fullest extent permitted by law, the sole and exclusive forum for (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.

Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all such Securities Act actions. Accordingly, both state and federal courts have jurisdiction to entertain such claims. To prevent having to litigate claims in multiple jurisdictions and the threat of inconsistent or contrary rulings by different courts, among other considerations, our amended and restated bylaws also provide that the federal district courts of the United States of America will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act. We note, however, that investors cannot waive compliance with the federal securities laws and the rules and regulations thereunder, and that there is uncertainty as to whether a court would enforce this exclusive forum provision. Further, the enforceability of similar choice of forum provisions in other companies’ charter documents has been challenged in legal proceedings, and it is possible that a court could find

 

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these types of provisions to be inapplicable or unenforceable. For example, in December 2018, the Court of Chancery of the State of Delaware determined that a provision stating that U.S. federal district courts are the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act is not enforceable. Although this decision was reversed by the Delaware Supreme Court in March 2020, other courts may still find these provisions to be inapplicable or unenforceable.

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. This exclusive forum provision will not apply to any causes of action arising under the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. If a court were to find either 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 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.

 

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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 Nasdaq Global Select Market 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.

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;

 

   

the impact of the COVID-19 pandemic and any associated economic downturn on our business and results of operations;

 

   

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, including our ongoing discussions with the CFPB;

 

   

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, such as our recent introduction of auto loans;

 

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

 

   

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, as modified on September 11, 2020.

 

   

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.

 

   

Matt Komos, TransUnion: Consumer Credit Origination, Balance and Delinquency Trends: Q2 2020, September 2020.

 

   

Matt Komos, TransUnion: Consumer Credit Origination, Balance and Delinquency Trends: Q1 2020, June 2020.

 

   

Matt Komos, TransUnion: Consumer Credit Origination, Balance and Delinquency Trends: Q4 2019, March 2020.

 

   

Matt Komos, TransUnion: Consumer Credit Origination, Balance and Delinquency Trends: Q3 2019, November 2019.

 

   

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

 

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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.

 

   

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.

 

   

Statista: Value of Loans of all Commercial Banks in the United States from March 2014 to August 2020, September 2020.

 

   

Wei Wu, Vadim Verkhoglyad and Alex Kale, dv01 Insights: Covid-19 Performance Report Volume 9, July 2020.

References to market size estimates are based on quarterly U.S. loan origination data published by TransUnion as part of its quarterly Consumer Credit Origination, Balance and Delinquency Trends reports.

As disclosed in this prospectus, the Net Promoter Scores for our bank partners’ lending programs are approximately 79, which represents the weighted average of the Net Promoter Scores of each of our bank partners in the third quarter of 2020. 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 third quarter of 2020. 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 $166.9 million, based upon the assumed initial public offering price of $21.00 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. We will not receive any proceeds from the sale of common stock by the selling stockholders in this offering.

Each $1.00 increase or decrease in the assumed initial public offering price of $21.00 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 $8.4 million, 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 $19.5 million, 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 September 30, 2020 as follows:

 

   

on an actual basis;

 

   

on a pro forma basis, giving effect to (i) the exercise in November 2020 of a warrant to purchase 600,208 shares of our Series B preferred stock resulting in the reclassification of our convertible preferred stock warrant liability to additional paid-in capital, (ii) the Capital Stock Conversion, as if such conversions had occurred on September 30, 2020 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 (i) the pro forma adjustments set forth above, (ii) the sale and issuance by us of 9,000,000 shares of our common stock in this offering, based upon the assumed initial public offering price of $21.00 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, and (iii) the issuance of 466,389 shares of common stock upon the exercise of options held by certain selling stockholders in connection with the sale of such shares by such selling stockholders in this offering.

