UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 333-147019

PROSPER MARKETPLACE, INC.

(Exact name of registrant as specified in its charter)

Delaware	6199	73-1733867
(State or other jurisdiction of incorporation or organization)	(Primary Standard Industrial Classification Code Number	(I.R.S. Employer Identification Number)

111 Sutter Street, 22nd Floor

San Francisco, CA  94104

(415) 593-5400

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o(Do not check if a smaller reporting company)	Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of November 7, 2012 there were 3,006,745 shares of the registrant’s common stock outstanding.

TABLE OF CONTENTS

	Page No.
Forward-Looking Statements	i
PART I. FINANCIAL INFORMATION
Item 1.   Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 2012 (Unaudited) and December 31, 2011	1
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2012 and 2011 (Unaudited)	2
Consolidated  Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2012 and 2011 (Unaudited)	3
Consolidated  Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011 (Unaudited)	4
Notes to Consolidated Financial Statements (Unaudited)	5
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.    Quantitative and Qualitative Disclosures About Market Risk	41
Item 4.    Controls and Procedures	41
PART II. OTHER INFORMATION
Item 1.    Legal Proceedings	42
Item 1A. Risk Factors	42
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3.    Defaults upon Senior Securities	42
Item 4.    Mine Safety Disclosures	42
Item 5.    Other Information	42
Item 6.    Exhibits	42
Signatures	43
Exhibit Index	44

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include all statements that do not relate solely to historical or current facts, and can generally be identified by the use of words such as “may,” “believe,” “will,” “expect,” “project,” “estimate,” “intend,” “anticipate,” “plan,” “continue” or similar expressions.   In particular, information appearing under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” includes forward-looking statements. Forward-looking statements inherently involve many risks and uncertainties that could cause actual results to differ materially from those projected in these statements.

Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is based on the current plans and expectations of our management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. More information on factors that could cause actual results or events to differ materially from those anticipated is included from time to time in our reports filed with the Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K/A for the year ended December 31, 2011, particularly under the caption “Risk Factors.”

All forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this Quarterly Report on Form 10-Q or our Annual Report on Form 10-K/A for the year ended December 31, 2011, particularly under the caption “Risk Factors.” We undertake no obligation to update or revise forward-looking statements that may be made to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events, other than as required by law.

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and current reports and other information with the SEC. You can inspect, read and copy these reports and other information at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You can obtain information regarding the operation of the SEC’s Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that makes available reports, proxy statements and other information regarding issuers that file electronically.

i 

PART I. Financial Information

Item 1. Consolidated Financial Statements

Prosper Marketplace, Inc.

Consolidated Balance Sheets

(Unaudited)

				Restated
	September 30,			December 31,
	2012			2011
	(Unaudited)			(Note 2)
ASSETS
Cash and cash equivalents	$	4,033,981		$	9,216,133
Restricted cash		5,364,159			4,364,102
Short term investments		3,999,402			9,997,420
Receivables		76,909			12,941
Loans held for investment at fair value		193,403			137,314
Borrower Loans Receivable at fair value		148,546,530			75,762,894
Property and equipment, net		1,397,505			1,337,572
Prepaid and other assets		422,451			234,539
Total assets	$	164,034,340		$	101,062,915
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable	$	1,527,026		$	1,123,732
Accrued liabilities		2,839,218			2,027,313
Borrower Payment Dependent Notes at fair value		149,177,364			76,159,501
Repurchase obligation		35,500			22,168
Total liabilities		153,579,108			79,332,714
Commitments and contingencies (see Note 12)
Stockholders' Equity
Convertible preferred stock – Series A ($0.001 par value; 4,023,999 shares authorized, issued and outstanding as of September 30, 2012 and December 31, 2011)		4,024			4,024
Convertible preferred stock – Series B ($0.001 par value; 3,310,382 shares authorized, issued and outstanding as of September 30, 2012 and December 31, 2011)		3,310			3,310
Convertible preferred stock – Series C ($0.001 par value; 2,063,558 shares authorized, issued and outstanding as ofSeptember 30, 2012 and December 31, 2011)		2,064			2,064
Convertible preferred stock – Series D ($0.001 par value; 20,340,705 shares authorized, issued and outstanding as of September 30, 2012 and December 31, 2011)		20,341			20,341
Convertible preferred stock – Series E ($0.001 par value; 23,222,747 shares authorized, issued and outstanding as of September 30, 2012 and December 31, 2011)		23,223			23,223
Convertible preferred stock – Series E-1 ($0.001 par value; 10,000,000 shares authorized, issued and outstanding as of September 30, 2012 and December 31, 2011)		10,000			10,000
Convertible preferred stock – Series F ($0.001 par value; 8,996,739 shares authorized, issued and outstanding as of September 30, 2012 and December 31, 2011)		8,997			8,997
Common stock ($0.001 par value; 82,630,003 shares authorized; 3,006,745 and 2,872,859 shares issued and outsanding as of September 30, 2012 and December 31, 2011, respectively)		4,830			4,696
Additional paid-in capital		83,066,775			82,733,624
Less Treasury Stock		(291,046	)		(291,046	)
Accumulated deficit		(72,397,286	)		(60,789,032	)
Total stockholders' equity		10,455,232			21,730,201
Total liabilities and stockholders' equity	$	164,034,340		$	101,062,915

The accompanying notes are an integral part of these consolidated financial statements.

1

Prosper Marketplace, Inc.

Consolidated Statements of Operations

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Revenues
Origination fees	$	2,083,196		$	762,000		$	5,222,542		$	1,753,852
Loan servicing fees		48			3,236			442			22,800
Interest income on Borrower  Loans		5,026,938			2,670,066			15,437,216			6,089,978
Interest expense on Payment Dependent Notes		(4,715,853	)		(2,516,166	)		(14,618,105	)		(5,751,364	)
Rebates and promotions		(454,880	)		(314,320	)		(1,004,265	)		(759,284	)
Total Revenues		1,939,449			604,816			5,037,830			1,355,982
Cost of revenues
Cost of services		(375,037	)		(302,999	)		(1,055,932	)		(898,975	)
Reversal of (Provision for) loan and Note repurchases		(5,308	)		(7,148	)		(16,845	)		50,644
Net revenues		1,559,104			294,669			3,965,053			507,651
Operating expenses
Compensation and benefits		2,777,901			1,746,136			7,584,541			4,907,562
Marketing and advertising		1,578,437			375,219			3,979,980			1,225,589
Depreciation and amortization		166,748			114,501			492,948			347,771
General and administrative
Professional services		863,189			489,207			2,495,822			1,630,130
Facilities and maintenance		301,961			197,010			926,960			522,963
Other		319,641			209,886			1,169,666			645,763
Total expenses		6,007,877			3,131,959			16,649,917			9,279,778
Loss before other income and expenses		(4,448,773	)		(2,837,290	)		(12,684,864	)		(8,772,127	)
Other income and expenses
Interest income		1,324			846			5,606			3,443
Change in fair value on Borrower Loans, Loans Held for Investment and  Payment Dependent Notes, net		316,071			390,469			835,799			865,993
Insurance recoveries		-			-			-			1,896,844
Loss on impairment of fixed assets		-			-			-			(1,714	)
Other Income		144,594			25,438			235,205			66,467
Total other income and expenses, net		461,989			416,753			1,076,610			2,831,033
Loss before income taxes		(3,986,784	)		(2,420,537	)		(11,608,254	)		(5,941,094	)
Provision for income taxes		-			-			-			-
Net loss	$	(3,986,784	)	$	(2,420,537	)	$	(11,608,254	)	$	(5,941,094	)
Net loss per share – basic and diluted	$	(1.37	)	$	(0.52	)	$	(4.01	)	$	(1.30	)
Weighted average shares - basic and diluted net loss per share		2,909,925			4,669,249			2,898,368			4,583,997

The accompanying notes are an integral part of these consolidated financial statements.

2

Prosper Marketplace, Inc.

Consolidated Statements of Stockholders' Equity

	Preferred Stock						Common Stock				Treasury Stock						Additional Paid- In			Accumulated
	Shares			Amount			Shares		Amount		Shares			Amount			Capital			Deficit			Total
Balance as of January 1, 2011 (Audited)		32,848,832		$	32,849			4,478,667	$	4,480	$	-		$	-		$	56,659,849		$	(50,767,983	)	$	5,929,195
Issuance of convertible preferred stock, Series E		23,222,747			23,223							-			-			17,116,777			-			17,140,000
Issuance of convertible preferred stock, Series E-1		10,000,000			10,000							-			-						-			10,000
Conversion of convertible preferred stock, Series D-1		(3,110,188	)		(3,110	)		1		-		-			-			3,110			-			-
Offering costs on preferred stock		-			-							-			-			(454,336	)		-			(454,336	)
Exercise of stock options		-			-			100,416		100		-			-			20,983			-			21,083
Exercise of common stock warrants		-			-			90,165		90		-			-			17,943			-			18,033
Issuance of common stock warrants		-			-							-			-			78,884			-			78,884
Compensation expense		-			-							-			-			240,930			-			240,930
Net loss		-			-							-			-						(5,941,094	)		(5,941,094	)
Balance as of September 30, 2011 (Unaudited)		62,961,391		$	62,962			4,669,249	$	4,670	$	–		$	–		$	73,684,140		$	(56,709,077	)	$	17,042,695
Balance as of January 1, 2012 (Audited)		71,958,130		$	71,959			4,695,499	$	4,696		(1,822,640	)	$	(291,046	)	$	82,733,624		$	(60,789,032	)	$	21,730,201
Exercise of stock options		-			-			133,886		134		-			-			18,862			-			18,996
Issuance of common stock warrants		-			-							-			-			52,541			-			52,541
Purchase of Treasury Stock		-			-							-			-									-
Compensation expense		-			-							-			-			261,748			-			261,748
Net loss		-			-							-			-			-			(11,608,254	)		(11,608,254	)
Balance as of September 30, 2012 (Unaudited)		71,958,130		$	71,959			4,829,385	$	4,830		(1,822,640	)	$	(291,046	)	$	83,066,775		$	(72,397,286	)	$	10,455,232

The accompanying notes are an integral part of these consolidated financial statements.

3

Prosper Marketplace, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

	Nine Months Ended September 30,
	2012			2011
Cash flows from operating activities:
Net loss	$	(11,608,254	)	$	(5,941,094	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		492,948			347,771
Loss on impairment of fixed assets		–			1,714
Change in fair value of Loans held for investment		13,980			46
Change in fair value of Borrower Loans		(2,912,700	)		(2,161,235	)
Change in fair value of Borrower Payment Dependent Notes		2,062,921			1,295,196
Stock-based compensation expense		261,748			240,930
Issuance of common stock warrants		52,541			78,884
Provision for (Reversal of) loan and Note repurchases		13,332			(50,644	)
Change in fair value of servicing rights		–			2,986
Amortization of discount on long-term debt		–			11,406
Changes in operating assets and liabilities:
Restricted cash		(1,000,058	)		(1,267,469	)
Receivables		(63,969	)		(10,073	)
Prepaid and other assets		(187,912	)		(95,174	)
Accounts payable and accrued liabilities		1,215,201			801,661
Loan and Note repurchases					1,811
Net cash used in operating activities		(11,660,222	)		(6,743,284	)
Cash flows from investing activities:
Purchases of short term investments		(3,000,000	)		–
Maturities of short term investments		8,998,018			–
Origination of Loans held for investment at fair value		(164,002	)		(146,794	)
Repayment of Loans held for investment at fair value		93,933			–
Origination of Borrower Loans held at fair value		(116,148,204	)		(47,927,629	)
Repayment of Borrower Loans held at fair value		46,277,268			16,877,985
Purchases of property and equipment		(552,881	)		(780,364	)
Net cash used in investing activities		(64,495,868	)		(31,976,802	)
Cash flows from financing activities:
Proceeds from issuance of convertible preferred stock		–			17,149,999
Offering costs - convertible preferred stock		–			(454,336	)
Proceeds from issuance of Notes held at fair value		116,148,204			47,927,629
Payment of Notes held at fair value		(45,193,262	)		(16,367,639	)
Principal repayment of notes payable		–			(300,000	)
Proceeds from issuance of common stock		18,996			39,116
Net cash provided by financing activities		70,973,938			47,994,769
Net increase (decrease) in cash and cash equivalents		(5,182,152	)		9,274,683
Cash and cash equivalents at beginning of the period		9,216,133			4,284,228
Cash and cash equivalents at end of the period	$	4,033,981		$	13,558,911

The accompanying notes are an integral part of these consolidated financial statements.

4

PROSPER MARKETPLACE, INC.

Notes to Consolidated Financial Statements

(Unaudited)

1. Operations and Business

Prosper Marketplace, Inc. (“Prosper,” the “Company,” “we,” “us,” “our”) was incorporated in the state of Delaware on March 22, 2005. Prosper is an online marketplace for peer-to-peer lending. Prosper’s website provides an online marketplace for loans where people list and bid on loans with interest rates of return determined by Prosper.   Lender members access our platform and bid the amount they are willing to commit to the purchase of a note payable by Prosper that is dependent for payment on the corresponding borrower loan, at interest rates set by Prosper (the “Note”).  Loan terms are subject to minimum and maximum loan amounts determined by the borrower’s credit bureau score and Prosper score, at interest rates set by Prosper.  Prosper facilitates the lending and borrowing activities and acts as an agent to the lender by maintaining its online marketplace. Prosper also handles all ongoing loan administration tasks, including loan servicing and collections on behalf of the lenders. Prosper generates revenue by collecting one-time fees from borrowers on funded loans and from loan servicing fees paid by lender members.

