F-1 1 d146303df1.htm FORM F-1 Form F-1
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As filed with the Securities and Exchange Commission on March 31, 2017.

Registration Statement No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

China Rapid Finance Limited

(Exact name of Registrant as specified in its charter)

 

 

Not Applicable

(Translation of Registrant’s name into English)

 

 

 

Cayman Islands   6199   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

5th Floor, Building D, BenQ Plaza

207 Songhong Road

Changning District, Shanghai 200335

People’s Republic of China

+86-21-6032-5999

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

 

 

Corporation Service Company

1180 Avenue of the Americas, Suite 210

New York, New York 10036

(800) 927-9801

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Alan Seem, Esq.

Shearman & Sterling LLP

1460 El Camino Real, 2nd Floor

Menlo Park, California 94025-4110

(650) 838-3600

 

Adam Fleisher

Cleary Gottlieb Steen & Hamilton LLP

One Liberty Plaza

New York, New York 10006

(212) 225-2000

 

Robert K. Williams

Cleary Gottlieb Steen & Hamilton LLP

c/o 37th Floor, Hysan Place

500 Hennessy Road

Causeway Bay, Hong Kong

+ (852) 2521 4122

 

 

Approximate date of commencement of proposed sale to the public: as soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of

securities to be registered

 

Proposed

maximum aggregate

offering price(2)(3)

 

Amount of

registration fee

Class A Ordinary Shares, par value $0.0001 per share(1)

  $100,000,000   $11,590

 

 

(1) American depositary shares issuable upon deposit of Class A ordinary shares registered hereby will be registered under a separate registration statement on Form F-6 (Registration No. 333-            ). Each American depositary share represents              Class A ordinary shares.
(2) Includes              Class A ordinary shares that are issuable upon the exercise of the underwriters’ over-allotment option. Also includes Class A ordinary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public. These Class A ordinary shares are not being registered for the purpose of sales outside the United States.
(3) Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(o) under the Securities Act of 1933.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion)

Issued             , 2017

                American Depositary Shares

 

LOGO

China Rapid Finance Limited

Representing              Class A Ordinary Shares

 

 

China Rapid Finance Limited is offering              American depositary shares, or ADSs. Each ADS represents              Class A ordinary shares, par value US$0.0001 per share. This is our initial public offering and no public market currently exists for our ADSs or shares. We anticipate the initial public offering price of our ADSs will be between US$             and US$             per ADS.

We are an “emerging growth company” under applicable U.S. federal securities laws and are eligible for reduced public company reporting requirements.

 

 

Our ADSs have been approved for listing on the New York Stock Exchange under the symbol “XRF.”

 

 

Investing in the ADSs involves risks. See “Risk Factors” beginning on page 14.

 

 

PRICE US$             AN ADS

 

 

 

    

Per ADS

    

Total

 

Initial public offering price

   $                   $               

Underwriting discounts and commissions(1)

   $      $  

Proceeds, before expenses, to us

   $      $  

 

(1) See “Underwriting” for additional information regarding underwriting compensation.

We have granted the underwriters the right to purchase up to              additional ADSs from us and to cover over-allotments within 30 days after the date of this prospectus.

Following the completion of this offering, our outstanding share capital will consist of Class A ordinary shares and Class B ordinary shares. The Class B Holders will be deemed to beneficially own all of our issued Class B ordinary shares and will be able to exercise approximately             % of the total voting power of our issued and outstanding share capital immediately following the completion of this offering. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. Each Class A ordinary share is entitled to one vote, and each Class B ordinary share is entitled to ten votes, subject to the limitations set forth in “Description of Share Capital—Ordinary Shares,” and is convertible into one Class A ordinary share. Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances.

The Securities and Exchange Commission and state securities regulators have not approved or disapproved of these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the ADSs to purchasers on                    , 2017.