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 September 30, 2020  
(In thousands, except share and per share amounts)    Actual     Pro
forma
    Pro
forma as
adjusted (1)(2)
 

Cash

   $ 53,234     $ 53,240     $ 224,608  
  

 

 

   

 

 

   

 

 

 

Convertible preferred stock warrant liability

   $ 7,458     $ —       $ —    

Total borrowings

     100,588       100,588       100,588  

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       —         —    

Stockholders’ (deficit) equity:

      

Preferred stock, par value $0.0001 per share: no shares authorized, issued and outstanding, actual; 70,000,000 shares authorized, no shares issued and outstanding, pro forma and pro forma as adjusted

      

Common stock, par value $0.0001 per share: 90,000,000 shares authorized, 15,044,707 shares issued and outstanding, actual; 700,000,000 shares authorized, 62,994,492 shares issued and outstanding, pro forma; and 700,000,000 shares authorized, 72,460,881 shares issued and outstanding, pro forma as adjusted

     2       6       7  

Additional paid-in capital

     22,914       192,919       364,286  

Accumulated deficit

     (70,249     (70,249     (75,134

Noncontrolling interests

     —         —         —    
  

 

 

   

 

 

   

 

 

 

Total stockholders’ (deficit) equity

     (47,333     122,676       289,159  
  

 

 

   

 

 

   

 

 

 

Total capitalization

   $ 223,259     $ 223,264     $ 389,747  
  

 

 

   

 

 

   

 

 

 

 

(1)

Each $1.00 increase or decrease in the assumed initial public offering price of $21.00 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

 

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  of our pro forma as adjusted cash, additional paid-in capital, total stockholders’ equity, and total capitalization by $8.4 million, 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 $19.5 million, assuming the assumed initial public offering price remains the same, and after deducting estimated underwriting discounts and commissions payable by us.

 

(2)

Pro forma as adjusted cash excludes $4.2 million of deferred offering costs that had been paid as of September 30, 2020.

The pro forma column in the table above is based on 62,994,492 shares of our common stock (including shares of preferred stock issued in November 2020 upon the exercise of a warrant to purchase Series B preferred stock and the Capital Stock Conversion) outstanding as of September 30, 2020. The pro forma as adjusted column in the table above is based on 63,460,881 shares of our common stock (including shares of preferred stock issued in November 2020 upon the exercise of a warrant to purchase Series B preferred stock, the Capital Stock Conversion, and the exercise of options to purchase common stock by certain selling stockholders in connection with the sale by such selling stockholders in this offering) outstanding as of September 30, 2020. The pro forma and pro forma as adjusted columns exclude the following:

 

   

18,889,653 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock outstanding as of September 30, 2020, with a weighted-average exercise price of $3.17 per share;

 

   

319,669 shares of our common stock issuable upon the exercise of warrants outstanding as of September 30, 2020, with a weighted-average exercise price of $1.77 per share;

 

   

1,540,938 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock issued after September 30, 2020, with a weighted-average exercise price of $15.16 per share; and

 

   

10,765,271 shares of our common stock reserved for future issuance under our equity compensation plans, consisting of:

 

   

5,520,000 shares of our common stock reserved for future issuance under our 2020 Plan, which will become effective prior to the completion of this offering;

 

   

3,865,271 shares of our common stock reserved for future issuance under our 2012 Plan, provided that we will cease granting awards under our 2012 Plan upon the effectiveness of the 2020 Plan; and

 

   

1,380,000 shares of our common stock reserved for future issuance under our ESPP, which will become effective prior to the completion of this offering.

Each of our 2020 Plan and our ESPP provides for annual automatic increases in the number of shares reserved thereunder, and our 2020 Plan also provides for increases to the number of shares that may be granted thereunder based on awards 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 September 30, 2020 was $(66.1) million, or $(4.39) per share. Our pro forma net tangible book value as of September 30, 2020 was $103.9 million, or $1.65 per share, based on the total number of shares of our common stock outstanding as of September 30, 2020, after giving effect to (i) the exercise in November 2020 of a warrant to purchase shares of our Series B preferred stock resulting in the reclassification of our convertible preferred stock warrant liability to additional paid-in capital, (ii) the Capital Stock Conversion 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 (i) the sale by us of 9,000,000 shares of our common stock in this offering at the assumed initial public offering price of $21.00 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, and (ii) the issuance of 466,389 shares of common stock upon the exercise of options held by certain selling stockholders in connection with the sale of such shares by such selling stockholders in this offering, our pro forma as adjusted net tangible book value as of September 30, 2020 would have been $270.4 million, or $3.73 per share. This represents an immediate increase in pro forma net tangible book value of $2.08 per share to our existing stockholders and an immediate dilution in pro forma net tangible book value of $17.27 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

     $ 21.00  

Historical net tangible book value (deficit) per share as of September 30, 2020

   $ (4.39  

Increase per share attributable to the pro forma adjustments described above

     6.04    

Pro forma net tangible book value per share as of September 30, 2020, before giving to effect new investors purchasing shares of common stock in this offering

     1.65    

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

     2.08    
  

 

 

   

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

       3.73  
    

 

 

 

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

     $ 17.27  
    

 

 

 

Each $1.00 increase or decrease in the assumed initial public offering price of $21.00 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 $0.12, and would increase or decrease, as applicable, dilution per share to new investors purchasing shares of common stock in this offering by $0.88, 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

 

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adjusted net tangible book value by approximately $0.22 per share and increase or decrease, as applicable, the dilution to new investors purchasing shares of common stock in this offering by $(0.22) 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.