All loans requested and obtained by Prosper borrower members through our platform are unsecured obligations of individual borrower members with a fixed interest rate and a loan term set at one, three or five years.  All loans are funded by WebBank, an FDIC-insured, Utah-chartered industrial loan company.  After funding a loan, WebBank assigns the loan to Prosper, without recourse to WebBank, in exchange for the principal amount of the borrower loan.  WebBank does not have any obligation to purchasers of the Notes.

On July 13, 2009, we implemented a new operating structure and began issuing Borrower Payment Dependent Notes (“Notes”).  The post-registration operating structure resulted in Prosper purchasing loans from WebBank, and holding the loans until maturity.  Prosper issues new securities, the Notes, to the lenders.  Prosper’s obligation to repay the Notes is conditioned upon the repayment of the associated borrower loan owned by Prosper.  As a result of these changes, borrower loans and the Notes originated on or after July 13, 2009 are carried on Prosper’s balance sheet as assets and liabilities, respectively.  Prosper has elected to carry the borrower loans and the Notes on its balance sheet at fair value.

As reflected in the accompanying consolidated financial statements, Prosper has incurred net losses and negative cash flows from operations since inception, and has an accumulated deficit of approximately $72.4 million as of September 30, 2012. For the three and nine months ended September 30, 2012, the Company incurred a net loss of $4.0 million and $11.6 million, respectively and the Company had negative cash flows from operations of $11.7 million during the nine months ended September 30, 2012.  Since its inception, Prosper has financed its operations primarily through equity financing from various sources.  In June 2011, the Company raised $17.1 million through the issuance of our Series E and E-1 Preferred Stock to certain new investors and certain of Prosper’s existing investors.  In November 2011, the Company raised $9.0 million through the issuance of our Series F Preferred Stock to certain new investors.  Please see Note 9 for further discussion of our Preferred Stock.

5

2. Summary of Significant Accounting Policies

Basis of Presentation

The Company’s unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (US GAAP) and disclosure requirements for interim financial information and the requirements of Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements.  The unaudited interim consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K/A filed with the Securities Exchange Commission (SEC) for the year ended December 31, 2011.  The consolidated balance sheet at December 31, 2011 has been derived from the audited financial statements at that date. Management believes these unaudited interim consolidated financial statements reflect all adjustments, including those of a normal recurring nature, which are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.

The accompanying consolidated financial statements include the accounts of Prosper and its wholly-owned subsidiary, Prosper Funding LLC. Prosper Funding LLC was formed in the state of Delaware on February 17, 2012, but has not commenced operations as of September 30, 2012. All significant intercompany transactions and balances have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and the related disclosures at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. These estimates, judgments and assumptions include but are not limited to the following: valuation of borrower loans receivable and associated member payment dependent notes, valuation allowance on deferred tax assets, valuation and amortization periods of intangible assets, repurchase obligation, stock-based compensation expense, and contingent liabilities. Prosper bases its estimates on historical experience and on various other assumptions that Prosper believes to be reasonable under the circumstances. Actual results could differ from those estimates.

Certain Risks and Concentrations

In the normal course of its business, Prosper encounters two significant types of risk: credit and regulatory. Financial instruments that potentially subject Prosper to significant concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash and short term investments. The Company places cash and cash equivalents, restricted cash and short term investments with high-quality financial institutions. Prosper is exposed to credit risk in the event of default by these institutions to the extent the amount recorded on the balance sheet exceeds federally insured amounts. Prosper performs periodic evaluations of the relative credit standing of these financial institutions and has not sustained any credit losses from instruments held at these financial institutions.

Loans originated by Prosper are carried on our balance sheet.  The loans are funded by the Notes and repayment of the Notes is wholly dependent on the repayment of the loan associated with a Note.  As a result, Prosper does not bear the risk associated with the repayment of principal on loans carried on its balance sheet.  A decrease in the value of the loans carried on Prosper’s balance sheet associated with increased credit risk is directly offset by a reduction in the value of the Notes Prosper issued in association with the loan. However, Prosper charges a servicing fee that is deducted from loan payments.  To the extent that loan payments are not made, Prosper’s servicing income will be reduced.  

Prosper is subject to various regulatory requirements. The failure to appropriately identify and address these regulatory requirements could result in certain discretionary actions by regulators that could have a material effect on Prosper’s financial position and results of operations (See Note 12 — Commitments and Contingencies — Securities Law Compliance).

6

Cash and Cash Equivalents

Prosper invests its excess cash primarily in highly liquid debt instruments of the U.S. government and its agencies. All highly liquid investments with stated maturities of three months or less from date of purchase are classified as cash equivalents. Cash equivalents are recorded at cost, which approximates fair value. Such deposits periodically exceed amounts insured by the FDIC.

Restricted Cash

Restricted cash consists primarily of cash deposits required to support the Company’s Automated Clearing House and loan origination activities, and secured corporate credit cards.

Short Term Investments

Our short term investments consist of highly liquid debt instruments of the U.S. government and its agencies with maturity periods greater than three months and less than 12 months.

Fair Value of Borrower Loans, Borrower Payment Dependent Notes and Loans Held for Investment

The Company accounts for its borrower loans and loans held for investment as assets and accounts for its borrower payment dependent notes as liabilities and carries these instruments at fair value.

Borrower Loans and Borrower Payment Dependent Notes

On July 13, 2009, the Company implemented its new operating structure and began issuing Notes and purchasing loans from WebBank, and holding the loans until maturity.  Prosper’s obligation to repay the Notes is conditioned upon the repayment of the associated borrower loan owned by Prosper.   As a result of these changes, borrower loans and the Notes are carried on our balance sheet as assets and liabilities, respectively, and are carried at fair value.

Loans Held for Investment

From time to time, Prosper will fund all or a portion of a borrower loan or repurchase a loan to indemnify a lender member. These performing Notes are classified as loans held for investment based on management’s intent to hold these loans for the foreseeable future or to maturity, and are carried at fair value.

Fair Value Election

For our borrower loans, borrower payment dependent notes and loans held for investment, we adopted the provisions of Accounting Standards Codification (ASC) Topic 825, Financial Instruments.  ASC Topic 825 permits companies to choose to measure certain financial instruments and certain other items at fair value on an instrument-by-instrument basis with unrealized gains and losses on items for which the fair value option has been elected reported in earnings.  The fair value election, with respect to an item, may not be revoked once an election is made.  In applying the provisions of ASC Topic 825, we recorded assets and liabilities measured using the fair value option in a way that separates these reported fair values from the carrying values of similar assets and liabilities measured with a different measurement attribute.  We do not record a specific allowance account related to the borrower loans, loans held for investment and Notes in which we have elected the fair value option, but rather estimate the fair value of the borrower loans, loans held for investment and Notes using discounted cash flow methodologies adjusted for Prosper’s historical loss and recovery rates.  We have reported the aggregate fair value of the borrower loans, loans held for investment and Notes as separate line items in the assets and liabilities sections of the balance sheet using the methods described in ASC Topic 820, Fair Value Measurements and Disclosures– See Fair Value Measurement.

7

Property and Equipment

Property and equipment consists of computer equipment, office furniture and equipment, and software purchased or developed for internal use. Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method based on the estimated useful lives of the assets, which range from three to seven years. Prosper capitalizes expenditures for replacements and betterments and expenses amounts for maintenance and repairs as they are incurred.  Depreciation and amortization commences once the asset is placed in service.

Internal Use Software and Website Development

Prosper accounts for internal use software costs, including website development costs, in accordance with ASC Topic 350-40, Internal Use Software and ASC Topic 350-50, Website Development Costs. In accordance with ASC Topics 350-40 and 350-50, the costs to develop software for Prosper’s website and other internal uses are capitalized when management has authorized and committed project funding, preliminary development efforts are successfully completed, and it is probable that the project will be completed and the software will be used as intended. Capitalized software development costs primarily include software licenses acquired, fees paid to outside consultants, and salaries for employees directly involved in the development efforts. Costs incurred prior to meeting these criteria, together with costs incurred for training and maintenance, are expensed. Costs incurred for upgrades and enhancements that are considered to be probable to result in additional functionality are capitalized. Capitalized costs are included in property and equipment and amortized to expense using the straight-line method over their expected lives.

Intangible Assets

Prosper records the purchase of intangible assets not purchased in a business combination in accordance with ASC Topic 350. Prosper has an intangible asset resulting from the purchase of the “Prosper.com” domain name.  The intangible asset was amortized on a straight-line basis over five years, and was fully amortized during 2011.

Impairment of Long-Lived Assets Including Acquired Intangible Assets

In accordance with ASC Topic 360, Property Plant and Equipment, Prosper reviews property and equipment including its software assets and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying values of those assets may not be recoverable.  Recoverability of assets to be held and used is measured by comparing the carrying value of the asset to future net undiscounted cash flows that the assets are expected to generate. If an asset is considered to be impaired, the impairment to be recognized equals the amount by which the asset’s carrying value exceeds its fair value. Fair value is estimated using discounted net cash flows.

Repurchase Obligation

Prosper is obligated to indemnify lenders and repurchase certain Notes sold to lenders in the event of Prosper’s violation of applicable federal, state, or local lending laws, a breach of the Company’s representations and warranties under the lender registration agreement or verifiable identify theft. The amount of the Note repurchase obligation is estimated based on historical experience and instances where the Company intends to indemnify lenders under the terms of the Company’s representations and warranties under the lender registration agreement.  Prosper accrues a provision for the repurchase obligation as loans are funded.  Repurchased Notes are recorded as Loans Held for Investment and held at fair value.  Loans associated with verifiable identity theft are written off at the time of repurchase.

Revenue Recognition

Prosper recognizes revenue in accordance with ASC Topic 605, Revenue Recognition.  Under ASC Topic 605, Prosper recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price of the services is fixed and determinable and collectability is reasonably assured. Revenues primarily result from fees earned and net interest income. 

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Origination Fees

Borrowers pay an origination fee upon the successful closing of a loan. We deduct and retain the origination fee from the loan amount prior to disbursing the net amount to the borrower member. The loan origination fee is determined by the term and credit grade of the loan and ranges from 0.50% to 4.95% of the original principal amount. Since Prosper accounts for borrower loans, loans held for investment, and Borrower Payment Dependent Notes at fair value, origination fees are not deferred but are recognized at origination of the loan and direct costs to originate loans are recorded as operating expenses as incurred.

Loan servicing fees

Loan servicing revenue includes monthly loan servicing fees and non-sufficient funds (NSF) fees on loans originated prior to October 16, 2008.  Loan servicing fees are accrued daily based on the current outstanding principal balance of the borrower loan but are not recognized until payment is received due to the uncertainty of collection of borrower loan payments. Our servicing fee is equal to 1.0% of the outstanding principal balance of the corresponding borrower loan.  Prosper charges a NSF fee to borrowers for the first failed payment of each billing period.  NSF fees are charged to the borrower and collected and recognized immediately.

Net Interest income on Borrower Loans Receivable and Payment Dependent Notes

For loans originated after July 13, 2009, we recognize interest income on our borrower loans receivable using the accrual method based on the stated interest rate to the extent that we believe it to be collectable.  We record interest expense on the corresponding Payment Dependent Note based on the contractual interest rate paid by the borrower, less 1% which we deduct from each lender member’s share of the borrower loan payments for our servicing fee.

Advertising and Promotional Expenses

Under the provisions of ASC Topic 720, Other Expenses,the costs of advertising are expensed as incurred.

Rebate and Promotional Expenses

The Company accounts for rebates and promotions in accordance with ASC Topic 605, Revenue Recognition.  From time to time we offer rebates and promotions to our borrower and lender members.  We record these rebates and promotions as an offset to revenue if a particular rebate or promotion is earned upon the origination of the loan. Our rebate and promotions have in the past been in the form of cash back and other incentives paid to lenders and borrowers.

Stock-Based Compensation

The Company accounts for its stock-based compensation for employees using fair-value-based accounting in accordance with ASC Topic 718, Stock Compensation.  ASC Topic 718 requires companies to estimate the fair value of stock-based awards on the date of grant using an option-pricing model. The fair value of share-option awards is estimated on the date of grant using the Black-Scholes option pricing model. The Black-Scholes model requires the input of highly subjective assumptions, including the expected stock price volatility. Because Prosper’s equity awards have characteristics significantly different from those of traded options, the changes in the subjective input assumptions can materially affect the fair value estimate. The stock-based compensation related to an award that is expected to vest is amortized using the straight line method over the vesting term of the award, which is generally four years.  Stock-based compensation expense is recorded net of estimated forfeitures, such that expense is recorded only for those stock-based awards that are expected to vest.