 

 

 

MORGAN STANLEY  

CREDIT SUISSE

 

JEFFERIES

                    , 2017


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LOGO


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TABLE OF CONTENTS

 

     Page  

Our Industry

     107  

Business

     112  

Regulation

     133  

Management

     147  

Principal Shareholders

     158  

Related Party Transactions

     161  

Description of Share Capital

     162  

Description of American Depositary Shares

     176  

Shares Eligible for Future Sale

     187  

Taxation

     189  

Underwriting

     195  

Expenses Relating to this Offering

     201  

Legal Matters

     202  

Experts

     203  

Where You Can Find Additional Information

     204  

Index to Consolidated Financial Statements

     F-1  
 

 

 

No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus or in any free writing prospectus we may authorize to be delivered or made available to you. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the ADSs offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

Neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus or any filed free writing prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus or any filed free writing prospectus must inform themselves about, and observe any restrictions relating to, the offering of the ADSs and the distribution of this prospectus or any filed free writing prospectus outside of the United States.

Until                     , 2017 (the 25th day after the date of this prospectus), all dealers that buy, sell or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements appearing elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in our ADSs discussed under “Risk Factors,” before deciding whether to buy our ADSs. In addition, this prospectus contains information from a report prepared by Oliver Wyman, Inc., or Oliver Wyman, a leading global management consulting firm. Oliver Wyman was commissioned by us to provide information on the marketplace lending industry in China.

Our Mission

Our mission is to use technology to create a marketplace that fulfills the lifetime consumer credit needs of China’s emerging middle class and provides investors with attractive returns.

Our Business

We operate one of China’s largest consumer lending marketplaces in terms of total number of loans, having facilitated more than 10.7 million loans to more than 1.4 million borrowers at significantly lower borrowing costs than many of our competitors. We believe that higher quality borrowers are price-sensitive and correlated to lower borrowing costs. Our technology-driven marketplace facilitates loans between borrowers and sophisticated investors, providing borrowers accessible, affordable credit and offering investors attractive risk-adjusted returns. According to the People’s Bank of China, or the PBOC, as of the end of 2015, there were approximately 500 million individuals with quality employment records but no credit history. We refer to these individuals, who regularly use mobile devices, as EMMAs (Emerging Middle-class, Mobile Active consumers). We believe EMMAs constitute one of the largest untapped consumer credit market opportunities in the world.

Our technology enables EMMAs to access affordable and flexible digital credit through mobile devices. We generate recurring fee revenue from borrowers and investors, including transaction and service fees for loans facilitated on our marketplace. We do not bear credit risk for loans facilitated on our marketplace.

We acquire quality borrowers through multiple channels, including social networks, online travel agencies, e-commerce platforms and payment service providers. Applying our predictive selection technology, we efficiently select prime and near-prime EMMAs for our platform. In 2016, 89% of all loan volume originated on our platform consisted of prime and near-prime borrowers, whose creditworthiness is roughly comparable to FICO scores of between 660 and 720. Through our “low and grow” strategy, we initially offer smaller, shorter-term loans to these EMMAs and then use our proprietary decisioning technology to proactively offer them larger, longer-term loans as they demonstrate positive credit behavior, allowing us to retain high quality EMMAs with significant lifetime customer value.

The investors on our marketplace consist primarily of affluent, high net worth and family office investors seeking attractive returns at well-defined risk levels. We plan to further diversify our investor base, including more institutional investors. Investors are attracted to our marketplace because of range of loan durations available on our platform, including short-term loans, our marketplace’s risk-adjusted investment returns, our track record, the intrinsic diversification on our platform and our corporate governance standards. In addition, we believe that our marketplace is one of the few marketplaces in China with full risk transfer to investors, which appeals to sophisticated investors that we believe provide a more stable source of lending capital.

We believe that Chinese banks do not extend credit to EMMAs due to the absence of credit data, the high costs of traditional data collection and the inability of banks to engage in variable pricing, which refers to the practice of charging different interest rates to different borrowers based on credit quality. This is illustrated by the fact that only 16% of China’s adult population had credit cards in 2014, according to the World Bank Global

 



 

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Findex Database. As a result, hundreds of millions of financially active and technologically savvy consumers in China lack access to affordable credit. According to Oliver Wyman, China’s total non-bank consumption loan market is expected to reach RMB 4.4 trillion (approximately US$630 billion) by 2020.