The following table presents, as of September 30, 2020, after giving effect to an exercise in November 2020 of a warrant to purchase shares of our Series B preferred stock, the Capital Stock Conversion and the 466,389 shares of common stock to be issued upon the exercise of options to purchase shares of our common stock by certain selling stockholders in connection with this offering, 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 $21.00 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

     63,460,881        88   $ 163,995,250        46   $ 2.15  

New investors

     9,000,000        12   $ 189,000,000        54   $ 21.00  
  

 

 

    

 

 

   

 

 

    

 

 

   

Totals

     72,460,881        100   $ 352,995,250        100  
     

 

 

      

 

 

   

Sales by the selling stockholders in this offering will reduce the number of shares held by existing stockholders to 60,445,191, or approximately 83% of the total shares of common stock outstanding after this offering, and will increase the number of shares held by new investors to 12,015,690, or approximately 17% of the total shares of common stock outstanding after this offering.

Each $1.00 increase or decrease in the assumed initial public offering price of $21.00 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 $9.0 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 before 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 $21.0 million, assuming the assumed initial public offering price remains the same before 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 certain selling stockholders. If the underwriters’ option to purchase additional shares of our common stock were exercised in full, our existing stockholders would own approximately 81% and our new investors would own approximately 19% 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 63,460,881 shares of our common stock (including the preferred stock issued in November 2020 upon the exercise of a warrant to purchase Series B preferred stock, the Capital Stock Conversion and the

 

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466,389 shares of common stock to be issued upon the exercise of options to purchase shares of our common stock by certain selling stockholders in connection with this offering) outstanding as of September 30, 2020, and excludes:

 

   

18,889,653 shares of our common stock issuable upon the exercise of options to purchase shares of our common stock outstanding as of September 30, 2020, with a weighted-average exercise price of $3.17 per share;

 

   

319,669 shares of our common stock issuable upon the exercise of warrants outstanding as of September 30, 2020, with a weighted-average exercise price of $1.77 per share;

 

   

1,540,938 shares of common stock issuable upon the exercise of options to purchase shares of our common stock issued after September 30, 2020, with a weighted-average exercise price of $15.16 per share; and

 

   

10,765,271 shares of our common stock reserved for future issuance under our equity compensation plans, consisting of:

 

   

5,520,000 shares of our common stock reserved for future issuance under our 2020 Plan, which will become effective prior to the completion of this offering;

 

   

3,865,271 shares of our common stock reserved for future issuance under our 2012 Plan, provided that we will cease granting awards under our 2012 Plan upon the effectiveness of the 2020 Plan; and

 

   

1,380,000 shares of our common stock reserved for future issuance under our ESPP, which will become effective prior to the completion of this offering.

Each of our 2020 Plan and our ESPP provides for annual automatic increases in the number of shares reserved thereunder, and our 2020 Plan also provides 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. The selected consolidated statements of operations data for the nine months ended September 30, 2019 and 2020 and the consolidated balance sheet data as of September 30, 2020 have been derived from our unaudited interim consolidated financial statements included elsewhere in this prospectus. We have prepared the unaudited interim consolidated financial statements on the same basis as the audited consolidated financial statements and have included all adjustments, consisting only of normal recurring adjustments that, in our opinion, are necessary to state fairly the financial information set forth in those statements. 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,     Nine Months Ended
September 30,
 
(In thousands, except share and per share amounts)   2017     2018     2019     2019     2020  

Revenue:

         

Revenue from fees, net

  $ 51,161     $ 88,482     $ 159,847     $ 98,699     $ 144,179  

Interest income and fair value adjustments, net

    6,128       10,831       4,342       2,918       2,527  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    57,289       99,313       164,189       101,617       146,706  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

         

Sales and marketing(1)

