Their new startup, Keep Financial, says it has mastered a business model everyone else has been too afraid to try.
6/2/2022
Keep Financial, backed by top investors and two serial entrepreneurs, says it has solved a financial problem for businesses and, crucially, figured out how to package it into a product and sell it.
Kathryn Petralia and Rob Frohwein, two of the co-founders of Kabbage, have devised a way to offer forgivable loans, or what they call “vesting cash plans,” for businesses to offer employees. By signing up with Keep, employers will be able to distribute a cash bonus to employees on a regular basis, so long as the employee agrees to stay at the company for a designated period of time. It takes some of the concepts that made stock options such a popular compensation vehicle for Silicon Valley while putting them within reach of smaller businesses that might never contemplate issuing shares to employees.
Frohwein offers the example of a $5,000 bonus to cover a tradesman’s initial cost of materials if they stay at a company for a year.
The loans are similar to employer-forgivable loans, which are offered in a variety of industries to cover tuition or ongoing education, equipment needed for a job or major life purchases like a down payment on a home. In these cases, the employer typically administers the loan through a bank, and covers the principal or offers employees cash bonuses to cover the payments.
Keep Financial does things differently. It’s a licensed lender in 46 states, underwrites risk and manages the loan. This way, employers don’t have to go through a financial institution and keep track of payments themselves.
According to Frohwein, the business model was a no-brainer. He first discovered employer-forgivable loans as a lawyer early in his career, when he was representing a young doctor who was offered a loan that incentivized him to choose to work in a rural area.
After American Express acquired Kabbage in 2020, Frohwein was ready to start a new business, he said. He and Petralia started talking to HR leaders about why they didn’t offer these types of loans to keep employees around. “They all said, ‘Hey, if this was available to us, we’d do it in a heartbeat. It’s just really hard to execute,’” Frohwein explains. “And I thought, OK, we’ll take all the execution challenges out.’”
Keep announced $9 million in funding in May, in a seed round led by Andreessen Horowitz. Launchpad Capital, Thomvest Ventures, Cambrian Ventures and Worklife Ventures participated in the round.
The hefty sum illustrates how seed funding is more readily available than growth-stage funding right now, especially for a team with a strong idea and a track record.
“What stands out about Rob and Kathryn is how good they are at translating real-world experiences into financial services products,” said Launchpad Capital founder Ryan Gilbert. Andreessen Horowitz General Partner Anish Acharya cited the “massive and fragmented compensation market” as well as the co-founders’ reputation.
Case Western Reserve University corporate law professor Anat Alon-Beck agreed that a product like Keep’s answers a key need in a period of high turnover. “There’s a clear market failure,” she said, referring to multiple research papers she’s written about economic factors leading to increased job-hopping. “I get invited to lecture about this a lot, and I always say someone needs to come up with a solution, and that that person is going to make a lot of money.”
But there’s obvious tax and legal implications that make offering forgivable loans to employees difficult, and may explain why Keep Financial appears to be the only fintech offering them. In the past the IRS has taxed some employer-forgivable loans as one-time cash bonuses, making the employee liable for tax on the full amount of the loan up-front, rather than over time as vesting plans anticipate.
In order for a loan to be taxed as a vesting loan, it must be clear that the employee is liable for the loan should they leave the job. This, in turn, also comes with consequences: Employees who have been fired or laid off can find themselves on the hook for thousands of dollars.
But Keep has a unique way of financing the loans that solves this problem, Frohwein told Protocol. Keep is the licensed lender for the employee, who is told the complete terms of the loan when they are hired. The employer sets a vesting schedule with Keep and pays off the loan as vesting milestones are reached; at those points, the employee counts the forgiven loan amounts as taxable income. The loans are zero-interest as long as the vesting plans are active.
If employees leave the job early they must pay back the “unvested” portion of the loan within 60 days without interest. Ex-employees also have the option of paying back the loan over the course of a year at 5% APR, or over three years at 7% APR. Keep Financial receives this interest as revenue, though the company makes most of its money off of a fee it charges employers. The fee is an undisclosed percentage of bonuses the employer offers employees through Keep.
Horacio Mendez, president and CEO of the Woodstock Institute, highlights one more potential pitfall: A lack of financial education can mean employees are not only strapped with a loan when they quit early, but also may not see it coming. He points out that beyond any moral obligations, lenders must provide clear loan cost information under the Truth in Lending Act.
Frohwein said this is top of mind for Keep, too. “We plan to make sure, one, that employees understand their obligation to repay in the event they leave before they’ve vested, and, two, [that they have] education around how they can use these funds to build wealth,” he said.
Keep’s vesting cash plans are its primary product, and will be complemented by an online portal where businesses and employees can check up on the loans. Frohwein says he and Petralia may develop companion financial products, too, like insurance for when employees have to leave a job under circumstances outside their control.
But the real question is, now that Keep Financial has cracked the code on forgivable loans, what’s to keep a bunch of other startups from copying their work?
Frohwein is unbothered by that scenario, daring the competition to try it. “Folks should copycat us — copycat the product, do it,” he said. “We have a lot of vision for how to extend this product, extend this company and really help fix recruiting and retention.”
Protocol link: https://www.protocol.com/fintech/keep-financial-forgivable-loans
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