SoFi raises $500M to fix the broken student loan market

SoFi just reached a new milestone: It has raised half a billion dollars in financing, making it one of the most well-funded startups you haven’t heard of — yet.

The company, which was formerly known as “Social Finance,” is on a mission to prevent students from falling into crippling debt. It was cofounded by a fellow at Stanford’s Business School, Mike Cagney, who realized that wealthy alumni had the resources to provide loans to students at more affordable rates.

SoFi launched in 2011 at Stanford University and has spread to 100 schools around the country. To Cagney’s surprise, not a single student has defaulted on a loan — the rates are more reasonable (variable rates are as low as 2.94 percent / fix rates are as low as 4.99 percent) than a private loan or federal Stafford loan, and borrowers do not want to jeopardize alumni relationships.

The founders believe that “social” is the missing ingredient in the way that loans operate, so they take advantage of social networking sites. Students are matched with potential lenders based on shared interests. Alumni can often become mentors and are connecting rising seniors and grad students with job opportunities.

To date, approximately 3,000 students have signed up for a SoFi loan.

Cagney does not intend to expand to more schools in the near future. He fears that some universities would not be a fit, as the “school is charging way more for that education than the value,” so default rates would be through the roof.

Before making the decision to expand, the team will assess whether a school is suitable for SoFi. If they get a green light, SoFi raises money from alumni, puts it in the fund, loans it out, and collects a management fee of .75 percent and service fee of .5 percent from that fund.

SoFi is constantly raising money and has secured $90 million in equity, $151 million in debt, and $200 million in bank participations, with the remaining capital coming from alumni and community investors. Student loan guarantor ECMC Group made the most recent investment of $30 million, pushing the company over the half a billion mark.

Most of the funding is used to lend to students and graduates, but SoFi sets aside a portion for product development and to sustain its growing team.

Cagney told me he intends to take the company public, but is in no rush. SoFi is making money — about $10 million in revenues this year, with a goal for $40 or $50 million in 2014 — but Cagney believes the company is at a “hockey stick” inflection point of growth.

SoFi will go public when its revenues are more consistent. “It’s a relatively young business,” he said. “I’m confident that it will become apparent when it’s time to IPO.”