American Express is buying “substantially all” of the online lender Kabbage, but not its loan portfolio. So what is it getting?

Technology and people.

American Express could use Kabbage’s software and talent to provide a broad range of services to small businesses that would rival any bank’s, observers said.

“It makes sense for American Express because it allows them to bring on some additional strong technology and a related technology team at a good price instead of building that up and recruiting organically,” said Sam Kilmer, senior director of Cornerstone Advisors. “American Express is already one of the nation’s leading small-business lenders, so it allows them to spread the use of that tech over a large client and prospect base.”

Lending platform

Amex did not say what it is paying for Kabbage, though recent news reports said the lender could be worth as much as $1 billion following a $250 million investment by SoftBank.

The technology that Kabbage has created is a lending platform that gathers data about small-business borrowers, including bank account data, payment processing data, social data, shipping data, credit card transaction data, and accounting information.

“All this data gives us a unique view into that business performance,” Kathryn Petralia, co-founder and president of Kabbage, said in an earlier interview. “It’s what enables the user experience we have today, which is a really rapid onboarding process.”

Automated loan decisions are often made within 10 minutes.

Kilmer said the fact that Amex is acquiring the team and technology and not the loan portfolio itself speaks to the value of the technology itself.

“This is not a market share grab or roll-up acquisition," he said. "This is about intellectual property, the time to market of it and its impact on capabilities.”

Indeed, in a research note to investors published Tuesday, Keefe, Bruyette & Woods analyst Sanjay Sakhrani said that the deal would have little impact on Amex’s profits in the near term.

Longer term, though, it could give Amex an edge over other lenders. Competitiveness in small-business lending, much like consumer lending, requires the ability to make decisions instantly, Kilmer said.

“This is the area where credit card lenders like American Express and Capital One have tended to shine and where fintechs like OnDeck and Kabbage shined,” he said. “The credit card lenders have historically done especially well with data analytics while online lenders like Kabbage and OnDeck have excelled at user interface and user experience. That’s because credit card lenders need strong analytics to survive earnings and regulatory scrutiny while online lenders like Kabbage and OnDeck had to shine on user experience to get both customers and investors to try them.”

Amex plans to use Kabbage’s technology to start making its own loans to small businesses.

The card company already offers charge and credit cards and other short-term business financing products, and with Kabbage's technology, "we can better address the needs of small businesses who may feel underserved by banks and have limited awareness of financial management tools that provide insights and information on their spending and finances," the company said in a news release announcing the deal.

“American Express doesn't really want the existing Kabbage business,” said Todd Baker, managing principal of Broadmoor Consulting and senior fellow at Columbia University. “It wants the ability to originate small-business loans seamlessly, cheaply and effectively. It wants the underwriting knowledge that exists in the Kabbage lending algorithms and data. It’s essentially leaving the past behind and starting fresh with all the things that are truly valuable.” American Express and Kabbage told the Financial Times they will establish and capitalize an entity that will service all of Kabbage’s outstanding loans, and that borrowers will not be affected.

Kabbage’s online lending technology is “generally viewed as the best,” Baker said.

"We’re excited about Kabbage’s product suite integrated into a single online platform that uses real-time data processing to help small businesses better understand, forecast and manage their cash flow," an Amex spokesperson said.

The Atlanta company, founded in 2008, has rolled out many innovations over the years.

For instance, last September, Kabbage co-founders launched a new startup called Drum that helps small businesses connect with influencers and gig workers. American Express Ventures is one of its backers.

In October, Kabbage created a payments service, Kabbage Payments, that lets small businesses create and send invoices to customers and create a URL through which they accept card payments through Kabbage for a 2.25% per-transaction fee. Fifth Third Bancorp sponsors the service.

In February, Kabbage rolled out the ability to make short-term loans to its clients that can be repaid in as little as three days. (Up to then, it offered loan terms of six, 12 or 18 months.) This was a response to the fact that often, companies were paying off loans early.

In July, it launched checking accounts with Green Dot Bank.

The Kabbage team has also built a line of credit capability and a dashboard small businesses can use to monitor their cash flow.

Adding talent

Kabbage co-founders Petralia and Rob Frohwein built a quirky, scrappy startup that grew quickly. They also have been outspoken and passionate influencers, making the case for years that credit scores are an outdated form of assessing creditworthiness and that alternative types of data, including cash flow, give a better view of a small business’s performance and value.

The two are expected to join Amex when the sale closes later this year. "Everyone at Kabbage will join Amex, including Rob and Kathryn," a Kabbage spokesperson said.

Baker said that often in cases like this, executives’ contracts are written such that they only receive their full equity-linked compensation if they stay with the company for a defined length of time.

Folding a free-spirited startup into a large corporation with $198 billion in assets is bound to be a challenge.

At a large bank Baker previously worked for, when smaller companies were acquired, “once they were brought into the mothership, innovation was typically crushed because it didn't fit in with what the bank was doing. I called it destroying the village in order to save it."

For now, though, Amex is not planning any wholesale changes. "For the time being, the Kabbage brand, and digital platform will continue to exist and be led and operated by the current Kabbage leadership team, all part of American Express Company," the spokesperson said.

Tough times for online lenders

It’s no accident that American Express announced its deal for Kabbage shortly after Enova said it had agreed to buy Kabbage’s main rival, OnDeck Capital, in July.

Both online lenders are, like others in the space, revenue challenged.

The basic business for Kabbage and OnDeck is to originate and securitize loans to small businesses. (In Kabbage’s case, the loans are issued by Celtic Bank in Salt Lake City.) When the pandemic hit, Kabbage was slammed. Many of its borrowers went out of business and it had to stop originating loans.

When the government rolled out the Paycheck Protection Program, Kabbage pivoted its platform to handle the new Small Business Administration loans. It made more than 300,000 small business loans totaling $7 billion, making it the second-largest PPP lender in the country by application volume.

But the loans Kabbage made before the crisis are hard to value now, and therefore hard to sell.

“While performance has been surprisingly good on these small- business loans, no one is quite sure whether that's just because of the government assistance and if that government assistance stops they'll suddenly start to fall down,” Baker said. “It's very difficult for a buyer and seller to come together on the value of those loans. Everyone in the small-business space is realizing that being just a lender is not viable, but if you can embed various financial products into a business model, that provides real value to customers. That's why you see software providers, the Intuits of the world, going into lending and payments.”

Becoming a full-service bank for small businesses

Amex has spent years trying to build up a small-business capability, Baker said.

“They've been constrained because they’ve been largely card-based, although they have done other types of installment and line-of-credit lending," he said. "They've been very focused on trying to make the American Express card itself accepted by small businesses. This is another way for them to provide more credit products and become a supporter of small business.”

Frohwein, Kabbage's CEO, said he hoped to help with such a goal.

“We have built a technology and data platform that provides them with the kind of capabilities and insights often reserved for larger businesses,” he said in Kabbage’s press release. “By joining American Express, we can help more small businesses succeed with a fully digital suite of financial products to help them run and grow their companies.”

Amazon, Square, PayPal and Intuit are also building out a range of financial products for small businesses.

It’s likely there will be more deals like Enova-OnDeck and American Express-Kabbage, Baker said.

“The online marketplace lending model just isn't a good one,” Baker said. “Nobody was making any money. But the technology and the capability of doing that lending placed in another business model in other hands” could work.