Worthy Bonds Review: 5% Interest, Backed By Small Business Inventory Loans

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Worthy Bonds are a fintech startup that offers you 5% interest by “supporting your fellow humans”. You can invest a little bit at a time, even doing “round-ups” of your purchases. However, whenever you see an interest rate well above FDIC-insured accounts, you have to dig deeper! The basic business model is that Worthy will pay you 5% interest and then take that money to loan out to small business owners (inventory-backed loans) at much higher interest rates, with Worthy keeping any difference as their profit. Here’s why I don’t like that structure.

You are buying bonds issued by a single start-up. Worthy Bonds are really just 36-month bonds issued by Worthy Peer Capital, Inc. In other words, it’s a bond backed by a single corporation, in this case a very young startup that has never been profitable. The bonds are not rated and not traded publicly. Worthy is not a bank. Your funds are not FDIC-insured. They do promise to invest your money into “fellow humans”, which in reality are small business loans secured by the value of their inventory. Which brings me to…

Inventory-backed loans are NOT low-risk loans. Worthy makes a big deal about how they make “asset-backed loans” which are amongst the safest loans out there. Yes, these loans are less risky than unsecured loans like credit card debt, but if you perform some basic research about inventory financing, you’ll see that there are still many risks involved. From Investopedia:

Lenders may view inventory financing as a type of unsecured loan because if the business can’t sell its inventory, the bank may not be able to either. This reality may partially explain why, in the aftermath of the credit crisis of 2008, many businesses found it more difficult to obtain inventory financing.

The easiest way to confirm this is to ask the market. A bond backed by Microsoft might yield about 3.5% interest. Now pretend that you are a small business looking for an inventory loans. Online lenders quote rates varying from 10% APR to 100% APR. Now, which is really “low risk”? From Fundbox:

Yes, applying for an inventory loan is an easy and fast process; however, approval isn’t. Because the merchandise purchased will be considered as collateral, lenders will have to assess just how risky your business is. If they determine that you will have a challenging time selling your products, then that means they will have an equally hard time unloading the inventory in the event you can’t repay your loan, and they end up with it. […] Inventory financing typically comes with higher interest rates. Lenders feel they need extra security as there is no personal guarantee or collateral involved other than the inventory.

The loans they have taken out so far have 7.44% to 18% annual interest rates, plus collateral management fees of 6% to 12% annually. This is taken directly from their SEC filings:

As of December 31, 2018 we had entered in to three loan receivable agreements for an aggregate amount of $1,200,000, with small business borrowers. The loans pay interest at varying rates ranging from 0.62% per month to 1.5% per month and collateral management fees ranging from of 0.5% to 1% per month.

Limited upside, unlimited downside. I’m not saying inventory loans are a bad deal, if you are compensated properly for the risk. If Worthy was more of an “access” play, where they took a small cut (maybe 1%) of these risky business loans and gave you the rest, I would be more interested. However, this is more of a “we do fancy stuff in the background, and give you 5% and make you think that’s a good deal” play. Even if their loans work out and they get 10% or 20% or ???, you just get 5%. Meanwhile, if these loans go sour, and Worthy runs out of venture capital, then you may be stuck losing everything you put in. What happens when a company borrows money against their warehouse holding $10 million “value” of fidget spinners, but suddenly they are no longer trendy?

They advertise that you can take your money out at any time, but they don’t advertise as heavily that this is all unless they default. Everything can look great, until one day it doesn’t. There is no FDIC insurance coming to the rescue. Worthy is doubly-exposed in the event of a recession. Inventory loans will default at higher rates, and their venture capital backing may also dry up. At this time, they also don’t have a bankruptcy remote vehicle where the inventory loans are directly connected to your investments.

Bottom line. Worthy Bonds are one of the many fintech startups out there asking for your money. If you look past the 5% interest and slick app, the underlying investment is small business inventory loans, which carry a meaningful risk of loss and usually charge north of 10% annual interest to the borrowers. However, Worthy Bonds limit your upside to 5% interest, while the downside is unlimited.

If you want to invest in corporate bonds for about 5% interest, I would recommend Vanguard High-Yield Corporate Fund Investor Shares (VWEHX). The SEC yield is right about 5%, and you get a diversified portfolio of 500 different bonds from rated businesses after they charge a low .23% expense ratio (less if you buy Admiral Shares). That 0.23% is the only gap between the market returns of the underlying bonds and what you receive.

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Comments

  1. Technically you don’t have unlimited downside. You CAN lose all that you invested, but no more. A naked call is an example of unlimited downside where you could be liable for any amount of money.

  2. Also, thank you for the review. It is interesting to see the sort of stuff they are coming up with.

    I agree that this sounds risky for us investors.