We have developed our proprietary technology over 16 years through our work with some of China’s largest banks, including Bank of China and China Construction Bank, to help them develop credit scoring models and risk management systems to issue over 100 million credit cards. This proprietary technology enables us to cost-effectively identify quality EMMAs to be potential borrowers on our platform and offer them affordable credit. Our predictive selection technology analyzes hundreds of variables based on each EMMA’s online footprint, and we use this to selectively target high quality EMMAs and offer them initial loans on our platform. After repayment of these initial loans, our automated decisioning technology determines on a loan-by-loan basis which borrowers qualify for larger loans, the loan amount, fees, interest rate and term, before the loans are recommended to investors on our marketplace. We use cumulative borrowing behavior data from over 10.7 million loans facilitated on our marketplace to continuously improve our algorithms and technology.

We offer flexible products to serve the lifetime credit needs of EMMAs. Our consumption loans are loans with terms of between two weeks and three months, which have principal amounts generally in the range of RMB500 (approximately US$72) to RMB6,000 (approximately US$865). Consumption loans are initially approved using our predictive selection technology and subsequently approved using our automated decisioning technology based on historical repayment behavior on our platform. Our lifestyle loans are loans with terms of between three months and three years, which have principal amounts generally in the range of RMB6,000 (approximately US$865) to RMB100,000 (approximately US$14,400). Borrowers of loans with principal amounts greater than RMB6,000 (approximately US$865) are required to submit their data for verification at one of our data verification centers as part of our anti-fraud and risk management processes prior to loan approval.

Our platform’s technology advantage and data access have enabled us to become one of the most affordable and scalable consumer lending marketplaces in China. Our end-to-end automation allows us to match EMMAs with investors and execute transactions in an efficient and cost-effective manner. Our ability to access and analyze alternative sources of data on potential borrowers allows us to continuously develop, refine and validate the scoring capabilities of our predictive selection technology. Collectively, this results in lower borrowing costs for our borrowers.

The attractiveness of our marketplace to EMMAs is evidenced by the fact that, as of December 31, 2016, 67% of the borrowers on our marketplace were repeat borrowers. We have experienced a high rate of borrower retention on our marketplace consistently over time. Using the borrower cohort of first-time consumption loan borrowers from the fourth quarter of 2015, as set forth in the following graphs, during a twelve-month period on our platform, the average loan size per borrower increased from US$71 in the first month to US$148 in the twelfth month, and average cumulative loan volume per borrower increased ten times from approximately US$100 in the first month to approximately US$1,000 in the twelfth month.

 



 

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LOGO

The growth of EMMAs’ lifetime customer value on our marketplace is just beginning. Our strategy is to serve EMMAs’ lifetime credit needs. We seek to facilitate more loans that are larger and have longer terms to higher quality borrowers and gradually lower borrowing costs to borrowers who have demonstrated favorable repayment behavior on our platform. We believe rewarding favorable repayment behavior will help us retain borrowers and that we will be able to generate increasing fee revenue from increased loan volumes from these higher quality borrowers.

The following graph shows when our cumulative transaction and service fees from cumulative consumption loan volume exceed customer acquisition cost for consumption loans on an average per borrower basis.

 

LOGO

 



 

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(1) Represents breakeven volume to recover customer acquisition costs, which is based on an average transaction and service fee of 1.6% for consumption loans for 2016, and customer acquisition cost for consumption loans on an average per borrower basis of US$17 for 2016. The customer acquisition cost for consumption loans on an average per borrower basis for 2015 was US$20 and the average transaction and service fee for consumption loans during 2015 was 1.5%.
(2) The amount of customer acquisition cost for consumption loans on an average per borrower basis is calculated by dividing the customer acquisition cost for consumption loans by the number of new consumption loan borrowers in the relevant period. The customer acquisition cost for consumption loans is the sum of (i) the customer acquisition incentive offered to investors of consumption loans for first-time consumption loan borrowers, and (ii) any expenses directly related to the acquisition of first-time consumption loan borrowers. In 2015, our customer acquisition cost for consumption loans also included provisions for loan losses from loans issued by our subsidiary, Haidong CRF Micro-credit Co., Ltd., or Haidong, in connection with its participation as a marketplace investor on a test basis in our newly launched consumption loan business. Since the fourth quarter of 2015, Haidong has not acted as a marketplace investor for any consumption loans facilitated on our marketplace.
(3) All figures presented using exchange rates as of December 31, 2016.
(4) The actual cumulative loan volume needed to generate the cumulative transaction and service fees to recover customer acquisition costs, or the breakeven volume, and the actual period needed to generate the cumulative transaction and service fees to recover such costs, or the breakeven time, may differ from the graph and vary from cohort to cohort.