Prosper has granted options to purchase shares of common stock to nonemployees in exchange for services performed. Prosper accounts for stock options and restricted stock issued to nonemployees in accordance with the provisions of ASC Topic 505-50, Equity-Based Payments to Non-Employees, which requires that equity awards be recorded at their fair value.  Under ASC Topics 718 and 505-50, Prosper uses the Black-Scholes model to estimate the value of options granted to nonemployees at each vesting date to determine the appropriate charge to stock-based compensation. The volatility of common stock was based on comparative company volatility.

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Net Loss Per Share

Prosper computes net loss per share in accordance with ASC Topic 260, Earnings Per Share. Under ASC Topic 260, basic net loss per share is computed by dividing net loss per share available to common stockholders by the weighted average number of common shares outstanding for the period and excludes the effects of any potentially dilutive securities. Diluted earnings per share, if presented, would include the dilution that would occur upon the exercise or conversion of all potentially dilutive securities into common stock using the “treasury stock” and/or “if converted” methods as applicable. At September 30, 2012, there were outstanding convertible preferred stock, warrants and options convertible into 61,958,136, 2,609,870 and 12,914,199 common shares, respectively, which may dilute future earnings per share. Due to the Company reporting a net loss for the three and nine months ended September 30, 2012 and 2011, there is no calculation of fully-diluted earnings per share as all common stock equivalents are anti-dilutive.

Income Taxes

Prosper uses the liability method to account for income taxes. Under this method, deferred income tax assets and liabilities are based on the differences between the financial statements and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.  

Under ASC Topic 740, Income Taxes, our policy to include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes did not change.

Fair Value Measurement

Prosper follows ASC Topic 820, Fair Value Measurements and Disclosures. ASC Topic 820 provides a framework for measuring the fair value of assets and liabilities.  ASC Topic 820 also provides guidance regarding a fair value hierarchy, which prioritizes information used to measure fair value and the effect of fair value measurements on earnings and provides for enhanced disclosures determined by the level within the hierarchy of information used in the valuation.  ASC Topic 820 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.

ASC Topic 820 defines fair value in terms of the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The price used to measure the fair value is not adjusted for transaction costs while the cost basis of certain financial instruments may include initial transaction costs. Under ASC Topic 820, the fair value measurement also assumes that the transaction to sell an asset occurs in the principal market for the asset or, in the absence of a principal market, the most advantageous market for the asset. The principal market is the market in which the reporting entity would sell or transfer the asset with the greatest volume and level of activity for the asset. In determining the principal market for an asset or liability under ASC Topic 820, it is assumed that the reporting entity has access to the market as of the measurement date. If no market for the asset exists or if the reporting entity does not have access to the principal market, the reporting entity should use a hypothetical market.

Under ASC Topic 820, assets and liabilities carried at fair value in the balance sheets are classified among three levels based on the observability of the inputs used to determine fair value:

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Level 1 — The valuation is based on quoted prices in active markets for identical instruments.

Level 2 — The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 — The valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies, or similar techniques, which incorporate management’s own estimates of assumptions that market participants would use in pricing the instrument or valuations that require significant management judgment or estimation.

Prosper determines the fair values of its financial instruments based on the fair value hierarchy established in that standard, which requires an entity to maximize the use of quoted prices and observable inputs and to minimize the use of unobservable inputs when measuring fair value. Various valuation techniques are utilized, depending on the nature of the financial instrument, including the use of market prices for identical or similar instruments, or discounted cash flow models.  When possible, active and observable market data for identical or similar financial instruments are utilized. Alternatively, fair value is determined using assumptions that management believes a market participant would use in pricing the asset or liability.

Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2012, as compared to the recent accounting pronouncements described in our 2011 10-K/A, that are of significance, or potential significance to us.

3. Borrower Loans and Borrower Payment Notes Held at Fair Value

The Company’s financial instruments consist principally of cash and cash equivalents, restricted cash, short term investments, receivables, loans held for investment, borrower loans, accounts payable, accrued liabilities, and borrower payment dependent notes.  The estimated fair values of cash and cash equivalents, restricted cash, accounts payable and accrued liabilities approximate their carrying values because of their short term nature.

The following tables present the assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011:

September 30, 2012	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Fair Value
Assets
Short term investments	$	3,999,402	$	-	$	-	$	3,999,402
Borrower loans receivable		-		-		148,546,530		148,546,530
Loans held for investment		-		-		193,403		193,403
Liabilities
Borrower payment dependent notes	$	-	$	-	$	149,177,364	$	149,177,364

December 31, 2011	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Fair Value
Assets
Short term investments	$	9,997,420	$	-	$	-	$	9,997,420
Borrower loans receivable		-		-		75,762,894		75,762,894
Loans held for investment		-		-		137,314		137,314
Liabilities
Borrower payment dependent notes	$	-	$	-	$	76,159,501		76,159,501

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Our short term investments consist of United States Treasuries with maturity periods greater than three months and less than 12 months.  In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. The Company classifies United States Treasuries as Level 1 assets.  The Company intends to hold these investments until maturity.

As observable market prices are not available for the borrower loans, Notes and loans held for investment, or for similar assets and liabilities, we believe that these assets and liabilities should be considered Level 3 financial instruments under ASC Topic 820.  In a hypothetical transaction as of the measurement date, the Company believes that differences in the principal marketplace in which the loans are originated and the principal marketplace in which the Company might offer those loans may result in differences between the originated amount of the loans and their fair value as of the transaction date.

 Our obligation to pay principal and interest on any Note is equal to the loan payments, if any, we receive on the corresponding borrower loan, net of our 1.0% servicing fee.  As such, the fair value of the Note is approximately equal to the fair value of the borrower loans, adjusted for the 1.0% servicing fee.  Any unrealized gains or losses on the borrower loans, loans held for investment and Notes for which the fair value option has been elected is recorded as a separate line item in the statement of operations.  The effective interest rate associated with the Notes will be less than the interest rate earned on the borrower loans due to the 1.0% servicing fee.

Prosper estimates the fair value of the borrower loans and Notes using discounted cash flow methodologies based upon a set of valuation assumptions. The main assumptions Prosper uses to value the borrower loans and Notes include prepayment rates derived from historical prepayment rates for each credit score, default rates derived from historical performance, recovery rates and discount rates applied to each credit tranche based on the perceived credit risk of each credit grade.

Loss rate estimates will vary based on the age and credit grade of the underlying loan. We use historical delinquency status and default rates combined with current performance metrics to estimate the amount and timing of defaults.  During the quarter, the Company modified the estimated default assumptions to incorporate varying loss rates as the status of the loan progresses. For the remaining fair value assumptions, we used the following averages:

Monthly prepayment rate speed	1.60	%
Recovery rate	5.39	%
Discount rate *	9.97	%

* This is the weighted average discount rate among all of Prosper’s credit grades

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The changes in Level 3 assets measured at fair value on a recurring basis are as follows:

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Servicing  Rights			Borrower Loans			Borrower Payment Dependent Notes			Total
Balance at January 1, 2012	$	-		$	75,762,894		$	(76,159,501	)	$	(396,607	)
Originations		-			116,148,204			(116,148,204	)		-
Principal repayments and credit losses		-			(46,277,268	)		45,193,262			(1,084,006	)
Change in fair value on borrower loans and Payment Dependent Notes		-			2,912,700			(2,062,921	)		849,779
Balance at September 30, 2012	$	-		$	148,546,530		$	(149,177,364	)	$	(630,834	)
Balance at January 1, 2011	$	2,986		$	23,689,950		$	(23,478,046	)	$	214,890
Originations		-			47,927,629			(47,927,629	)		-
Principal repayments		-			(16,877,985	)		16,367,639			(510,346	)
Change in fair value on borrower loans and Payment Dependent Notes		-			2,161,235			(1,295,196	)		866,039
Change in fair value of servicing rights		(2,986	)		-			-			(2,986	)
Change in fair value of loans held for investment		-			-			-			-
Balance at September 30, 2011	$	-		$	56,900,829		$	(56,333,232	)	$	567,597

The fair value of a Note is approximately equal to the fair value of the corresponding borrower loan, less the 1.0% service fee.  If the fair value of the borrower loan decreases due to our expectation regarding both the likelihood of default of the loan and the amount of loss in the event of default, there will also be a corresponding decrease in the fair value of the Note (an unrealized gain related to the Note and an unrealized loss related to the borrower loan). As such, the change in fair value attributable to instrument-specific credit risk is immaterial.  The Company had no originations of borrower loans or issuances of Notes prior to July 13, 2009. Of the loans originated from July 13, 2009 to September 30, 2012, the Company had 214 loans which were 90 days or more delinquent for an aggregate principal amount of $1,060,736 and a fair value of $164,916 as of September 30, 2012.

4. Loans Held for Investment at Fair Value

As of September 30, 2012, we held a net amount of $193,403 in loans held for investment. When a borrower member loan has been repurchased or funded in whole, or in part, by us, we retain the portion of the borrower’s monthly loan payment that corresponds to the percentage of the loan that we have funded. In these cases, we record interest income on these borrower loans.

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Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Loans Held for  Investment
Balance at January 1, 2012	$	137,314
Originations		164,002
Principal repayments and credit losses		(93,933	)
Change in fair value of loans held for investment		(13,980	)
Balance at September 30, 2012	$	193,403
Balance at January 1, 2011	$	-
Originations		146,794
Principal repayments		-
Change in fair value on borrower loans and Payment Dependent Notes		-
Change in fair value of servicing rights		-
Change in fair value of loans held for investment		(46	)
Balance at September 30, 2011	$	146,748

Prosper estimates the fair value of the loans held for investment using discounted cash flow methodologies based upon a set of valuation assumptions similar to those of Borrower Loans, which are set forth in Note 3, as they have similar characteristics and we expect these loans to behave in a comparable manner.  The valuation assumptions the Company used to value these loans include prepayment rates, default rates and recovery rates derived from historical loan performance data and discount rates based on credit grade applied to each loan.

The fair value adjustment on these loans held for investment was $13,980, which is included in earnings for the nine months ended September 30, 2012.  As of September 30, 2012, there were 151 loans held for investment that were greater than 90 days delinquent totaling $7,649.

5. Notes Payable

In 2006, we entered into a non-interest bearing promissory note in the amount of $380,000 for the purchase of the “Prosper.com” domain name. The note was discounted by $109,583 for a net payable of $270,417. The promissory note includes both principal and interest and was payable in annual installments of $20,000 due on the first, second, third, and fourth anniversary of the note and $300,000 due on the fifth anniversary of the note. Interest on the note was imputed at an 8% annual rate and is amortized to interest expense over the five year life of the loan. In June 2011, the promissory note was paid in full. We recorded amortized interest expense of approximately $11,400 for the nine months ended September 30, 2011.

6. Accrued Liabilities

As of September 30, 2012 and December 31, 2011, accrued liabilities consist of the following:

	September 30,		December 31,
	2012		2011
Legal accruals and fees	$	698,218	$	530,252
Audit, tax and accounting		340,732		284,174
Payroll and benefits		274,070		262,507
Loan servicing costs		964,210		448,631
Other		561,988		501,749
	$	2,839,218	$	2,027,313

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7. Repurchase Obligation

Changes in the repurchase obligation are summarized below:

Balance at January 1, 2012	$	22,168
Increase in provision for Loan and Note repurchases		13,332
Repurchased Loan and Note recoveries during the period		-
Balance at September 30, 2012	$	35,500

8. Net Loss Per Share

As mentioned in Note 2, the Company computes net loss per share in accordance with ASC Topic 260. Under ASC Topic 260, basic net loss per share is computed by dividing net loss per share available to common stockholders by the weighted average number of common shares outstanding for the period and excludes the effects of any potentially dilutive securities. Diluted earnings per share, if presented, would include the dilution that would occur upon the exercise or conversion of all potentially dilutive securities into common stock using the “treasury stock” and/or “if converted” methods as applicable.

Basic and diluted loss per share was calculated as follows:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2011			2012			2011
Numerator:
Net loss	$	(3,986,784	)	$	(2,420,537	)	$	(11,608,254	)	$	(5,941,094	)
Denominator:
Weighted average shares used in computing basic and diluted net loss per share		2,909,925			4,669,249			2,898,368			4,583,997
Basic and diluted net loss per share	$	(1.37	)	$	(0.52	)	$	(4.01	)	$	(1.30	)

Due to losses attributable to common stockholders for each of the periods below, the following potentially dilutive shares are excluded from the diluted net loss per share calculation because they were anti-dilutive under the treasury stock method, in accordance with ASC Topic 260:

	September 30,
	2012		2011
Excluded Securities:
Convertible preferred stock issued and outstanding		61,958,136		62,961,391
Stock options issued and outstanding		12,914,199		11,963,780
Warrants issued and outstanding		2,609,870		1,343,589
Total common stock equivalents excluded from diluted net loss per common share computation		77,482,205		76,268,760

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9. Stockholders’ Equity

Preferred Stock

Under Prosper’s certificate of incorporation, preferred stock is issuable in series, and the Board of Directors is authorized to determine the rights, preferences, and terms of each series.