    33,838       63,633       93,175       61,236       65,113  

Customer operations(1)

    10,232       15,416       24,947       16,593       24,792  

Engineering and product development(1)

    5,324       8,415       18,777       11,480       24,651  

General, administrative, and other(1)

    15,431       19,820       31,865       20,399       30,778  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    64,825       107,284       168,764       109,708       145,334  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from operations

    (7,536     (7,971     (4,575     (8,091     1,372  

Other income

    330       487       1,036       832       5,497  

Expense on warrants and convertible notes, net

    (1,649     (3,734     (1,407     (2,626     (2,317
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income before income taxes

    (8,855     (11,218     (4,946     (9,885     4,552  

Provision for income taxes

    6       —         74       —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income before attribution to noncontrolling interests

    (8,861     (11,218     (5,020     (9,885     4,552  

Net (loss) income attributable to noncontrolling interests

    (1,144     1,101       (4,554     (3,368     (404
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income attributable to Upstart Holdings, Inc. common stockholders

  $ (7,717   $ (12,319   $ (466   $ (6,517   $ 4,956  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

  $ (0.56   $ (0.87   $ (0.03   $ (0.46   $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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       14,313,262       14,663,623  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net income per share attributable to Upstart Holdings, Inc. common stockholders, basic

      $ 0.06       $ 0.11  
     

 

 

     

 

 

 

Weighted-average number of shares used to compute pro forma net income per share attributable to Upstart Holdings, Inc. common stockholders, basic

        62,249,893         62,613,408  
     

 

 

     

 

 

 

Pro forma net income per share attributable to Upstart Holdings, Inc. common stockholders, diluted(2)

      $ 0.05       $ 0.09  
     

 

 

     

 

 

 

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

        71,497,924         71,733,580  
     

 

 

     

 

 

 

 

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(1)

Includes stock-based compensation expense as follows:

     Year ended December 31,      Nine Months
Ended
September 30,
 
(In thousands)    2017      2018      2019      2019      2020  

Sales and marketing

   $ 32      $ 183      $ 278      $ 157      $ 1,136  

Customer operations

     124        178        433        252        625  

Engineering and product development

     574        753        1,803        932        3,181  

General, administrative, and other

     560        931        1,292        863        2,160  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 1,290      $ 2,045      $ 3,806      $ 2,204      $ 7,102  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(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 income 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,     As of
September 30,

2020
 
(In thousands)    2018     2019  

Cash

   $ 73,038     $ 44,389     $ 53,234  

Loans (at fair value)

     502,666       232,305       122,708  

Notes receivable and residual certificates (at fair value)

     8,314       34,116       22,053  

Total assets

     645,908       393,462       309,804  

Borrowings

     74,983       118,609       100,588  

Payable to securitization note holders and residual certificate holders

     373,068       96,107       —    

Total liabilities

     542,655       292,604       194,591  

Convertible preferred stock

     157,923       162,546       162,546  

Accumulated deficit

     (75,078     (75,205     (70,249

Total Upstart Holdings, Inc. stockholders’ deficit

     (66,671     (62,714     (47,333

Noncontrolling interests

     12,001       1,026       —    

Total stockholders’ deficit

     (54,670     (61,688     (47,333

Total liabilities, convertible preferred stock and stockholders’ deficit

     645,908       393,462     $ 309,804  

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,      Nine Months Ended
September 30,
 
     2017      2018      2019      2019      2020  

Number of Loans Transacted

     70,457        114,125        215,122        136,468        176,983  

Conversion Rate

     8.1%        9.1%        13.1%        12.2%        14.0%  

Percentage of Loans Fully Automated

     34%        53%        66%        64%        69%  

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,      Nine Months Ended
September 30,
 
(In thousands)    2017     2018     2019      2019     2020  

Contribution Profit

   $ 9,265     $ 13,098     $ 48,940      $ 25,560     $ 63,697  

Adjusted EBITDA

   $ (4,679   $ (6,226   $ 5,595      $ (1,363   $ 16,006  

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, and the nine months ended September 30, 2019 and 2020:

 

     Year Ended December 31,     Nine Months Ended
September 30,
 
(In thousands)    2017     2018     2019     2019     2020  

Referral fees, net

   $ 30,921     $ 53,869     $ 90,672     $ 56,117     $ 80,828  

Platform fees, net

     17,146       29,512       53,383       32,932       42,657  

Servicing fees, net

     3,094       5,101       15,792       9,650       20,694  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Revenue from fees, net