The total cost of acquiring a new consumption loan borrower (including customer acquisition incentives) was US$17 for the year ended December 31, 2016. The average breakeven time required to recover the customer acquisition cost is becoming shorter in the more recent cohorts as compared to earlier cohorts due to repeat borrowing by high-quality borrowers of larger loans with longer terms. In addition, our continuous improvement of algorithms utilizing the credit behavior data of over 10.7 million loans facilitated on our platform has helped us shorten our breakeven time. We expect these quality borrowers to generate significant lifetime customer value on our marketplace through their repeat borrowing of loans with progressively larger amounts and longer terms.

Our Competitive Strengths

We have been able to establish a leadership position in China’s consumer lending industry because we are able to use our proprietary technology to identify and efficiently select prime and near-prime EMMAs for our platform, offer them smaller, shorter-term affordable loans and retain quality EMMAs on our platform by offering them larger, longer-term loans as they demonstrate positive credit behavior. These capabilities have allowed us to create a marketplace offering affordable credit for EMMAs. We believe that the following strengths differentiate us from our competitors and provide us with advantages for realizing the potential of our substantial market opportunity:

 

    Leading online consumer lending marketplace in China.

 

    Expansive customer reach to quality EMMAs through multiple channels and data sources.

 

    Predictive selection technology enabling large-scale, low-cost acquisition of quality EMMAs.

 

    Automated decisioning technology enabling us to proactively facilitate loans.

 

    “Low and Grow” strategy that provides scalability with high lifetime customer value and allows us to meet EMMAs’ evolving credit needs.

 

    Diversified investor base with full risk transfer to sophisticated investors.

 

    Recognized industry leaders on our management and advisory teams.

Our Strategies

Leveraging our competitive strengths discussed above, we plan to implement the following key strategies to extend our leadership position in facilitating consumer loans to China’s EMMAs and achieve our mission of fulfilling their lifetime credit needs:

 

    Rapidly grow our borrower base using our predictive selection technology.

 

    Help EMMAs build their credit histories on our platform and meet their evolving lifetime credit needs through our “low and grow” strategy.

 

    Continue to work with multiple channels and multiple data sources and further penetrate our total addressable market.

 



 

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    Further diversify our marketplace’s investor base.

 

    Invest in our technology platform.

 

    Enhance the profile of our brand.

Selected Risks Related to Our Business

Our business is subject to numerous risks described in the section titled “Risk Factors” and elsewhere in this prospectus. The risks below and others you should consider are discussed more fully in the section entitled “Risk Factors” beginning on page 18, which you should read in its entirety.

 

    The marketplace lending industry is a new and evolving industry, and we may not succeed.

 

    Our recent, rapid growth in the number of loans facilitated on our platform may not be indicative of our future growth and, if we continue to grow rapidly, we may not be able to manage our growth effectively.

 

    We have incurred net losses in the past, and may incur them in the future.

 

    Our marketplace requires adequate funding from investors and access to adequate lending capital cannot be assured.

 

    If our proprietary credit assessment technology is ineffective, our platform may be less attractive to potential borrowers and investors, our reputation may be harmed and our market share could decline.

 

    We rely on data from third parties and prospective borrowers for the successful operation of our platform, and this data may be inaccurate or may not accurately reflect the potential borrower’s creditworthiness, which may cause us to inaccurately price loans facilitated through our marketplace and cause our reputation to be harmed.

 

    Our use of customer acquisition incentives has resulted and may continue to result in substantial reductions in our revenues.

 

    As the regulatory framework for our business evolves, domestic and foreign governments may draft and propose new laws, regulations, notices or interpretive releases to regulate marketplace lending, including our online and mobile-based channels, which may negatively affect our business.