In April 2005, Prosper issued and sold 4,023,999 shares at $1.875 per share of Series A convertible preferred stock (Series A Preferred Stock) in a private placement for $7,464,450, net of issuance costs of $80,550.

In February 2006, Prosper issued and sold 3,310,382 shares at $3.776 per share of Series B convertible preferred stock (Series B Preferred Stock) in a private placement for $12,412,302, net of issuance costs of $87,700.

In June 2007, Prosper issued and sold 2,063,558 shares at $9.692 per share of Series C convertible preferred stock (Series C Preferred Stock) in a private placement for $19,919,009, net of issuance costs of $80,996.

In April 2010, Prosper issued and sold 20,340,705 shares at $0.7385 per share of Series D convertible preferred stock (Series D Preferred Stock) in a private placement for $14,595,709, net of issuance costs of $125,903. In connection with that sale, we issued 4,978,854 Series D shares pursuant to the conversion of $3,676,884 in promissory notes payable, including $300,000 that represented consideration for a note holder’s agreement to convert its note prior to maturity. Also, in connection with the Series D transaction, we issued 3,110,188 shares of Series D-1 convertible preferred stock (Series D-1 Preferred Stock). We issued the Series D-1 Preferred Stock as additional consideration for certain holders of Series A, B or C Preferred Stock that participated in the Series D transaction at significant levels but did not receive any cash consideration for those shares.  As part of the Series D transaction, the aggregate liquidation preferences of the Series A, B and C Preferred Stock were reduced from $40 million to $20 million. The Series D-1 Preferred Stock established aggregate liquidation preferences of $3.1 million which offset, for the recipients of Series D-1 Preferred Stock, some of the reduction in liquidation preference they experienced with respect to their Series A, B and C Preferred Stock. The Series D-1 Preferred Stock was convertible into Common Stock at a ratio of 1,000,000:1.  Holders of Series D-1 Preferred Stock that held less than 1 million Series D-1 shares were entitled on conversion of those shares to receive a cash payment equal to a pro rata fraction of the par value of a single share of Common Stock.  The Series D-1 Preferred Stock had no voting rights and limited preference and conversion rights. As a result, we allocated the fair value of Series D-1 Preferred Stock at the par value of $.001 per share from the proceeds of Series D.

In June 2011, Prosper issued and sold 23,222,747 shares at $0.7385 per share of Series E convertible preferred stock (Series E Preferred Stock) in a private placement for $16,708,524, net of issuance costs of $441,476.  In connection with that sale, we issued and recorded 10,000,000 shares at the par value $0.001 per share of Series E-1 convertible preferred stock (Series E-1 Preferred Stock) to certain holders of Series A, Series B and Series C Preferred Stock who participated in the sale. The Series E-1 shares established certain liquidation rights, as described below, have no voting rights and are convertible into one share of common stock (Common Stock) for every one million shares of Series E-1. We allocated the fair value of the shares of Series E-1 Preferred Stock at the par value of $.001 per share from the proceeds of Series E. Upon issuance of our Series E and Series E-1 Preferred Stock, the Series D-1 Preferred Stock was converted into a single share of Common Stock.

In November 2011, Prosper issued and sold 8,996,739 shares at $1.00 per share of Series F convertible preferred stock (Series F Preferred Stock) in a private placement for $8,941,602, net of issuance costs of $58,735.

Dividends

The holders of Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock are entitled to receive an annual dividend per share in an amount equal to 8% times the liquidation preference for such share, payable in preference and priority to any declaration or payment of any distribution on Common Stock in such calendar year.  The right to receive dividends on shares of Series D Preferred Stock, Series E Preferred Stock and Series F Preferred Stock is cumulative from and after the date of issuance of such shares. Such dividends shall be payable only when, as, and if declared by the Board of Directors.  Holders of Series E-1 Preferred Stock are not entitled to receive dividends in preference and priority to, or on a pari passu basis with, the other Preferred Stock or the Common Stock. Dividends on shares of Series E-1 Preferred Stock shall be payable only when, as, and if declared by the Board of Directors. To date, no dividends have been declared on any of the Company’s Preferred Stock or Common Stock, and there are no dividends in arrears at September 30, 2012.

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Conversion

Each share of Preferred Stock shall automatically be converted into fully-paid, non-assessable shares of Common Stock at the conversion rate for such share (i) immediately prior to the closing of an underwritten initial public offering at a price per share (prior to underwriting commissions and expenses) that values the Company at least $200,000,000 in an offering with aggregate proceeds to the Company of at least $40,000,000 (before  deducting underwriters commissions and expenses), pursuant to an effective registration statement filed under the Securities Act of 1933, as amended (the “Securities Act”), covering the offer and sale of Common Stock, or (ii) upon the receipt of a written request for such conversion from the holders of more than sixty percent (60%) of the outstanding shares of Preferred Stock, or, if later, the effective date for conversion specified in such request, provided that shares of Series D Preferred Stock will not be automatically converted pursuant to any such request unless the holders of eighty-two percent (82%) of the outstanding shares of Series D Preferred Stock approve such conversion, shares of Series E Preferred Stock shall not be automatically converted pursuant to any such request unless the holders of eighty-two percent (82%) of the outstanding shares of Series E Preferred Stock approve such conversion, and shares of Series F Preferred Stock shall not be automatically converted pursuant to any such request unless the holders of eighty-two percent (82%) of the outstanding shares of Series F Preferred Stock approve such conversion.  In addition, when a liquidation event occurs, if a holder of Series E-1 Preferred Stock has converted any of such holder’s shares of Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock into Common Stock, then all shares of Series E-1 Preferred Stock held by such holder shall automatically be converted into fully-paid, non-assessable shares of Common Stock at the then effective conversion rate for such shares immediately prior to such liquidation event. 

Liquidation Rights

In the event of any sale, liquidation, dissolution, or winding up of Prosper, whether voluntary or involuntary, the holders of Series F Preferred Stock and Series E Preferred Stock shall be entitled to receive, pari passu with each other and prior and in preference to any distribution of the proceeds to the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E-1 Preferred Stock or Common Stock by reason of their ownership of such stock, an amount for each share of Series E Preferred Stock or Series F Preferred Stock held by them equal to the liquidation preference of such share (as adjusted for any stock dividends, combinations, or splits), plus all declared but unpaid dividends (if any) on such share.  If upon such liquidation event, the assets of the Company legally available for distribution to the holders of the Series E Preferred Stock and Series F Preferred Stock are insufficient to pay the preferential amount specified above, then the entire assets of the Company legally available for distribution shall be distributed with equal priority and pro rata among the holders of the Series E Preferred Stock and Series F Preferred Stock.

After the payment or setting aside for payment to the holders of Series E Preferred Stock and Series F Preferred Stock of the preferential amount specified above, the holders of Series D Preferred Stock shall be entitled to receive, prior and in preference to any distribution of proceeds to the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, Series E-1 Preferred Stock or Common Stock by reason of their ownership of such stock, an amount for each share of Series D Preferred Stock held by them equal to the liquidation preference of such share (as adjusted for any stock dividends, combinations, or splits), plus all declared but unpaid dividends (if any) on such share.   After the payment of or setting aside for payment to the holders of Series F Preferred Stock, Series E Preferred Stock and Series D Preferred Stock of the full amounts specified above, the holders of Series E-1 Preferred Stock shall be entitled to receive, prior and in preference to any distribution of proceeds to the holders of Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock or Common Stock, by reason of their ownership of such stock, an amount per share for each share of Series E-1 Preferred Stock held by them equal to $1.00.

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After the payment or setting aside for payment to the holders of Series F Preferred Stock, Series E Preferred Stock, Series D Preferred Stock and Series E-1 Preferred Stock of the preferential amounts specified above, the entire remaining proceeds legally available for distribution shall be distributed pro rata to the holders of Series F Preferred Stock, Series E Preferred Stock, Series D Preferred Stock and Common Stock in proportion to the number of shares of common stock held by them, assuming for purposes of the calculation that all outstanding shares of Series F Preferred Stock, Series E Preferred Stock and Series D Preferred Stock were converted into Common Stock at the conversion rate then in effect, provided, however, that the maximum aggregate amount per share that may be paid to a holder of Series F Preferred Stock, Series E Preferred Stock or Series D Preferred Stock in connection with a liquidation event will be three times the original issue price for such share.

Voting

Each holder of shares of Preferred Stock shall be entitled to the number of votes equal to the number of shares of Common Stock into which such shares of Preferred Stock could be converted and shall have voting rights and powers equal to the voting rights and powers of the Common Stock (except as otherwise expressly provided in Prosper’s Amended and Restated Certificate of Incorporation, as amended, or as required by law), voting together with the Common Stock as a single class, and shall be entitled to notice of any stockholders’ meeting in accordance with the Bylaws of Prosper. The holders of Preferred Stock shall vote as oneclass with the holders of the Common Stock except with respect to certain matters that require separate votes.

Common Stock

Prosper is authorized to issue up to 82,630,003 shares of common stock, $0.001 par value, of which 3,006,745 and 2,872,859 shares were issued and outstanding as of September 30, 2012, and December 31, 2011, respectively.  Each holder of common stock shall be entitled to one vote for each share of common stock held.

Common Stock Issued upon Exercise of Stock Options

For the nine months ended September 30, 2012 and 2011, the Company issued 133,886 and 100,416 shares of common stock, respectively, upon the exercise of options for cash proceeds of $18,996 and $21,083, respectively.

10. Stock Option Plan and Other Stock Compensation

In 2005, Prosper’s stockholders approved the adoption of the 2005 Stock Option Plan (the “Plan”). Under the Plan, options to purchase up to 1,879,468 shares of common stock were reserved and may be granted to employees, directors, and consultants by the Board of Directors to promote the success of Prosper’s business. During 2008, the Board of Directors increased the total number of options under the Plan by 500,000 for a total of 2,379,468 options available for grant. During 2009, the Board of Directors increased the total number of options under the Plan by an additional 500,000 for a total of 2,879,468 options available for grant. During 2010, the Board of Directors increased the total number of options under the Plan by an additional 6,109,321 for a total of 8,988,789 options available to grant. During 2011, the Board of Directors increased the total number of options under the Plan by an additional 4,550,875 for a total of 13,539,664 available for grant.  During 2012, the Board of Directors increased the total number of options under the Plan by an additional 1,700,000 for a total of 15,239,664 available for grant.

Incentive stock options are granted to employees at an exercise price not less than 100% of the fair value of Prosper’s common stock on the date of grant. Non-statutory stock options are granted to consultants and directors at an exercise price not less than 85% of the fair value of Prosper’s common stock on the date of grant. If options are granted to stockholders who hold 10% or more of Prosper’s common stock on the option grant date, then the exercise price shall not be less than 110% of the fair value of Prosper’s common stock on the date of grant. The fair value is based on a good faith estimate by the Board of Directors at the time of each grant. As there is no active trading market for these options, such estimate may ultimately differ from valuations completed by an independent party. The options generally vest over four years, which is the same as the performance period. In no event are options exercisable more than ten years after the date of grant.

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Option activity under the Option Plan is summarized as follows for the periods below:

	Options Issued and Outstanding			Weighted- Average Exercise Price
Balance as of January 1, 2011		5,766,859		$	0.30
Options granted (weighted average fair value of $0.13)		6,854,008		$	0.13
Options exercised		(100,416	)	$	0.21
Options canceled		(556,671	)	$	0.25
Balance as of September 30, 2011		11,963,780		$	0.37
Balance as of January 1, 2012		12,087,620		$	0.21
Options granted (weighted average fair value of $0.11)		2,887,959		$	0.17
Options exercised		(133,886	)	$	0.14
Options canceled		(1,927,494	)	$	0.22
Balance as of September 30, 2012		12,914,199		$	0.20
Options outstanding and exercisable at September 30, 2012		5,457,229		$	0.25

Other Information Regarding Stock Options

Additional information regarding common stock options outstanding as of September 30, 2012 is as follows:

	Options Outstanding								Options Exercisable
Range of Exercise  Prices	Number Outstanding		Weighted Avg. Remaining Life		Weighted Avg. Exercise Price		Intrinsic Value		Number Exercisable		Weighted Avg.  Exercise Price		Intrinsic Value
$0.12 - $0.12		4,261,739		8.94	$	0.12	$	213,087		1,172,090	$	0.12	$	58,605
$0.17 - $0.17		3,194,309		9.55		0.17		–		224,063		0.17		–
$0.20 - $0.20		4,704,802		7.81		0.20		–		3,372,624		0.20		–
$0.25 - $0.25		25,000		2.87		0.25		–		25,000		0.25		–
$0.50 - $0.50		284,117		4.08		0.50		–		284,117		0.50		–
$0.56 - $0.56		322,500		6.85		0.56		–		258,124		0.56		–
$1.94 - $1.94		96,732		6.26		1.94		–		96,211		1.94		–
$2.17 - $2.17		25,000		5.39		2.17		–		25,000		2.17		–
		12,914,199		8.48	$	0.20	$	213,087		5,457,229	$	0.25	$	58,605

The intrinsic value is calculated as the difference between the value of Prosper's common stock at September 30, 2012, which was $0.17 per share, and the exercise price of the options.