     51,161       88,482       159,847       98,699       144,179  

Borrower acquisition costs

     (32,777     (61,658     (89,569     (58,764     (59,464

Borrower verification and servicing costs

     (9,119     (13,726     (21,338     (14,375     (21,018
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total direct expenses

     (41,896     (75,384     (110,907     (73,139     (80,482
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Contribution Profit

   $ 9,265     $ 13,098     $ 48,940     $ 25,560     $ 63,697  

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 over 620,000 personal loans that have generated more than 9 million repayment events. Our key milestones include:

 

 

LOGO

 

*

2020 metrics are as of September 30, 2020

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 an exceptional AI lending platform that they can configure as they originate consumer loans under their own brand, according to their own business and regulatory requirements.

 

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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 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. For loans that are not retained by our bank partners, we help diversify the funding of these loans to a broad base of approximately 100 institutional investors that invest in Upstart-powered loans. In the third quarter of 2020, 22% of the loans funded through our platform were retained by the originating bank (compared to 27% in the third quarter of 2019). 76% of loans were purchased by institutional investors through our loan funding programs in the third quarter of 2020 (compared to 67% in the third quarter of 2019), and the remaining 2% were funded through our balance sheet (compared to 6% in the third quarter of 2019). Over the last few years, the percentage of loans retained by bank partners has fluctuated from quarter-to-quarter, but 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 for the year ended December 31, 2018 to 215,122 over the same period in 2019, and 30% to 176,983 in the nine months ended September 30, 2020 from 136,468 over the same period in 2019. Total revenue increased 65% for the year ended December 31, 2019 to $164.2 million from $99.3 million over the same period in 2018, and 44% to $146.7 million in the nine months ended September 30, 2020 from $101.6 million in the same period of 2019. Net loss decreased from $12.3 million in 2018 to $0.5 million in 2019. During the nine months ended September 30, 2020, net income increased to $5.0 million from net loss of $6.5 million in the same period of 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 98% of our revenue in the nine months ended September 30, 2020. In addition, we earn a small portion of our revenue from interest income and our securitization activities.

 

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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 September 30, 2020.

 

     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

 

Loans on our platform today are predominantly sourced from Upstart.com. For these loans, we incur variable costs in the form of borrower acquisition costs and borrower verification and servicing costs; in the nine months ended September 30, 2020, this category of loans generated a 44% 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. A small number of loans were sourced directly through bank partners in which we received no referral fee and incurred no acquisition cost; in the nine months ended September 30, 2020 this category of loans generated a 67% contribution margin. In 2018, 2019 and the nine months ended September 30, 2020, the average contribution margin per loan of all Upstart-powered loans was 15%, 31% and 44%, respectively. 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 improving loan unit economics over time. We further believe that bank-sourced loans can be an important driver of volume growth in the medium-term future; 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 below table summarizes the contribution economics for loans originated by our bank partners in the nine months ended September 30, 2020, which reflects the COVID-19 impact as described below:

 

 

LOGO

COVID-19 Pandemic Impact

The onset of the COVID-19 pandemic began to impact origination volumes on our platform in the second half of March 2020. A rapid rise in unemployment in the United States led to the potential for

 

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increased losses for new originations by our AI models, reduction in originations by bank partners, and a temporary pause in loan funding from institutions and capital markets. These factors collectively resulted in an 86% reduction in the number of loans originated and a 73% reduction in revenue in the second quarter of 2020 compared to the first quarter of 2020.

In response to the market conditions caused by the COVID-19 pandemic, we made certain operational changes, including increases to the fees we charge our bank partners and reductions in our sales and marketing activities and certain operational expenses. We continue to evaluate market and other conditions and may make additional changes to our fees or marketing activities, or implement additional operational changes, in the future.

Origination volumes recovered quickly, beginning in June 2020, as unemployment plateaued. This recovery continued through subsequent months, such that the Number of Loans Transacted in the three months ended September 30, 2020 was 80,893, representing a 26% increase compared to the Number of Loans Transacted in the three months ended September 30, 2019. Our revenue in the three months ended September 30, 2020 was $65.4 million, representing a 32% increase compared to our revenue in the three months ended September 30, 2019.

