Student loan confusion opens market niche

Chaos and confusion can create great conditions for a start-up. Or they can kill it.

That's what makes entrepreneurship so much fun.

As summer approaches, millions of students and parents will begin hunting for the loans that will help cover their college tuition bills. What they'll likely find is less choice, since more than 50 lenders have ducked out of the market for federally backed student loans in recent months. And issuers of private loans are expected to be more stringent on credit scores, while ratcheting up interest rates.

That may influence parents and students to spend more time shopping for loans. And that situation, which is part of the global credit drought, could prove to be a cool drink of water for companies trying to build businesses around connecting students with money for their education.

"As a start-up, you either have to figure out how to change the world, or wait for things to happen organically," says Kevin Walker, cofounder and chief executive of Newton-based Simple Tuition Inc., an online service that helps students compare various loan options. The growing challenge of piecing together college financing, Walker believes, could help accelerate that organic change.

In 2005, when Walker was laying the groundwork for his company, the idea of parents or students doing much comparison shopping - or of schools encouraging it - was not particularly welcomed.

"Families would simply go through the school's financial aid office," says Walker. "We'd explain what we were doing, and we were told, 'That's not the way things work.' "

Lenders especially didn't want their loans to be easily comparable - as companies like LendingTree had done with home mortgages and car loans. "That would put them in a whole new world of competition," Walker says.

But a scandal last year made colleges more receptive to pointing students and parents to Simple Tuition's site. At schools like Columbia University and Johns Hopkins, financial aid officials were found to be trading stock or receiving consulting fees from the schools' "preferred lenders," and some loan companies were dangling bribes to win designation as a school's most-favored lender.

Since then, Walker says, financial aid offices at places like Brown, Stanford, and Harvard Business School have been more willing to create links to Simple Tuition so that students can evaluate lots of options, not just those on a school's in-house list.

Walker says that media reports this spring about the cloudy outlook for student loans also have helped his company. The site had about 600,000 users last year, and is on track to hit about 2 million users in 2008, Walker says.

"Students and parents are more and more aware that they ought to be doing their own research, and that takes pressure off our need to market," he says.

But one challenge for Simple Tuition is that some of the lenders with which it works - that pay a fee for every prospective customer the site refers to them - have vanished. Last year, the site had 55 of these "partner lenders," and this year it has 31 - though Walker says many of those that have stopped working with the company were loan consolidators that didn't supply much revenue.

Another challenge is that the lenders trying to decrease the amount of student lending they do are likely reducing their marketing budgets. Walker says he has watched the prices that student lenders pay to Google for each click on an ad plummet in the past year. He claims his ad prices haven't been affected as severely. The company has raised $12 million in venture capital so far, much of it from the local firms IDG Ventures and Atlas Venture, and Walker hopes to raise a third round later in 2008.

Planning for a June launch is another start-up, College Loan Market LLC, based in North Reading. That site will put a student's loan applications out to bid to a group of lenders, which should produce a more customized loan offer than Simple Tuition can. The site will also help students solicit loan offers without damaging their credit scores - a common side effect of filling out multiple loan applications.

Getting lenders' attention in the midst of the current turbulence has been tough, admits College Loan Market cofounder Marc Stein. He says the goal is to have at least five lenders bidding on applications. Two are already committed to participate, and Stein says that "seven others are at various stages of contract negotiations."

And while news stories about student loans make students more inclined to shop around, Stein says they've given some prospective investors in his company cold feet. "People who aren't inside the student loan business read in the Wall Street Journal that the business is crashing and burning," he says. "It has made our financing round much more difficult."

The company is looking to raise $1.5 million, but has raised just a sliver of that so far.

So-called peer-to-peer lending companies are also sailing into the student loan fray. Waltham-based Virgin Money (part of Richard Branson's empire) offers to formalize loans between students and their family members for $299. Fynanz Inc., a younger New York start-up, recently began doing the same thing in Massachusetts, though Fynanz allows strangers (perhaps alumni of a school) to make loans to students and earn interest - anywhere from 6 to 10 percent, depending on the borrower's credit score.

But online peer-to-peer lending is still new, and Fynanz has completed one loan since its launch in March. "We don't expect this to be mainstream anytime soon, but I do expect some of the smarter, more involved students to see this as an option," says chief executive Chirag Chaman, an alumnus of Worcester's Clark University.

"It could help a small number of students, but I don't think it's going to solve a national credit crunch," Tony Erwin says of peer-to-peer lending. Erwin is Northeastern University's director of financial aid services. "It's a fine idea, but it's not the fix," he adds.

As long as students and parents are searching for a fix, that creates openings for start-ups.

"It's a really disruptive time in the market," says Stein. "But I really view chaos in a marketplace as a great opportunity."

Innovation Economy is a weekly column focusing on entrepreneurship, technology, and venture capital in New England. Scott Kirsner can be reached at kirsner@pobox.com.