No compensation expense is recognized for unvested shares that are forfeited upon termination of service, and the stock-based compensation expense for the nine months ended September 30, 2012 and 2011 reflect the expenses that Prosper expects to recognize after the consideration of estimated forfeitures. Expected forfeitures of unvested options are estimated at the time of grant and reduce the recognized stock-based compensation expense. The forfeitures were estimated based on historical experience. The Company estimated its annual forfeiture rate to be 27.6% and 23.6% for the nine months ended September 30, 2012 and 2011, respectively.

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 The fair value of stock option awards for the nine months ended September 30, 2012 and 2011 was estimated as of the respective grant dates using the Black-Scholes model with the following average assumptions:

	Three Months Ended September 30,						Nine months Ended September 30,
	2012			2011			2012			2011
Volatility of common stock		75.0	%		79.38	%		76.20	%		77.59	%
Risk-free interest rate		0.72	%		0.74	%		0.86	%		0.87	%
Expected life*	5.1 years			4.5 years			5.0 years			4.5 years
Dividend yield		0	%		0	%		0	%		0	%
Weighted-average fair value of grants	$	0.10	%	$	0.12	%	$	0.10	%	$	0.13

*For nonemployee stock option awards, the expected life is the contractual term of the award, which is generally ten years.

Total stock-based compensation expense for employee and non-employee stock-option awards reflected in the statements of operations for the nine months ended September 30, 2012 and 2011 was approximately $272,300 and $235,400, respectively and $102,900 and $72,300 for the three months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, the unamortized stock-based compensation expense related to unvested stock-based awards was approximately $696,000 which will be recognized over the remaining vesting period of approximately 2.9 years.

11. Income Taxes

As part of the process of preparing the Company’s financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves determining the Company’s income tax expense (benefit) together with calculating the deferred income tax expense (benefit) related to temporary differences resulting from differing treatment of items, such as deferred revenue or deductibility of certain intangible assets, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the accompanying balance sheet. The Company must then assess the likelihood that the deferred tax assets will be recovered through the generation of future taxable income.

Due to the book and tax net losses incurred during the nine months ended September 30, 2012 and 2011, Prosper has not incurred any income tax expense during those periods.  In addition, Prosper has maintained a full valuation allowance against its net deferred tax assets because the realization of those deferred tax assets is dependent upon future earnings, and the amount and timing of those earnings, if any is uncertain.

12. Commitments and Contingencies

Future minimum lease payments and other commitments

Prosper leases its corporate office and co-location facility under non-cancelable operating leases that expire in July 2013 and August 2014, respectively. Prosper’s corporate office lease has the option to renew for an additional two years.  Future minimum rental payments under these leases as of September 30, 2012 are as follows:

Remaining three months ended December 31, 2012	$	134,257
Years ended December 31:
2013		368,913
2014		86,569
Total future operating lease obligations	$	589,739

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Rental expense under premises-operating lease arrangements was approximately $134,000 and $397,500 for the three and nine months ended September 30, 2012 and $106,000 and $325,000 for the corresponding periods during 2011, respectively.

The Company amended and restated an agreement with WebBank, a Utah-chartered industrial bank, under which all loans originated through the Prosper marketplace are made by WebBank under its bank charter. The arrangement allows for loans to be offered to borrowers at uniform nationwide terms. The Company is required to pay the greater of a monthly minimum fee or a fee calculated based on a certain percentage of monthly loan origination volume.

The Company has an agreement with a third party broker-dealer in which the third party agreed to operate and maintain the Note Trader Platform for the secondary trading of Borrower Payment Dependent Notes.  The Company is required to pay the third party broker-dealer an agreed upon monthly fee which equals the difference between the minimum monthly fee and the transaction fees collected by the third party provider during that month.

Securities Law Compliance

From inception through October 16, 2008, the Company sold approximately $178.1 million of loans to lender members through the old platform structure, whereby the Company assigned promissory notes directly to lender members. The Company did not register the offer and sale of the promissory notes corresponding to these loans under the Securities Act or under the registration or qualification provisions of any state securities laws. Prosper believes that the question of whether or not the operation of the platform during this period constituted an offer or sale of “securities” involved a complicated factual and legal analysis and was uncertain. If the sales of promissory notes offered through the platform during this period were viewed as a securities offering, the Company would have failed to comply with the registration and qualification requirements of federal and state laws and lender members who hold these promissory notes may be entitled to rescission of unpaid principal, plus statutory interest. Generally, the federal statute of limitations for noncompliance with the requirement to register securities under the Securities Act is one year from the violation, although the statute of limitations period under various state laws may be for a longer period of time.

The Company’s decision to restructure the platform and cease sales of promissory notes offered through the platform effective October 16, 2008 limited this contingent liability to the period covering its activities prior to October 16, 2008.

On April 21, 2009, the Company and the North American Securities Administrators Association (“NASAA”) reached agreement on the terms of a model consent order between the Company and the states in which the Company offered loan notes for sale prior to November 2008. The consent order involves payment by the Company of up to an aggregate of $1.0 million in penalties, which have been allocated among the states based on the Company’s loan sale transaction volume in each state prior to November 2008. A state that enters into a consent order receives its portion of the $1.0 million in exchange for its agreement to terminate, or refrain from initiating, any investigation of the Company’s note sale activities prior to November 2008.  Penalties are paid promptly after a state enters into a consent order. NASAA has recommended that each state enter into a consent order.  However, no state is obliged to do so, and there is no deadline by which a state must make its decision. The Company is not required to pay any portion of the penalty to those states that do not elect to enter into a consent order. If a state does not enter into a consent order, it is free to pursue its own remedies against the Company, subject to any applicable statute of limitations. As of September 30, 2012, the Company has entered into consent orders with 33 states and has paid an aggregate of $436,717 in penalties to those states, which were paid prior to 2012.

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As of September 30, 2012 and 2011, the Company had accrued approximately $277,000 in connection with the contingent liability associated with the states that have not entered into consent orders, in accordance with ASC Topic 450, Contingencies. The methodology applied to estimate the accrual was to divide the $1,000,000 maximum fee pro-rata by state, using the Company’s note sales from inception through November 2008. A weighting was then applied by state to each state that has not entered into a consent order, assigning a likelihood that the penalty will be claimed. In estimating the probability of a claim being made by a state, the Company considered factors such as the standard terms of the consent orders; whether the state ever gave any indication of concern regarding the sale of promissory notes through the platform; the probability of a state electing not to enter into a consent order in order to pursue its own litigation against the Company; whether the penalty is sufficient to compensate a state for the cost of processing the settlement consent order; and finally the impact that current economic conditions have had on state governments. The Company will continue to evaluate this accrual and related assumptions as new information becomes known.

On November 26, 2008, plaintiffs, Christian Hellum, William Barnwell and David Booth, individually and on behalf of all other plaintiffs similarly situated, filed a class action lawsuit against the Company and certain of its executive officers and directors in the Superior Court of California, County of San Francisco, California.  The suit was brought on behalf of all loan note purchasers on the platform from January 1, 2006 through October 14, 2008.  The lawsuit alleges that the Company offered and sold unqualified and unregistered securities in violation of the California and federal securities laws.  The lawsuit seeks class certification, damages and the right of rescission against the Company and the other named defendants, as well as treble damages against the Company and the award of attorneys’ fees, experts’ fees and costs, and pre-judgment and post-judgment interest.

On February 25, 2011, the plaintiffs filed a Third Amended Complaint, which removed David Booth as a plaintiff and added Brian Russom and Michael Del Greco as plaintiffs.  The new plaintiffs are representing the same putative class and prosecuting the same claims as the previously named plaintiffs. On February 29, 2012, the court granted the plaintiffs’ motion for class certification. The Company intends to vigorously defend the class action lawsuit.  The Company cannot, however, presently determine or estimate the final outcome of the lawsuit, and there can be no assurance that it will be finally resolved in the Company’s favor.  If the class action lawsuit is not resolved in the Company’s favor, the Company might be obliged to pay damages, and might be subject to such equitable relief as a court may determine.   Accordingly, the Company has not recorded an accrued loss contingency in connection with its sale of notes through the platform prior to November 2008. Accounting for loss contingencies involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: first, the amount can be reasonably estimated; and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements.

As of September 30, 2012, the class action lawsuit is in its preliminary stages and its probable outcome cannot presently be determined, nor can the amount of damages or other costs that might be borne by Prosper be estimated.

The Company’s insurance carrier with respect to the class action lawsuit, Greenwich Insurance Company (“Greenwich”), denied coverage.  On August 21, 2009, the Company filed suit against Greenwich in the Superior Court of California, County of San Francisco, California.  The lawsuit sought a declaration that the Company was entitled to coverage under its policy with Greenwich for losses arising out of the class action lawsuit as well as damages and the award of attorneys’ fees and pre- and post-judgment interest.

On January 26, 2011, the court issued a final statement of decision finding that Greenwich had a duty to defend the class action lawsuit, and requiring that Greenwich pay the Company's past and future defense costs in the class action suit up to $2.0 million.  

On July 1, 2011, the Company and Greenwich entered into a Stipulated Order of Judgment pursuant to which the Company agreed to dismiss its remaining claims against Greenwich.

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On August 12, 2011, Greenwich filed a notice of appeal of the court's decision regarding Greenwich’s duty to defend up to $2.0 million. On July 16, 2012, the California Court of Appeal affirmed the trial court’s decision.

As of September 30, 2012, Greenwich had made payments to the Company in the amount of $2.0 million to reimburse the Company for the defense costs it had incurred in the class action suit.  On October 2, 2012, subsequent to the balance sheet date of September 30, 2012, Greenwich made an additional payment of $142,585 to the Company for pre-judgment interest. As a result, Greenwich has now satisfied its obligations with respect to the Company’s defense costs for the Hellum suit. 

13. Related Parties

Prosper’s executive officers, directors and certain affiliates participate on the Company’s lending platform by placing bids and purchasing Notes originated on the platform.  The aggregate amount of loans purchased and the income earned by these related parties as of September 30, 2012 and 2011 are summarized below:

Related Party	Aggregate Amount of Loans Purchased				Interest Earned on Loans for the  Nine Months Ended,
	September 30,		September 30,		September 30,		September 30,
	2012		2011		2012		2011
Executive officers and management	$	227,318	$	1,521,268	$	13,247	$	61,987
Directors		3,127,127		652,789		223,231		13,511
Affiliates		-		1,139,597		-		60,446
	$	3,354,445	$	3,313,654	$	236,478	$	135,944

The Notes purchased by officers, directors and certain affiliates were obtained on the same terms and conditions as those obtained by other Note purchasers.  Of the total aggregate amount of Notes purchased by officers, directors and certain affiliates since inception approximately $148,200 or 4% and $178,600 or 5% of principal has been charged off through September 30, 2012 and 2011, respectively. Prosper earned approximately $12,400 and $6,200 of servicing fees revenue related to these Notes for the nine months ended September 30, 2012 and 2011, respectively.

14. Postretirement Benefit Plans

Prosper has a 401(k) plan that covers all employees meeting certain eligibility requirements. The 401(k) plan is designed to provide tax-deferred retirement benefits in accordance with the provisions of Section 401(k) of the Internal Revenue Code. Eligible employees may defer up to 90% of eligible compensation up to the annual maximum as determined by the Internal Revenue Service. Prosper’s contributions to the plan are discretionary. Prosper has not made any contributions to the plan to date.

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Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATION

This management’s discussion and analysis of financial condition and results of operations, or MD&A, contains forward-looking statements that involve risks and uncertainties. Please see “Forward-Looking Statements” in this Quarterly Report on Form 10-Q for a discussion of the uncertainties, risks and assumptions associated with these statements. This discussion should be read in conjunction with our historical consolidated financial statements and related notes thereto and the other disclosures contained elsewhere in this Quarterly Report on Form 10-Q. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those included elsewhere in this Quarterly Report on Form 10-Q and those included in the “Risk Factors” section and elsewhere in our Annual Report on Form 10-K.

Overview

We provide a peer-to-peer online credit marketplace that permits our borrower members to apply for loans and lender members to purchase Notes issued by Prosper, the proceeds of which facilitate the funding of specific loans to borrowers.  Our platform enables our borrower members to request and obtain personal, unsecured loans by posting anonymous “listings” on the platform indicating the principal amount of the desired loan.  Loan terms are subject to minimum and maximum loan amounts determined by the borrower’s credit bureau score and Prosper score, at interest rates set by Prosper.  We assign a Prosper Rating consisting of letter credit grades, based in part on the borrower’s credit score, to each borrower who requests a borrower loan.  Prosper borrower members’ Prosper Rating, credit score range, debt-to-income ratios and other credit data are displayed with their listings and are available for viewing by lender members on an anonymous basis.  Lender members access our platform and “bid” the amount they are willing to commit to the purchase of a Note that is dependent for payment on the corresponding borrower loan, at interest rates set by Prosper.  By making a bid on a listing, a lender member is committing to purchase from Prosper a Note in the principal amount of the lender’s bid.  Lender members who purchase the Notes will designate that the sale proceeds be applied to facilitate the funding of the corresponding borrower loan.  Loans originated to borrower members are made by WebBank, an FDIC-insured, Utah-chartered industrial bank, and sold and assigned to Prosper.