To support borrowers suffering from income loss due to the pandemic, Upstart worked with its bank partners to offer hardship plans that, among other things, allowed affected borrowers to defer loan payments for up to two months. At the peak, approximately 5.6% of borrowers on our platform had enrolled in a hardship program, less than half the rate of online lending industry benchmarks.60 Since this time, approximately 95% of these impacted borrowers have exited the hardship program and resumed making loan payments. Further, our model was approximately five times more predictive than FICO credit score alone during the COVID-19 pandemic.61 Due to the strength of our AI model, we expect that the COVID-19 pandemic will have minimal impact on bank partners and institutional investor performance for Upstart-powered loans originated prior to the second quarter of 2020.

Although significant government assistance was provided during the COVID-19 pandemic, the resilience of our bank partner results during this time provides evidence of the benefits that our AI models can offer to bank lending programs. We believe these benefits are even more compelling and valuable during periods of economic downturn.

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

 

60 

Wei Wu, Vadim Verkhoglyad and Alex Kale, dv01 Insights: Covid-19 Performance Report Volume 9, July 2020.

61 

Based on an internal Upstart study conducted in May 2020 comparing the percentage of borrowers requesting to enter the hardship program based on their FICO credit scores and the risk tier assigned at origination by Upstart.

 

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improvements on our conversion funnel also allow us to unlock new marketing channels over time that have previously been unprofitable.

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 percent of loans funded and retained by originating banks in the nine months ended September 30, 2020 was 23%, unchanged from 23% in the same period of 2019. Historically, we have observed that each 100 basis point reduction in APR has led to an approximate 15% increase in our conversion rate.62

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 recently announced our entry into the auto lending market and we believe that significant growth opportunities exist to apply our evolving technology to additional segments of credit, such as credit cards, mortgages, student loans, point-of-sale loans, and HELOCs. 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 recently began offering an application programming interface product to banks that allows 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 new products. Monetization prospects for new products 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

 

62 

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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are willing to accept. In a potential downturn, we believe consumer lending will generally contract, including the volume transacted on our own platform. However, the performance of Upstart-powered loans through an economic downturn, such as that experienced during the COVID-19 pandemic, will be important in further validating our AI models with banks and institutional investors. If we are able to continue demonstrating the resilience of Upstart-powered loans through future macroeconomic cycles relative to general consumer credit, it could strengthen our competitive positioning as we emerge from such downturns.

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,      Nine Months Ended
September 30,
 
     2017      2018      2019      2019      2020  

Number of Loans Transacted

     70,457        114,125        215,122        136,468        176,983  

Conversion Rate

     8.1%        9.1%        13.1%        12.2%        14.0%  

Percentage of Loans Fully Automated

     34%        53%        66%        64%        69%  

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 during the period presented. We believe this metric to be a good proxy for our overall scale and reach as a platform. Number of Loans Transacted has benefited from continuous improvements to our AI models and technology and our ability to streamline and automate the loan application and origination process. Number of Loans Transacted is also driven by our strategic relationships with loan aggregators to attract applicants to our platform. In this regard, Credit Karma recently began directing more customer traffic to a program that hosts and aggregates the credit models of other loan providers directly on its platform for the purpose of giving credit offers. To date, Upstart has opted not to participate in this program. In November 2020, we experienced a reduction in the number of loan applicants directed to the Upstart platform by Credit Karma and a corresponding decrease in the Number of Loans Transacted, and we may experience additional reductions in traffic from Credit Karma in the future.

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 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

 

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Transacted in the same period. We have been successful in increasing the level of loan automation on the platform over the past few years while simultaneously holding fraud rates constant and at very low levels. 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.

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.63

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 currently 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 income (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.

 

63 

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

 

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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 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. During the nine months ended September 30, 2020, other income also included the proceeds from a forgivable loan under the Paycheck Protection Program. For additional details, refer to Note 1 “Description of Business and Significant Accounting Policies” of our consolidated financial statements.

 

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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.

We incurred higher expenses in the quarters when the increases in the valuation of our preferred and common stock increased the most. In the fourth quarter of 2020, we estimate the expense for outstanding warrants to be approximately $6.5 million, which is significantly higher than the amount of the warrant expenses we experienced historically. We do not expect to incur additional expenses for the warrants in 2021 and beyond due to the exercise of the preferred stock warrants and the amendment to the common stock warrants as discussed in the sections titled “Description of Capital Stock” and “Liquidity and Capital Resources—Revolving Credit Facility”, respectively.