Corporate Information

We were formed as a Delaware limited liability company on July 12, 2004 under the name “China Risk Finance LLC.” On August 18, 2015 China Risk Finance LLC was converted from a Delaware limited liability company to a Cayman Islands exempted company by way of continuation, and in conjunction therewith, its name was changed to China Rapid Finance Limited. For a further description of our corporate history and restructuring, see “History and Reorganization.” Our corporate headquarters is located at 5th Floor, Building D, BenQ Plaza, 207 Songhong Road, Changning District, Shanghai 200335, People’s Republic of China. Our telephone number is +86-21-6032-5999. Our agent for service of process in the United States is Corporation Service Company, located at 1180 Avenue of the Americas, Suite 210, New York, New York 10036. Our website address is http://www.chinarapidfinance.com. The information on our website is not deemed, and you should not consider such information, to be part of this prospectus.

Implications of Being an Emerging Growth Company

As a company with less than US$1.0 billion in revenue for the last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. As such, we may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally

 



 

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to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, in the assessment of our internal control over financial reporting. Under the JOBS Act we also do not need to comply with any new or revised financial accounting standards until the date that private companies are required to do so. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. Our decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We will remain an emerging growth company until the earliest of (i) the last day of our fiscal year during which we have total annual gross revenues of at least US$1.0 billion; (ii) the last day of our fiscal year following the fifth anniversary of completion of this offering; (iii) the date on which we have, during the previous three-year period, issued more than US$1.0 billion in non-convertible debt; or (iv) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which would occur if the market value of our ADSs that are held by non-affiliates exceeds US$700 million as of the last business day of our most recently completed second fiscal quarter. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above.

Conventions Which Apply to this Prospectus

Unless we indicate otherwise, all information in this prospectus reflects no exercise by the underwriters of their option to purchase up to              additional ADSs representing              Class A ordinary shares from us.

Except where the context otherwise requires and for purposes of this prospectus only:

 

    “ADSs” refers to our American depositary shares, each of which represents              Class A ordinary shares;

 

    “big data” refers to voluminous structured and unstructured data from multiple sources and in multiple formats;

 

    “China” or the “PRC” refers to the People’s Republic of China, excluding, for the purposes of this prospectus only, Hong Kong, Macau and Taiwan;

 

    “Class A ordinary shares” refers to Class A ordinary shares, par value US$0.0001 per share of China Rapid Finance Limited;

 

    “Class B Holders” refers to Dr. Zhengyu (Zane) Wang, Gary Wang and Andrew Mason;

 

    “Class B ordinary shares” refers to Class B ordinary shares, par value US$0.0001 per share of China Rapid Finance Limited;

 

    “CRF,” “we,” “us,” “our company” and “our” refer to China Rapid Finance Limited, an exempted company registered in the Cayman Islands with limited liability, and its subsidiaries, and, in the context of describing our operations and combined and consolidated financial information, also include its affiliated entity and its subsidiaries;

 

    “investors” refers to lenders of capital on our marketplace, unless the context indicates otherwise;

 

    “NYSE” refers to the New York Stock Exchange;

 

   

“ordinary shares” refers to the common shares representing membership interests of China Risk Finance LLC which were converted to ordinary shares, par value US$0.0001 per share, of China Rapid

 



 

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Finance Limited upon the completion of the conversion by way of continuation to the Cayman Islands and will be divided into Class A ordinary shares and Class B ordinary shares immediately prior to the completion of this offering;

 

    “RMB” and “Renminbi” refer to the legal currency of China; and

 

    “US$,” “U.S. dollars,” “$” and “dollars” refer to the legal currency of the United States.

Our reporting and functional currency is the U.S. dollar. The functional currency of our subsidiaries in China is the Renminbi. This prospectus contains translations of certain foreign currency amounts into U.S. dollars for the convenience of the reader. Unless otherwise stated, all translations of Renminbi into U.S. dollars in this prospectus were made at the rate of RMB6.9430 to US$1.00, the noon buying rate on December 31, 2016, as set forth in the H.10 statistical release of the U.S. Federal Reserve Board. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. On March 24, 2017, the noon buying rate for Renminbi was RMB6.8803 to US$1.00.

In addition, unless the context indicates otherwise, all information in this prospectus assumes no exercise by the underwriters of their over-allotment option.

 



 

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THE OFFERING

 

Offering price

   We currently estimate that the initial public offering price will be between US$             and US$             per ADS.

ADSs offered by us

                ADSs (or              ADSs if the underwriters exercise their over-allotment option in full).