All loans requested and obtained by Prosper borrower members through our platform are unsecured obligations of individual borrower members with a fixed interest rate and a loan term currently set at one, three or five years.  After funding a loan, WebBank assigns the loan to Prosper, without recourse to WebBank, in exchange for the principal amount of the borrower loan.  WebBank does not have any obligation to purchasers of the Notes.  We verify the identity of 100% of our borrowers using a variety of methods including credit bureau data, other electronic data sources and offline documentary procedures.  We verify income and/or employment on a subset of borrowers based on a proprietary algorithm.  The intention of the algorithm is to verify income or employment in cases where the self-reported income of the borrower is highly determinative of the borrower’s  Prosper Rating.

We derive our operating revenue by charging a transaction fee or origination fee equal to a specified percentage of the principal amount of the borrower loan paid by the borrower upon funding of the loan. The transaction fee is paid to WebBank, and WebBank, in turn, pays Prosper amounts equal to the transaction fees as compensation for its loan origination activities. We also charge lender members a servicing fee equal to an annualized rate set at a percentage of the outstanding principal balance of the corresponding borrower loan, which we deduct from each lender member’s share of the borrower loan payments.

Our Operating History

We incorporated in Delaware in March 2005 and launched our public website, www.prosper.com on February 13, 2006.  As of September 30, 2012, our platform has facilitated 63,055 borrower loans since its launch totaling an aggregate principal amount of approximately $406,250,000.

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We made significant changes to the operation of our lending platform on July 13, 2009.  Prior to October 16, 2008, we purchased loans from WebBank and then sold and assigned the loans to the lender members who bid on the listings for those loans.  From October 16, 2008 through July 12, 2009, we ceased originating loans on our platform while we waited for the Securities and Exchange Commission to declare effective our registration statement on Form S-1 covering our origination activity.  Since July 13, 2009, we retain the loans and issue new securities, the Notes, to the winning lenders.  Our obligation to repay the Notes is conditioned upon the repayment of the associated borrower loan.  We expect to generate increased revenue from borrower origination fees and non-sufficient funds fees and lender members’ servicing fees as our transaction volume increases.  Over time, we expect that the number of borrowers and lender members and the volume of borrower loans originated through our platform will increase.

We have a limited operating history and have incurred net losses since our inception.  Our net loss was $3,986,784 and $2,420,537 for the three months ended September 30, 2012 and 2011, respectively and $11,608,254 and $5,941,094 for the nine months ended September 30, 2012 and 2011, respectively. We earn revenues primarily from borrower origination fees, non-sufficient funds fees and lender member service fees. At this stage of our development, we have funded our operations primarily with proceeds from equity financings, which are described below under “Liquidity and Capital Resources.”

Our operating plan calls for a continuation of the current strategy of increasing transaction volume to increase revenue until we reach profitability.  In addition, our 2012 operating plan calls for continued investment in the development of our website, loan servicing platform, loan scoring and marketing efforts. In 2013, our emphasis will be on using the investments in our website and platform to improve the costs to acquire loans and to improve scale and efficiency in each marketing channel. Loan acquisition expenses are expected to increase, but at a slower rate than revenues. As a result of the combination of origination revenue growth combined with efficiency gains in variable expenses, we expect to become cash flow positive in 2013.

Our historical financial results and this discussion reflect the structure of our lending platform and our operations both prior to and after July 13, 2009.  For a discussion of the effect of our new structure on our consolidated financial statements, see “Borrower Loans and Payment Dependent Notes” under “Critical Accounting Policies and Estimates” below.

Trends and Uncertainties

The peer-to-peer lending industry remains a very innovative and unique industry, and the application of federal and state laws in areas such as securities and consumer finance to our business is still evolving.  We will continue to monitor this evolution actively in order to identify and respond quickly to any legislative or regulatory developments that may impact our platform.

Through the first nine months of 2012, we have increased our origination volume in terms of both units and total dollar amounts.  We hope to continue this trend of growth through marketing efforts and continued implementation of new features on our website and platform so as to improve the borrower and lender experience.  For example, in 2012 we built a data exchange program that allows Prosper and its partners to exchange data in a manner that enables sophisticated lead generation, which we expect to increase qualified leads and the efficiency of marketing spend.  Also, we expect to increase our lender base as we attract and retain lender members through marketing efforts that establish our Notes as a viable investment alternative, providing improved investment search tools such as Auto Quick Invest and new methods of providing data exchange specific to lender member objectives.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which we have prepared in accordance with U.S. generally accepted accounting principles.  The preparation of financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and the related disclosures.  Prosper bases its estimates on historical experience and on various other assumptions that Prosper believes to be reasonable under the circumstances.  Actual results could differ from those estimates.  Our significant accounting policies which include repurchase obligation, revenue recognition, stock-based compensation, and income taxes are more fully described in Note 2 to our consolidated financial statements included elsewhere in this quarterly report.

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Critical accounting policies are those policies that we believe present the most complex or subjective measurements and have the most potential to impact our financial position and operating results.  While all

decisions regarding accounting policies are important, we believe that the following policies could be considered critical.

Fair Value Measurement

Under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 820 Fair Value Measurements and Disclosures, we determine the fair values of our financial instruments based on the fair value hierarchy established in that standard, which requires an entity to maximize the use of quoted prices and observable inputs and to minimize the use of unobservable inputs when measuring fair value. We use various valuation techniques depending on the nature of the financial instrument, including the use of market prices for identical or similar instruments, or discounted cash flow models.  When possible, active and observable market data for identical or similar financial instruments are utilized. Alternatively, we determine fair value using assumptions that we believe a market participant would use in pricing the asset or liability.

The Company’s financial instruments consist principally of cash and cash equivalents, restricted cash, short term investments, receivables, loans held for investment, borrower loans, accounts payable, accrued liabilities, and borrower payment dependent notes.  The estimated fair values of cash and cash equivalents, restricted cash, accounts payable, and accrued liabilities approximate their carrying values because of their short term nature.

We account for our short term investments, loans held for investment, borrower loans, and borrower payment dependent notes on a fair value basis. We believe, however, that borrower loans and borrower  payment dependent notes represent a pertinent element of our current quarter financial statement.  For additional information and discussion regarding our significant accounting policies surrounding fair value measurement, see Note 2, Note 3, and Note 4 to the consolidated financial statements included elsewhere in this report.

Borrower Loans and Borrower Payment Dependent Notes

On July 13, 2009, we implemented our new operating structure and began issuing Notes.  This operating structure resulted in Prosper purchasing loans from WebBank and holding the loans until maturity.  Prosper issues new securities, the Notes, to the winning lenders.  Prosper’s obligation to repay the Notes is conditioned upon the repayment of the associated borrower loan owned by Prosper.  As a result of these changes, Prosper carries the borrower loans and the Notes on its balance sheet as assets and liabilities, respectively.

In conjunction with our new operating structure, we adopted the provisions of ASC Topic 825, Financial Instruments.  ASC Topic 825 permits companies to choose to measure certain financial instruments and certain other items at fair value.  The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings.  We applied the provisions of ASC Topic 825 to the borrower loans and Notes issued subsequent to July 13, 2009 on an instrument by instrument basis.  We did not apply the provisions of ASC Topic 825 to loans issued prior to July 13, 2009.  The aggregate fair value of the borrower loans and Notes are reported as separate line items in the assets and liabilities sections of the balance sheet using the methods described in ASC Topic 820.

We determine the fair value of the borrower loans and Notes in accordance with the fair value hierarchy established in ASC Topic 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  As observable market prices are not available for the borrower loans and Notes we hold or for similar assets and liabilities, we believe the borrower loans and Notes should be considered Level 3 financial instruments under ASC Topic 820.  ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  

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In a hypothetical transaction as of the measurement date, we believe that differences in the principal marketplace in which the loans are originated and the principal marketplace in which we might offer those loans may result in differences between the originated amount of the loans and their fair value as of the transaction date. Changes in the fair value of borrower loans and Notes subject to the provisions of ASC Topic 820 are recognized in earnings; fees and costs associated with the origination or acquisition of borrower loans are recognized as incurred.  Prosper estimates the fair value of the borrower loans and Notes using a discounted cash flow methodology based upon a set of valuation assumptions Prosper believes market participants would use for similar assets and liabilities. The main assumptions used to value the borrower loans and Notes include default rates, discount rates applied to each credit tranche/grade, prepayment rates, and recovery rates.

Loss rate estimates will vary based on the age and credit grade of the underlying loan. We use historical delinquency status and default rates combined with current performance metrics to estimate the amount and timing of defaults.  During the quarter, the Company modified the estimated default assumptions to incorporate varying loss rates as the status of the loan progresses. For the remaining fair value assumptions, we used the following averages:

Monthly prepayment rate speed	1.60	%
Recovery rate	5.39	%
Discount rate *	9.97	%

* This is the weighted average discount rate among all of Prosper’s credit grades

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Key economic assumptions and the sensitivity of the current fair value to immediate adverse changes in those assumptions at September 30, 2012 for borrower loans and Notes are presented in the following table:

				Payment
	Borrower			Dependent
	Loans			Notes
Discount rate assumption:		9.97	%		9.97	%
Decrease in fair value and income (loss) to earnings from:
100 basis point increase	$	(1,743,366	)	$	(1,726,214	)
200 basis point increase		(3,440,493	)		(3,406,692	)
Increase in fair value and income (loss) to earnings from:
100 basis point decrease	$	1,791,355		$	1,773,786
200 basis point decrease		3,632,844			3,597,266
Default rate assumption:
Decrease in fair value and income (loss) to earnings from:
10% higher default rates	$	(1,209,891	)	$	(1,197,697	)
20% higher default rates		(2,419,847	)		(2,395,340	)
Increase in fair value  and income (loss) to earnings from:
10% lower default rates	$	1,209,945		$	1,197,589
20% lower default rates		2,419,854			2,395,311

Overall, if the fair value of the borrower loans decrease or increase due to any changes in our assumptions, there will also be a corresponding decrease or increase in the fair value of the linked Notes. As a result, the effect on Prosper’s earnings of adverse changes in key assumptions is mitigated. However, the impact of these changes in fair value could have a material adverse impact on lender members’ investments in the Notes.

As we receive scheduled payments of principal and interest on the borrower loans we will in turn make principal and interest payments on the Notes.  These principal payments will reduce the carrying value of the borrower loans and Notes.  If we do not receive payments on the borrower loans, we are not obligated to and will not make payments on the Notes.  The fair value of a Note is approximately equal to the fair value of the corresponding borrower loan, less the 1.0% service fee.  If the fair value of the borrower loan decreases due to our expectation regarding both the likelihood of default of the loan and the amount of loss in the event of default, there will also be a corresponding decrease in the fair value of the Note (an unrealized gain related to the Note and an unrealized loss related to the borrower loan).

For additional information and discussion, see Note 2 and Note 3 to the consolidated financial statements, included elsewhere in this report.

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Results of Operations

Revenues

Origination Fees

Our borrowers pay an origination fee upon successful funding of the borrower loan.  The origination fee is paid by the borrower out of the proceeds of the borrower loan at the time of funding.  We charge an origination fee equal to a specified percentage of the aggregate principal balance of the loan based on the Prosper Rating of the loan.  Origination fees are charged by WebBank, which pays these fees to Prosper as compensation for our marketing and underwriting activities. 

From our re-launch in July 2009 to April 11, 2012, our origination fees were as follows:

	Origination Fee Percentage		Origination Fee Percentage		Origination Fee Percentage
Prosper Rating	(July 2009-July 2010)		(July 2010-Nov 2011)		(Nov 2011-Apr 11, 2012)
AA		0.50%		0.50%		0.50%
A-B		3.00%*		3.00%**		3.95%
C-HR		3.00%*		4.50%**		4.95%

*Subject to $50 minimum fee through July 2010

**Subject to $75 minimum fee July 2010 through December 20, 2010, minimum fee eliminated December 20, 2010 for all loan listings

From April 12, 2012 to September 30, 2012, our origination fees were as follows:

Prosper Rating	Origination Fee Percentage (1 year)		Origination Fee Percentage (3 year)		Origination Fee Percentage (5 year)
AA		0.50%		1.95%		4.95%
A		1.95%		3.95%		4.95%
B		2.95%		4.95%		4.95%
C-HR		3.95%		4.95%		4.95%

Origination fees for the three and nine months ended September 30, 2012 were $2.1 million and $5.2 million, respectively, representing an increase of 173% and 198%, as compared to $762.0 thousand and $1.8 million for the three and nine months ended September 30, 2011, respectively. Origination volume has grown steadily in 2012 as a result of our efforts to develop additional direct partnerships with other websites that send us qualified individuals seeking loans, and brand development work that increases potential borrower awareness of Prosper as a lending alternative.