Results of Operations

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

 

     Year Ended December 31,     Nine Months Ended
September 30,
 
(In thousands)    2017     2018     2019     2019     2020  

Revenue:

          

Revenue from fees, net

   $ 51,161     $ 88,482     $ 159,847     $ 98,699     $ 144,179  

Interest income and fair value adjustments, net

     6,128       10,831       4,342       2,918       2,527  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     57,289       99,313       164,189       101,617       146,706  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

          

Sales and marketing(1)

     33,838       63,633       93,175       61,236       65,113  

Customer operations(1)

     10,232       15,416       24,947       16,593       24,792  

Engineering and product development(1)

     5,324       8,415       18,777       11,480       24,651  

General, administrative, and other(1)

     15,431       19,820       31,865       20,399       30,778  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     64,825       107,284       168,764       109,708       145,334  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from operations

     (7,536     (7,971     (4,575     (8,091     1,372  

Other income

     330       487       1,036       832       5,497  

Expense on warrants and convertible notes, net

     (1,649     (3,734     (1,407     (2,626     (2,317
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income before income taxes

     (8,855     (11,218     (4,946     (9,885     4,552  

Provision for income taxes

     6       —         74       —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income before attribution to noncontrolling interests

     (8,861     (11,218     (5,020     (9,885     4,552  

Net (loss) income attributable to noncontrolling interests

     (1,144     1,101       (4,554     (3,368     (404
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income attributable to Upstart Holdings, Inc. common stockholders

   $ (7,717   $ (12,319   $ (466     (6,517   $ 4,956  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Includes stock-based compensation expense as follows:

     Year ended December 31,      Nine Months Ended
September 30,
 
(In thousands)      2017          2018          2019        2019      2020  

Sales and marketing

   $ 32      $ 183      $ 278      $ 157      $ 1,136  

Customer operations

     124        178        433        252        625  

Engineering and product development

     574        753        1,803        932        3,181  

General, administrative, and other

     560        931        1,292        863        2,160  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 1,290      $ 2,045      $ 3,806      $ 2,204      $ 7,102  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Comparison of Nine Months Ended September 30, 2019 and 2020

Revenue

Revenue from Fees, Net

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

 

    Nine Months Ended September 30,              
(In thousands)           2019                     2020             $ Change     % Change  

Platform and referral fees, net

  $ 89,049     $ 123,485     $ 34,436       39

Servicing fees, net

    9,650       20,694       11,044     114
 

 

 

   

 

 

     

Total revenue from fees, net

  $ 98,699     $ 144,179     $ 45,480       46
 

 

 

   

 

 

     

Revenue from fees, net increased $45.5 million, or 46%, in the nine months ended September 30, 2020, compared to the same period in 2019, which included an increase of $34.4 million in revenue from platform and referral fees, net and an increase of $11.0 million in servicing fees, net. The increase of the platform and referral fees net was primarily driven by a 30% increase in the Number of Loans Transacted from 136,468 in the nine months ended September 30, 2019 to 176,983 for the same period in 2020 as well as an increase in prices of our services in response to the market conditions caused by the COVID-19 pandemic. The increase in the servicing fees, net was primarily due to an 85% increase in outstanding loan principal, as well as a downward revaluation to the net liability of our servicing obligation.

Interest Income and Fair Value Adjustments, Net

 

    Nine Months Ended September 30,              
(In thousands)           2019                     2020             $ Change     % Change  

Operating entities(1):

       

Interest income

  $ 10,655     $ 16,275     $ 5,620       53

Interest expense

    (5,187     (4,655     (532     (10 %) 

Fair value adjustments, net

    (1,873     (9,675     7,802       417

Other consolidated entities(2):

       

Interest income

    40,644       6,430       (34,214     (84 %) 

Interest expense

    (16,941     (2,297     (14,644     (86 %) 

Fair value adjustments, net

    (24,380     (3,551     (20,829     (85 %) 

Total Company:

       

Interest income

    51,299       22,705       (28,594     (56 %) 

Interest expense

    (22,128     (6,952     (15,176     (69 %) 

Fair value adjustments, net

    (26,253     (13,226     (13,027     (50 %) 

Total interest income and fair value adjustments, net

  $ 2,918     $ 2,527     $ (391     (13 %) 

 

(1)

Consist of balances recognized by entities participating in our ongoing operating activities, including warehouse entities.