ADSs outstanding immediately after this offering

                ADSs (or            ADSs if the underwriters exercise their option to purchase additional ADSs representing Class A ordinary shares in full).

Ordinary shares outstanding immediately after this offering

  

             Class A ordinary shares and              Class B ordinary shares (or              Class A ordinary shares and              Class B ordinary shares if the underwriters exercise their option to purchase additional ADSs representing Class A ordinary shares in full).

The ADSs

   Each ADS represents            ordinary shares of par value US$0.0001 per share.
   The depositary will hold the ordinary shares underlying your ADSs and you will have rights as provided in the deposit agreement.
   You may surrender your ADSs for cancellation to the depositary in exchange for Class A ordinary shares. The depositary will charge you fees for any exchange.
   We do not expect to pay dividends in the foreseeable future. If, however, we declare dividends on our Class A ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our Class A ordinary shares after deducting its fees and expenses in accordance with the terms set forth in the deposit agreement.
   We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs after an amendment to the deposit agreement, you agree to be bound by the deposit agreement as amended.
   To better understand the terms of the ADSs, you should carefully read the “Description of American Depositary Shares” section of this prospectus. You should also read the deposit agreement, which is filed as an exhibit to the registration statement that includes this prospectus.

 



 

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Over-allotment option

   We have granted to the underwriters an option, exercisable within 30 days from the date of this prospectus, to purchase up to an additional              ADSs.

Reserved ADSs

   At our request, the underwriters have reserved for sale, at the initial public offering price, up to an aggregate of              ADSs offered in this offering to some of our directors, officers, employees, business associates and related persons through a directed share program.

Use of proceeds

   We expect that we will receive net proceeds of approximately US$             million from this offering, or approximately US$             million if the underwriters exercise their option to purchase additional ADSs from us in full, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.
   As of the date of this prospectus, we intend to use the net proceeds from this offering to acquire more EMMA customers to further penetrate our total addressable market, test and roll-out additional products to meet the lifetime credit needs of EMMAs and invest in our technology platform. We may also use a portion of the net proceeds for general corporate purposes, including working capital, operating expenses, capital expenditures and potential strategic investments. Accordingly, our management will have discretion in the application of net proceeds to us from this offering.
   In the event that the initial public offering price per ADS is not finally determined to be US$            , the amount of proceeds for each use set out above will be adjusted on a pro rata basis. See “Use of Proceeds” for more information.

Listing

   Our ADSs have been approved for listing on the NYSE under the symbol “XRF.”

Depositary

   Citibank, N.A.

Lock-up

   We, our directors and executive officers, all of our existing shareholders holding              or more of our shares on a fully diluted basis and certain of our incentive shareholders and option holders have agreed with the underwriters not to sell, transfer or dispose of any ADSs, ordinary shares or similar securities for a period of 180 days after the date of this prospectus, subject to certain exceptions. In addition, we have

 



 

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   agreed to, through a letter agreement, instruct Citibank, N.A., as depositary, not to accept any deposit of any Class A ordinary shares or issue any ADSs for 180 days after the date of this prospectus unless we consent to such deposit or issuance, and not to provide consent without the prior written consent of             . The foregoing does not affect the right of ADS holders to cancel their ADSs and withdraw the underlying Class A ordinary shares. See “Shares Eligible for Future Sale” and “Underwriting.”

Risk factors

   See “Risk Factors” and other information included in this prospectus for a discussion of risks you should carefully consider before investing in the ADSs.

The number of ordinary shares that will be outstanding immediately after this offering:

 

    is based upon             ordinary shares outstanding on an as-converted basis as of the date of this prospectus, which includes (i)              Class A ordinary shares redesignated and converted from our outstanding ordinary, preferred and incentive shares held by shareholders other than the Class B Holders and (ii)              Class B ordinary shares redesignated and converted from our outstanding ordinary, preferred and incentive shares held by the Class B Holders;

 

                 Class A ordinary shares to be sold in this offering by us in the form of ADSs;

 

    assumes no exercise of the underwriters’ option to purchase additional ADSs representing Class A ordinary shares; and

 

    excludes 7,663,707 Class A ordinary shares reserved for future issuances under our 2016 Equity Incentive Plan as of the date of this prospectus.