Origination Volume

During the three months ended September 30, 2012, a total of 5,632 loans amounting to $45.0 million were originated through the Company’s platform and during the nine months ended September 30, 2012, a total of 15,128 loans amounting to $116.1 million were originated through the platform. In comparison, during the three months ended September 30, 2011, a total of 3,093 loans amounting to $20.2 million were originated through the platform, and during the nine months ended on September 30, 2011, a total of 7,315 loans amounting to $47.9 million were originated through the platform. For the three months ended September 30, 2012, this represented a “unit,” or loan, increase of 82% and a dollar increase of 123%.  For the nine months ended September 30, 2012, this represented a “unit,” or loan, increase of 107% and a dollar increase of 142%.

The graph below shows quarterly originations in volume through our platform dating back to January 2010 and the steady origination growth we have experienced through September 30, 2012.

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The steady increase in volume is primarily due to improvements in operating efficiency and an increase in marketing and borrower and lender promotions.  Our increase in marketing efforts related to affiliate, online, and brand marketing have helped steadily increase our borrower listing and lender membership volume.  We continue to leverage our existing lender and borrower base and have seen an increase in the reinvestment of investor funds and additional capital being placed on the platform by existing investors as well as borrowers securing second loans.  We have also focused sales effort to attract additional capital through lender outreach programs.

Interest Income on Borrower Loans and Payment Dependent Notes

We recognize interest income on our borrower loans using the accrual method based on the stated interest rate to the extent that we believe it to be collectable.  We record interest expense on the corresponding Note based on the contractual interest rate.

Gross interest income earned and gross interest expense incurred were approximately $5.0 million and $4.7 million, respectively, for the three months ended September 30, 2012, resulting in net interest income of $311.0 thousand.  Gross interest income earned and gross interest expense incurred were approximately $2.7 million and $2.5 million, respectively, for the three months ended September 30, 2011, resulting in net interest income of approximately $153.9 thousand.  Gross interest income earned and gross interest expense incurred were approximately $15.4 million and $14.6 million, respectively, for the nine months ended September 30, 2012, resulting in net interest income of approximately $819.0 thousand.  Gross interest income earned and gross interest expense incurred were approximately $6.1 million and $5.8 million, respectively, for the nine months ended September 30, 2011, resulting in net interest income of approximately $338.6 thousand.  Overall net interest income for the above mentioned periods is driven by the rise in the amount of loans that we originate and service at any given point.  As discussed above, our origination volume has increased steadily since the corresponding prior period, which resulted in increases to our gross interest income and expense and ultimately our net interest income.  Over time, we expect that revenues and expenses related to borrower loans and Notes will increase as total loans and note originations grow.

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Rebates and Promotions

We account for rebates and promotions in accordance with ASC Topic 605, Revenue Recognition.  From time to time we offer rebates and promotions to our borrower and lender members.  We record these rebates and promotions as an offset to revenue if a particular rebate or promotion is associated with loan origination volume. Our rebate and promotions have in the past been in the form of cash back and other incentives paid to lender and borrowers.

For the three months ended September 30, 2012 and September 30, 2011, we incurred expenses related to rebates and promotions extended to borrowers and lenders of $454.9 thousand and $314.3 thousand, respectively, which represented an increase of $140.6 thousand.  For the nine months ended September 30, 2012 and September 30, 2011, we incurred expenses related to rebates and promotions extended to borrowers and lenders of $1.0 million and $759.3 thousand, respectively, which represented an increase of $245.0 thousand.  This is due to the increased frequency and volume of our rebates and promotion during the nine months of 2012 as compared to the first nine months of 2011 in order to incent borrowers and lenders.

Cost of Revenues

Cost of Services

       Cost of services consists primarily of credit bureau fees, payments to strategic partners, and other expenses directly related to loan funding and servicing. Cost of services expenses were $375.0 thousand for the three months ended September 30, 2012, representing an increase of 24% as compared to $303.0 thousand for the three months ended September 30, 2011. Cost of service expenses were $1.1 million for the nine months ended September 30, 2012, an increase of 17%, as compared to $899.0 thousand for the nine months ended September 30, 2011. The primary driver for the increase in our cost of service expense during these periods was an increase in credit bureau fees resulting from an increase in loan listing volume.

Loan and Note Repurchases

Under the terms of the Notes, we may, in certain circumstances, become obligated to repurchase a Note from a lender.  Generally these circumstances include the occurrence of verifiable identity theft, our failure to properly follow loan listing or bidding protocols, a violation of the applicable federal/state/local lending laws.  We accrue a provision for these potential repurchase obligations when the Notes are sold to the lender members in an amount considered appropriate to reserve for our potential repurchase obligation.  The repurchase obligation is evaluated at least once a quarter and represents an estimate based on the rate of historical repurchases as a percentage of originations (which generally occur within six to nine months of origination).  The repurchase obligation may include a judgmental management adjustment due to our limited operating history, changes in current economic conditions, the risk of new and as of yet undetected fraud schemes, origination unit and dollar volumes and the lack of industry comparable.  We increased our repurchase obligation to $35.5 thousand at September 30, 2012 compared to $22.2 thousand at September 30, 2011.  This increase reflects an increase in the estimate for investor indemnification and repurchases consistent with our increased loan originations. Through the first nine months of 2012 we repurchased a single Note upon the recent notification by law enforcement authorities of an identification related fraud for a loan originated in 2007. We continue to devote a significant amount of attention to fraud prevention and will continue to enhance our fraud control procedures to maintain a low level of repurchases.

Other Income

Change in Fair Value on Borrower Loans, Loans Held for Investment and Payment Dependent Notes, net

Under the methods described in ASC Topic 820, Fair Value Measurements and Disclosures, we elected to account for unrealized gains or losses on the borrower loans and borrower payment dependent notes on a fair value basis.  These amounts are included as a component of other income (expense) in our statement of operations.  The total fair value adjustment for the borrower loans and loans held for investment was an increase of $1.8 million offset by an increase of $1.5 million in the fair value of our Notes resulting in a net unrealized gain of $316.0 thousand for the three months ended September 30, 2012.  The total fair value adjustment for the borrower loans and loans held for investment was an increase of $1.1 million offset by an increase of $1.5 million in the fair value of our Notes resulting in a net unrealized gain of $390.5 thousand for the three months ended September 30, 2011.  The total fair value adjustment for the borrower loans and loans held for investment was an increase of $2.9 million offset by an increase of $2.1 million in the fair value of our Notes resulting in a net unrealized gain of $835.8 thousand for the nine months ended September 30, 2012.  The total fair value adjustment for the borrower loans and loans held for investment was an increase of $2.2 million offset by an increase of $1.3 million in the fair value of our Notes resulting in a net unrealized gain of $866.0 thousand for the nine months ended September 30, 2011.

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Insurance recoveries

As noted in Note 12 to the unaudited financial statements, Prosper and certain of its executive officers and directors are the subject of a class action lawsuit brought on behalf of all loan note purchasers on the platform from January 1, 2006 through October 14, 2008 that alleges that we offered and sold unqualified and unregistered securities in violation of the California and federal securities law. During the first quarter of 2011 the Superior Court of California issued a final statement of decision finding that Greenwich Insurance Company, our insurance carrier with respect to our class action lawsuit, had a duty to defend the suit and requiring that Greenwich pay Prosper's past and future defense costs in the suit up to $2.0 million.  During 2011, Greenwich made aggregate payments to us in the amount of $2.0 million to reimburse us for the defense costs we had incurred in the class action suit.  There were no insurance reimbursements received during the nine months ended September 30, 2012.  On October 2, 2012, subsequent to the balance sheet date of September 30, 2012, Greenwich made an additional payment of $142,585 to the Company for pre-judgment interest. Please see our Note 12 “Commitment and Contingencies” in the notes to our consolidated financial statements contained elsewhere in this report for further information related to this payment.

Other Income

Other income consists primarily of credit referral fees, where partner companies pay us an agreed upon amount for referrals of customers from our website.  Other income was $144.6 thousand for the three months ended September 30, 2012, which represented an increase of 468% over the corresponding prior year period.  Other income was $235.2 thousand for the nine months ended September 30, 2012, which represented an increase of 254% over the corresponding prior year period.  The increase in other income during these periods was due to the addition of a number of new partners as well as increased traffic to existing credit referral partners.

Operating Expenses

Compensation and benefits were $2.8 million and $7.6 million for the three and nine months ended September 30, 2012, respectively, which represented an increase of $1.0 million and $2.7 million over the corresponding periods in 2011. The increase was largely due to the Company steadily increasing its employee headcount in the first nine months of 2012, which in turn resulted in increased staffing costs such as salary and wages, payroll taxes, healthcare, accrued vacation and bonus compensation.  In particular, we increased our headcount across our engineering, operations, and administrative teams to respond to increased volume demands.  As of September 30, 2012, we had 68 full time employees compared to 53 full time employees as of September 30, 2011.  Among our employees as of September 30, 2012, our sales and marketing team had 17 employees, our engineering team had 19 employees, our operations team had 19 employees, and our administrative team had 13 employees. We intend to continue to increase headcount as we grow our lender and borrower bases and carry out our business plan, however, we expect our current investment in our lending platform and website to improve our operating expense efficiency going forward. 

Marketing and advertising costs consist primarily of online affiliate marketing, search engine marketing, online and offline campaigns, and public relations. Marketing and advertising costs were $1.6 million for the three months ended September 30, 2012 as compared to $375.2 thousand for the three months ended September 30, 2011, representing an increase of $1.2 million. Marketing and advertising costs were $4 million for the nine months ended September 31, 2012 as compared to $1.2 million for the nine months ended September 30, 2011, representing an increase of $2.8 million. The costs associated with search engine marketing are specifically related to increased volume and systematic testing to attract new borrowers through Google and other search engines.  The affiliate marketing expense is deployed through direct partnerships with other websites that send to us qualified individuals seeking loan options.  Other marketing costs are associated with online advertising campaigns specifically targeted at attracting new lenders to the platform and brand development work.  Each marketing effort is measured, analyzed and optimized to improve scale and efficiency in each channel.  Through optimization of targeting efforts we will shift marketing costs to efficient channels to balance the mix of growth and efficiency in our marketing activities in subsequent quarters.

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Depreciation and amortization expense was $166.7 thousand for the three months ended September 30, 2012, an increase of 46% from the $114.5 thousand expense for the three months ended September 30, 2011.  Depreciation and amortization expense was $493.0 thousand for the nine months ended September 30, 2012, an increase of 42%, from the $347.8 thousand expense for the nine months ended September 30, 2011.  This increase is mostly due to the capitalization of various internally developed software projects placed in service during the last year, which in turn increased depreciation expense taken on those assets during the first nine months of 2012. 

General and Administrative Expenses

Professional service expenses are comprised of legal expenses, audit and accounting fees, consulting services, and other outside costs.  For the three months ended September 30, 2012 professional service expenses were $863.2 thousand, a 76% increase from the $489.2 thousand expense for the three months ended September 30, 2011. For the nine months ended September 30, 2012 professional service expenses were $2.5 million, a 53% increase from the $1.6 million expense for the nine months ended September 30, 2011. The overall increase for professional service expenses as compared to the prior year period was due to a large increase in legal expenses related to the formation of Prosper Funding LLC, a Delaware limited liability company (“PFL”), and the preparation and filing of a registration statement for PFL, which is intended to allow us to begin offering borrower payment dependent notes through PFL instead of Prosper.

Facilities and maintenance expenses consist primarily of rents paid for our corporate office lease and data co-location facility, software licenses and subscriptions, office supplies and expenses, repairs and maintenance expense and equipment and software costs that did not meet capitalization criteria. Facilities and maintenance expenses for the three months ended September 30, 2012 were $302.0 thousand, an increase of 53% relative to the $197.0 thousand cost corresponding to the prior year period. Facilities and maintenance expenses for the nine months ended September 30, 2012 were $927.0 thousand, an increase of 77% relative to the $523.0 thousand cost corresponding to the prior year period. These increases were primarily due to higher general facility costs caused by the expansion of our corporate office facilities, and additional software licenses and subscriptions.

Other general and administrative expenses consist of bank service charges, dues and subscriptions, insurance costs, travel and entertainment expenses, taxes and licenses costs, communications costs, recruiting costs and administrative expenses.   For the three months ended September 30, 2012, other general administrative expenses were $319.6 thousand, an increase of $110.0 thousand, as compared to the $210.0 thousand cost for the three months ended September 30, 2011.  For the nine months ended September 30, 2012, other general administrative expenses were $1.2 million, an increase of $523.9 thousand, as compared to $645.8 thousand for the nine months ended September 30, 2011.  The increase for the three and nine months ended September 30, 2012 was primarily due to the expansion of our business which resulted in higher banking and insurance costs, state licensing fees related to the formation of PFL, and recruiting fees for new employees.

Liquidity and Capital Resources

We have incurred operating losses since our inception and we anticipate that we will continue to incur net losses through the end of 2012.  We had negative cash flows from operations of $11.7 million and $6.7 million for the nine months ended September 30, 2012 and 2011, respectively.  As reflected in the accompanying consolidated financial statements, Prosper has incurred net losses and negative cash flows from operations since inception, and has an accumulated deficit of approximately $72.4 million as of September 30, 2012.