(2)

Consists of balances recognized by other entities, including securitization entities and the fractional loan program (discontinued in 2019).

Interest income and fair value adjustments, net decreased $0.4 million, or 13%, in the nine months ended September 30, 2020, compared to the same period in 2019. The decrease was driven by a $34.2 million decline in interest income and a decline in interest expense and fair value adjustments, of $14.6 million and $20.8 million, respectively, recognized by other consolidated entities. These decreases were due to a reduction of consolidated loan balances from securitization-related

 

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VIEs caused by the deconsolidation of previously consolidated securitizations 2017-1, 2017-2, and 2018-1. The deconsolidation of these entities was a result of the expiration of the related risk retention requirements, which caused us to conclude that we are no longer a primary beneficiary of these entities. For additional details, refer to Note 3, “Securitizations and Variable Interest Entities” of our consolidated financial statements. The decrease of the total net interest income and fair value adjustment was also caused by an increase of $7.8 million of fair value adjustments recognized by the operating entities. These negative adjustments were primarily due to the market changes caused by the COVID-19 pandemic. This increase was partially offset by an increase of $5.6 million of interest income in these entities. This increase was a result of an increased average loan balances held by the operating entities during these periods.

Operating Expenses

Sales and Marketing

 

    Nine Months Ended September 30,              
(In thousands)           2019                     2020             $ Change     % Change  

Sales and marketing

  $ 61,236     $ 65,113     $ 3,877       6

Sales and marketing expenses increased by $3.9 million, or 6%, in the nine months ended September 30, 2020, compared to the same period in 2019. The increase was primarily due to a $2.1 million increase in payroll and other personnel-related expenses driven by increased headcount, as well as a $0.7 million increase in advertising and other traffic acquisition costs.

Customer Operations

 

    Nine Months Ended September 30,              
(In thousands)           2019                     2020             $ Change     % Change  

Customer Operations

  $ 16,593     $ 24,792     $ 8,199       49

Customer operations expenses increased by $8.2 million, or 49%, in the nine months ended September 30, 2020, compared to the same period in 2019. The increase was primarily due to an increase of $6.4 million in payroll and other personnel-related expenses due to an increase in headcount as well as increased spending of $1.7 million in information verification and platform operations due to a growing volume of loans facilitated through our platform.

Engineering and Product Development

 

    Nine Months Ended September 30,              
(In thousands)           2019                     2020             $ Change     % Change  

Engineering and product development

  $ 11,480     $ 24,651     $ 13,171       115

Engineering and product development expenses increased by $13.2 million, or 115%, in the nine months ended September 30, 2020, compared to the same period in 2019. The increase was primarily due to an increase of $10.2 million in payroll and other personnel-related expenses driven by an increase in headcount, as well as a $2.9 million increase in spending on consultants and other engineering support services.

General, Administrative, and Other

 

    Nine Months Ended September 30,              
(In thousands)           2019                     2020             $ Change     % Change  

General, administrative, and other

  $ 20,399     $ 30,778     $ 10,379       51

 

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General, administrative, and other expenses increased by $10.4 million, or 51%, in the nine months ended September 30, 2020, compared to the same period in 2019. The increase was primarily due to an increase of $3.1 million in personnel-related costs as a result of increased headcount; an increase of $2.2 million in office rent and other facility-related expenses due to the opening of our second headquarters in Columbus, Ohio, and relocation of our first headquarters from San Carlos, California to San Mateo, California; an increase of $1.5 million in legal and compliance-related expenses; and an increase of $1.1 million in other professional services fees.

Other Income

 

    Nine Months Ended September 30,              
(In thousands)           2019                     2020             $ Change     % Change  

Other income

  $ 832     $ 5,497     $ 4,665       561

Other income increased by $4.7 million, or 561%, in the nine months ended September 30, 2020, compared to the same period in 2019. The increase was primarily due to receipt of funds under the PPP, totaling $5.3 million and an increase in unrestricted cash balances held in interest-bearing deposit accounts throughout the year at commercial banks, which was partially offset by a decrease in dividend income of $0.8 million.

Expense on Warrants and Convertible Notes, Net

 

    Nine Months Ended September 30,              
(In thousands)           2019             &