 



 

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Summary Historical Financial Information of our Company

The following summary consolidated financial data for the three years ended December 31, 2014, 2015 and 2016, and as of December 31, 2015 and 2016, have been derived from our audited consolidated financial statements included elsewhere in this prospectus.

Our consolidated financial statements are prepared and presented in accordance with the generally accepted accounting principles in the United States of America, or U.S. GAAP. Our historical results are not necessarily indicative of results expected for future periods. You should read this Summary Consolidated Financial Data section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

The following table presents our summary consolidated statement of comprehensive income for the three years ended December 31, 2014, 2015, and 2016.

 

    For the Year Ended December 31,  
    2014     2015     2016  
    US$     US$     US$  
    (in thousands, except share data and
per share data)
 

Summary Consolidated Statement of Comprehensive Income:

     

Revenue

     

Transaction and service fees (net of customer acquisition incentive)

    60,281       62,535       55,891  

Other revenue

    1,027       946       1,092  
 

 

 

   

 

 

   

 

 

 
    61,308       63,481       56,983  
 

 

 

   

 

 

   

 

 

 

Provision for loan losses

    (580     (3,924      

Business related taxes and surcharges

    (2,960     (3,424     (1,122
 

 

 

   

 

 

   

 

 

 

Net revenue

    57,768       56,133       55,861  
 

 

 

   

 

 

   

 

 

 

Operating expense

     

Servicing expenses

    (7,465     (13,484     (13,889

Sales and marketing expenses

    (27,347     (34,182     (29,954

General and administrative expenses

    (23,739     (36,030     (45,372
 

 

 

   

 

 

   

 

 

 

Total operating expenses

    (58,551     (83,696     (89,215

Other income (expense)

     

Other income (expense), net

    1,267       (2,456     (9
 

 

 

   

 

 

   

 

 

 

Profit (loss) before income tax expense

    484       (30,019     (33,363

Income tax expense

    (353     (7     (3
 

 

 

   

 

 

   

 

 

 

Net profit (loss)

    131       (30,026     (33,366

Accretion on Series A convertible redeemable preferred shares to redemption value

    (288     (288     (288

Accretion on Series B convertible redeemable preferred shares to redemption value

    (1,621     (1,621     (1,621

Accretion on Series C convertible redeemable preferred shares to redemption value

          (1,292     (4,468

Deemed dividend to Series C convertible redeemable preferred shares at modification of Series C convertible redeemable preferred shares

                (635
 

 

 

   

 

 

   

 

 

 

Net loss attributable to ordinary shareholders

    (1,778     (33,227     (40,378
 

 

 

   

 

 

   

 

 

 

Net profit (loss)

    131       (30,026     (33,366

Foreign currency translation adjustment, net of nil tax

    1       (533     (1,885
 

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

    132       (30,559     (35,251
 

 

 

   

 

 

   

 

 

 

 



 

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    For the Year Ended December 31,  
    2014     2015     2016  
    US$     US$     US$  
    (in thousands, except share data and
per share data)
 

Weighted average number of ordinary shares used in computing net profit (loss) per share

     

Basic

    16,084,124       16,232,433       16,437,946  

Diluted

    16,084,124       16,232,433       16,437,946  

Loss per share attributable to ordinary shareholders

     

Basic

    (0.11     (2.05     (2.46

Diluted

    (0.11     (2.05     (2.46

The following table presents our summary consolidated balance sheet data as of December 31, 2015 and 2016.

 

     As of December 31,  
     2015     2016     2016  
     US$     US$    

US$

Pro forma(1)(2)

 
     (in thousands)  

Summary Consolidated Balance Sheet Data:

      

Cash and cash equivalents

     25,045       18,983       18,983  

Restricted cash(3)

     11,890       12,685       12,685  

Total assets

     68,272      
58,468
 
    58,468  

Total liabilities

     44,907       44,460       44,460  

Safeguard Program payable

     18,555       19,511       19,511  

Total mezzanine equity

     84,950       116,218        

Total shareholders’ (deficit) equity

     (61,585     (102,210     14,008  

 

(1) Immediately prior to the completion of this offering, all of the preferred shares held by the existing shareholders other than the Class B Holders will be automatically converted into Class A ordinary shares and all preferred shares held by the Class B Holders will be automatically converted into Class B ordinary shares.
(2) Assumes the automatic conversion of all of the outstanding preferred shares held by the existing shareholders other than the Class B Holders into Class A ordinary shares on a one-for-one basis and all preferred shares held by the Class B Holders into Class B ordinary shares on a one-for-one basis, as if the conversion had occurred as of December 31, 2016.
(3) Restricted cash represents funds received from investors and borrowers of lifestyle loans for the Safeguard Program, which is only available to lifestyle loan investors.