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At September 30, 2012, the Company had approximately $8.0 million in available cash and cash equivalents and short term investments.  Since its inception, Prosper has financed its operations primarily through equity financing from various sources. The Company is dependent upon raising additional capital or debt financing to fund its current operating plan, however we believe that our current cash position is sufficient to meet our current liquidity needs.

Net cash used in operating activities during the first nine months of 2012 and 2011 was $11.7 million and $6.7 million, respectively and $3.3 million and $2.9 million for the three months ended September 30, 2012 and 2011, respectively.  The increase in cash used in operating activities was used to fund ongoing operations to improve our borrower and lender customer experience on our lending platform and resulted in increased compensation and benefit expenses, particularly in our engineering and operations teams. As our business expanded we also incurred increased legal and accounting services and marketing expenses. We expect our efforts to improve our cost efficiency to generate greater increases in origination revenue and reduce our ongoing cash requirements.

Net cash used in investing activities during the first nine months of 2012 and 2011 was $64.5 million and $32.0 million, respectively. The increase in cash used is primarily related to increased borrower loan originations and payments in 2012 which totaled $116.1 million and $46.3 million. In addition, net cash used in investing activities included purchases of short term investments of approximately $3.0 million, maturities of short term investments of $9.0 million, the origination of $164.0 thousand in loans held for investment, repayments of $93.9 thousand related to loans held for investment. By comparison, in the first nine months of 2011, loan originations and repayments totaled $47.9 million and $16.9 million.

Net cash used in investing activities for the three months ended September 30, 2012 was $24.1 million which consisted of $45.1 million in borrower loan originations offset by $18.3 million in borrower loan principal repayments, maturities of short term investments totaling $3 million, the origination of $6.4 thousand in loans held for investment, repayments of $31.6 thousand related to loans held for investment, and purchases of property and equipment of $290.5 thousand.

Net cash provided by financing activities was $71.0 million and $48.0 million for the nine months ended September 30, 2012 and 2011, respectively.  The increase in cash provided is related to increased note issuances which provide the funding for the issuance of borrower loans. Net cash provided by the proceeds from the issuance of notes was $116.1 million and was offset by payments of $45.2 million on notes. In addition, cash from financing activities included, proceeds from the issuance of common stock of $19.0 thousand.  By comparison, in 2011 net cash provided by financing activities included the net proceeds from the issuance of convertible preferred stock of $16.7 million and common stock of $39.1 thousand. Cash provided by note issuances totaled $47.9 million was offset by payments of $16.4 million and the repayment of a note payable of $300.0 thousand.

Net cash provided by financing activities for the three months ended September 30, 2012 was $27.2 million which consisted of proceeds from the issuance of notes held at fair value of $45.1 million, proceeds from the issuance of common stock of $16.0 thousand, offset by $17.8 million in payment of notes held at fair value.

As discussed in Note 12 of our consolidated financial statements, “Commitments and Contingencies,” contained elsewhere in this report, and in the “Insurance Recoveries” section above, as of September 30, 2012, Greenwich had made payments to the Company in the amount of $2.0 million to reimburse the Company for the defense costs it had incurred in the class action suit.  On October 2, 2012, subsequent to the balance sheet dated September 30, 2012, Greenwich made an additional payment of $142,585 to the Company for pre-judgment interest. As a result, Greenwich has now satisfied its obligations with respect to the Company’s defense costs for the Hellum suit. 

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With regard to the class action lawsuit, Prosper cannot presently determine or estimate the final outcome of the lawsuit, and there can be no assurance that it will be finally resolved in our favor. If the class action lawsuit is not resolved in our favor, Prosper may be obliged to pay damages, and might be subject to such equitable relief as a court may determine. Accordingly, the Company has not recorded an accrued loss contingency in connection with the sale of promissory notes to lender members. Accounting for loss contingencies involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: first, the amount can be reasonably estimated; and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the consolidated financial statements.  Based on this standard, Prosper currently is unable to reasonably estimate the amount of loss, if any, that could arise in connection with this lawsuit. We will continue to evaluate these matters based on subsequent events, new information and future circumstances.  For more information, see Note 12 of our financial statements located elsewhere in this report.

Since our inception, inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.

Income Taxes

We incurred no income tax provision for the three and nine months ended September 30, 2012 and 2011.   Given our history of operating losses and inability to achieve profitable operations, it is difficult to accurately forecast how our results will be affected by the realization and use of net operating loss carry forwards.

ASC Topic 740, Income Taxes provides for the recognition of deferred tax assets if realization of such assets is more likely than not.  Based upon the weight of available evidence, which includes our historical operating performance and the reported cumulative net losses in all prior years, we have provided a full valuation allowance against our net deferred tax assets.  We will continue to evaluate our ability to realize the deferred tax assets on a quarterly basis.

Off-Balance Sheet Arrangements

In February 2012, we formed Prosper Funding LLC, a Delaware limited liability company (“PFL”). We are the sole member of PFL and its accounts have been included in the consolidated financial statements presented in this report. PFL has been organized and will be operated in a manner that is intended to minimize the likelihood that it will (i) become subject to bankruptcy proceedings or (ii) be substantively consolidated with the Company, and thus have its assets subject to claims by the Company’s creditors, in the event the Company becomes subject to a bankruptcy proceeding. We intended to restructure the platform so borrower loans are held by PFL and PFL issues and sells the borrower payment dependent notes tied to the loans. On March 7, 2012, PFL filed a registration statement on Form S-1 with the SEC for a continuous offering and sale of such notes, which remains under review by the SEC and has not yet been declared effective. Prosper Funding LLC has not commenced operations as of the date of this report.

Additional Information about the Prosper Marketplace Loan Platform

Comparing Estimated Loss Rates to Actual Losses

Loan performance is reviewed on a monthly basis to determine how loss estimates compare to the actual performance of loans. Actual performance relative to expectations is a major factor when deciding on adjustments to loss expectations going forward. The graphs below show the expected versus actual cumulative dollar loss rates by Prosper Rating for PMI Borrower Loans booked from July 13, 2009 through December 31, 2011. Performance is as of September 30, 2012. Loss performance is tracked by vintage and the rating segments shown are those that appeared on the note at the time it was funded. The graphs include quarterly and semi-annual vintages where all PMI Borrower Loans originated during that period have been outstanding at least 12 months.

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The plot below shows the vintage cumulative losses of all loans originated during the period of interest and compares those losses to an origination-dollar weighted average expectation.

The remaining plots show the actual vintage performance within each Prosper Rating grade. The rating segments are divided according to the rating that the loan was given at the point it was originated. All loans underwritten on the platform for the period of interest are shown.

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Note: Expectation line reflects the weighted average expected loss rate across all vintages at the time of origination

In aggregate, actual losses for each vintage and Prosper Rating have been well-calibrated relative to our expectations.  Some vintages came in slightly higher than expectations and some slightly lower, but there have not been any instances of losses systemically or materially deviating from expectations.  We track loan performance relative to our estimates regularly and adjust those estimates to the extent we deem appropriate to more accurately reflect anticipated deviations from historical performance that may arise due to changes in the macro-economic or competitive environment. But we have not made any fundamental changes to our methodology for estimating loss rates or calculating Prosper Ratings based on any such review. Please note that the historical performance of PMI Borrower Loans may not be indicative of the future performance of Prosper Funding borrower loans.

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Loan Originations

The tables below show loan volume, average loan size, average lender yield, average credit scores and other pertinent data by Prosper Rating for originations from July 13, 2009 to September 30, 2012:

Prosper Rating	Number		Amount		Average Loan Size		Dollar Percentage
AA		2,182		21,007,369		9,628		9	%
A		5,018		44,642,178		8,896		20	%
B		4,807		40,447,550		8,414		18	%
C		4,869		36,589,969		7,515		16	%
D		7,396		46,703,452		6,315		20	%
E		4,622		20,076,700		4,344		9	%
HR		5,148		17,645,779		3,428		8	%
Total		34,042	$	227,112,997	$	6,672		100	%

Prosper Rating	Weighted Average Borrower Rate			Weighted Average Estimated Loss			Weighted Average Lender Yield			Average Experian ScorexPlus Score		Weighted Average Borrower APR
AA		8.76	%		1.36	%		7.76	%		802		9.51	%
A		11.84	%		2.88	%		10.84	%		753		14.20	%
B		16.88	%		5.47	%		15.88	%		718		19.48	%
C		21.72	%		7.90	%		20.72	%		707		24.86	%
D		26.05	%		10.74	%		25.05	%		694		29.41	%
E		31.15	%		14.37	%		30.15	%		671		34.96	%
HR		31.89	%		17.71	%		30.89	%		688		35.67	%
Total		20.23	%		7.79	%		19.23	%		711		23.06	%

The tables below show loan volume, average loan size, average lender yield, average credit scores and other pertinent data by Prosper Rating for originations from July 1, 2012 to September 30, 2012:

Prosper Rating		Number		Amount		Average Loan Size		Dollar Percentage
	AA		321	$	4,565,443		14,223		10	%
	A		789		8,623,695		10,930		19	%
	B		768		7,581,645		9,872		17	%
	C		1,117		9,964,052		8,920		22	%
	D		1,006		8,447,370		8,397		19	%
	E		538		2,072,000		3,851		5	%
	HR		1,093		3,820,259		3,495		8	%
	Total		5,632	$	45,074,464		8,003		100	%

Prosper Rating		Weighted Average Borrower Rate			Weighted Average Estimated Loss			Weighted Average Lender Yield			Average Experian ScorexPlus Score		Weighted Average Borrower APR
	AA		9.36	%		1.39	%		8.36	%		792		11.07	%
	A		12.57	%		2.92	%		11.57	%		747		15.17	%
	B		17.63	%		5.32	%		16.63	%		712		20.81	%
	C		21.88	%		7.80	%		20.88	%		708		25.07	%
	D		25.41	%		10.56	%		24.41	%		694		28.68	%
	E		29.85	%		14.23	%		28.85	%		673		33.66	%
	HR		31.77	%		16.55	%		30.77	%		692		35.80	%
	Total		19.98	%		7.35	%		18.98	%		710		23.02	%

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable for smaller reporting companies.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and we are required to apply our judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Exchange Act Rule 15d-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal quarter covered by this report. Based on the foregoing, principal executive officer and our principal financial officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level. 

There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

The discussion of the NASAA settlement agreement, the class action lawsuit and our suit involving our insurance carrier with respect to the class action lawsuit, set forth in “Note 12. Commitments and Contingencies” of the Notes to the consolidated Financial Statements contained in Part I, Item 1 of this report is incorporated herein by reference.  From time to time, we may be involved in various legal proceedings arising in the ordinary course of our business. While any litigation contains an element of uncertainty, management believes that the outcome of all pending legal proceedings will not have a material adverse effect on our consolidated results of operation or financial position. However, because of the nature and inherent uncertainties of litigation, should the outcome of any legal actions be unfavorable, we may be required to pay damages and other expenses, which could have a material adverse effect on our consolidated financial position and results of operations.    We are not currently subject to any material legal proceedings other than the matters referenced above.  Except for those matters, we are not aware of any litigation matters which have had, or are expected to have, a material adverse effect on us.

Item 1A. Risk Factors.

Not Applicable for smaller reporting companies

Item 2. Unregistered Sale of Equity Securities and Use of Proceeds.

On July 13, 2009, we commenced a public offering of up to $500,000,000 in principal amount of our Borrower Payment Dependent Notes pursuant to a Registration Statement on Form S-1 (File No. 333-147019). The offering is a continuous offering and remains ongoing. The registration statement was declared effective by the SEC on July 10, 2009.  From July 13, 2009 to September 30, 2012, we sold $227,112,997 in principal amount of Notes at 100% of their principal amount.  The Notes are offered only through our website, and there are no underwriters or underwriting discounts.  We have incurred estimated expenses of approximately $2,305,000 in connection with the offering, none of which are being paid by us to our directors, officers, persons owning 10% or more of any class of our equity securities or affiliates. As set forth in the prospectus for the offering, we are using the proceeds of each series of Notes to fund a borrower loan through our platform designated by the lender members purchasing such series of Notes. None of the proceeds from the Notes are paid by us to our directors, officers, persons owning 10% or more of any class of our equity securities or affiliates.

Item 3. Defaults upon Senior Securities

Not applicable.

Item4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits.

The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as a part of this report and such Exhibit Index is incorporated herein by reference.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Prosper Marketplace, Inc.
Date: November 07, 2012	By:	/s/ Dawn G. Lepore
		Name:     Dawn G. Lepore
		Title:       Chiief Executive Officer
		(Principal Executive Officer)

	Prosper Marketplace, Inc.
Date: November 07, 2012	By:	/s/ Daniel P. Sanford
		Name:     Daniel P. Sanford
		Title:       SVP, Finance
		(Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit
Number	Exhibit Description
31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, with respect to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012.
31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, with respect to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012.
32.1	Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, with respect to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012.
101.INS	XBRL Instance Documents
101.SCH	XBRL  Taxonomy Extension Schema Document
101.CAL	Taxonomy Extension Calculation Linkbase Document
101.LAB	Taxonomy Extension Label Linkbase Document
101.PRE	Taxonomy Extension Presentation Linkbase Document
101.DEF	Taxonomy Extension Definition Linkbase Document

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