  3. So I met the owners recently and I’m in the secured lending space. Their model is less risky than you’re describing (IMO) because first of all, the bonds are totally liquid. You can remove your position pretty quickly if you start to feel uneasy (unless something drastic happens with the company)

    Second of all, their loans are built on several layers of cushions: they’re inventory loans which are UCC-1 secured, but loan amounts are also (1) based on liquidation value, not retail value. AKA they have to be certified by a liquidation specialist as to the value of the fire sale of the collateral and (2) loan principal is capped at 66% of liquidation value of the collateral, and (3) the interest rate vs bond payout cushion is large, which as you said limits the upside, but also seriously limits the downside. They’re bonds, after all, not stocks. Your upside should be somewhat limited.

    So let’s say you have $2,000,000 of retail collateral. Inspector says it would be worth $1,000,000 on liquidation/foreclosure. You could borrow – max – $667,000 from Worthy. So let’s say the value of fidget spinners crash and you are going out of business, and your $2mil of inventory is liquidated for only $350,000. If they’re halfway through the loan, the bank still recovers the ~$300kish left. Now multiply the risk times a normal default rate for a loan of these risk levels…you’d have to have a TON of defaults for you to lose everything as an investor.

    Not saying people should put their life savings here, but an emergency fund? Probably fine.

    The profitability/startup risk is real, but they’ve done enough business now that they’re on the verge of profitability.

  4. Timothy Wang says:

    Jonathan,

    I hate to say it but I don’t think you truly dived into company’s fundamentals before writing this somewhat negative review. I find that issue with many product reviews written by non-users… “I did not drive the car but I will tell you if you should buy it” type of mentality.

    I hold with Worthy aprox ~$200k as my portfolio diversifier and I did my due diligence before investing. Not only the bonds proceeds are not attached to a specific loan and are backed by entire portfolio of secured loans but Worthy also doesn’t fund random loans of every company that applies for it and that have some sort of inventory. The borrower needs to show a track record of successful sales of the specific product and, as Annie Ray correctly stated, the loan is given against ~65-70% of its liquidation value. They did not have any defaults so far but if they do (it will likely happen at some point) they are more than ready to recover loan capital. It would need to be an entire chain of catastrophic events for investors to actually lose their money. In other words, 1 or even 2 loan defaults at the same time (again, they had none to this day) would very likely be irrelevant to the safety of the investments. I hope this clarifies the company’s model to your readers since some (I would argue most) people like to hear review from the active service user and it doesn’t look like you’ll be becoming one any time soon…

    • A fund of AAA-rated corporate bonds is paying about 3% right now. An ETF of junk bonds is yielding about 5.6% right now. Is a bunch of small business inventory bonds sustainable at paying out 5%? Maybe, but I certainly wouldn’t argue that they are the same as a FDIC-insured bank account. However, we won’t find out until the next recession comes. As Warren Buffett says, “Only when the tide goes out do you discover who’s been swimming naked.” If things go south, it could be very messy and involve frozen redemptions.

      Again, this is my opinion and it is based on what I would tell my friends and family. It’s your money. I’m just saying I wouldn’t let my mom invest in Worthy.

      • Timothy Wang says:

        Trying to fit Worthy bonds somewhere between publicly traded bonds, I think, only confuses your readers further. They are private bonds that are only traded between investors and Worthy. And, since Worthy is in complete control who do they lend money to, it’s fair to say there is nothing like it on the market. In fact, Worthy only used bond structure to allow micorinvestments and to simplify model for the investors but otherwise they can’t be easily compared to conventional bonds. For example, one can try to put “junk bonds” sticker on their product but to me, as an investor, they function like AAA-rated bonds (stable-fixed return, I was paid interest to a penny and they are completely liquid). I do agree that a true test is coming in the form of recession but you can tell that about virtually any investment vehicle. All we know is that the recession will happen but you can not predict if and who will fail. During last recession there were AAA-rated securities that went under the water like stones (which is why I don’t particularly care about those ratings and experts opinions; I just do my own research and draw my own conclusions). The events that shaped the world history were almost always unexpected and unpredictable. Experts were talking about recession since 2014, if I listened to them I would go into fear mode and miss on almost tripling my net worth over the last 5 years. So, I guess it all depends who are your readers and what are their financial goals. If your advice is to help them get by and have enough money to retire at age of 60 or more then probably creating atmosphere of fear amongst them is a right technique to build your blog but if you want them to build substantial wealth then I will argue that it won’t happen without taking risks. I apologize for not knowing much about your readers; I only allowed myself to comment when I realized that you inaccurately presented investment model that Worthy uses.

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