 



 

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Key Operating and Financial Metrics

We regularly review a number of metrics to evaluate our business, measure our performance, identify trends, formulate financial projections and make strategic decisions. The main metrics we consider are set forth in the table below.

 

     As of or for the Year Ended
December 31,
 
     2014     2015     2016  

Number of loans facilitated(1)

      

Consumption loans

     21,046       4,593,591       5,967,785  

Lifestyle loans

     42,205       38,190       37,894  
  

 

 

   

 

 

   

 

 

 

Total

     63,251       4,631,781       6,005,679  

Number of borrowers(2)

     101,384       701,019       1,419,746  

Repeat borrower rate(3)

     10     65     67

Loan volume (in US$ millions)(4)

      

Consumption loans

     1.5       349.1       611.5  

Lifestyle loans

     334.0       391.6       450.5  
  

 

 

   

 

 

   

 

 

 

Total

     335.5       740.7       1,062.0  

Gross billings on transaction and service fee (in US$ millions)(5)

      

Consumption loans

     0       5.6       9.8  

Lifestyle loans

     60.3       60.5       58.1  
  

 

 

   

 

 

   

 

 

 

Total

     60.3       66.0       67.9  

 

(1) Number of loans facilitated is defined as the total number of loans facilitated on our marketplace during the relevant period.
(2) Number of borrowers is defined as the total number of unique borrowers on our marketplace since our inception as measured as of the relevant date.
(3) Repeat borrower rate is defined as the total number of borrowers who borrowed more than one loan on our marketplace since our inception divided by the total number of borrowers on our marketplace since our inception as measured as of the relevant date.
(4) Loan volume is defined as the total principal amount of loans facilitated on our marketplace during the relevant period.
(5) Gross billings on transaction and service fee is defined as transaction and service fee billed to customers, inclusive of related value added tax, before deduction of customer acquisition incentive.

We believe gross billings on transaction and service fees is a key operating metric and an important indicator of our growth and business performance. Gross billings on transaction and service fees are directly related to the loan volume that is successfully matched on our marketplace, thus showing a correlation between gross billings on transaction and service fees and loan volume. Presentation of gross billings on transaction and service fees helps illustrate growth rates and trends of our business and the collection of fees.

 



 

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RISK FACTORS

Investing in our ADSs involves a high degree of risk. You should carefully consider the following risks, as well as other information contained in this prospectus, before making an investment in our company. The risks discussed below could materially and adversely affect our business, prospects, financial condition, results of operations, cash flows, ability to pay dividends and the trading price of our ADSs. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business, prospects, financial condition, results of operations, cash flows and ability to pay dividends, and you may lose all or part of your investment.

Risks Related to Our Business and Industry

The marketplace lending industry is a new and evolving industry, and we may not succeed.

Although we began operations in 2001 in the credit analytics industry, we only began operating our marketplace in 2010 and our consumption loans in February 2015. The marketplace lending industry is a new and evolving industry, particularly in China. We are subject to all risks inherent in a developing business enterprise in a new and evolving industry. Our likelihood of continued success must be considered in light of the challenges, uncertainties, expenses, difficulties, complications, and delays frequently encountered in connection with a new and evolving industry and the competitive and regulatory environment in which we operate. China’s marketplace lending industry in general may not become accepted or be viable in the long term, particularly if PRC laws and regulations change in ways that do not favor our development. If that happens, there may not be an adequate market for the loan products facilitated on our marketplace. As a new industry, there are not established players whose business models we can follow or build upon. Similarly, there is limited public information about comparable companies available for potential investors to review in making a decision about whether to invest in our company.

Borrowers may not view marketplace lending obligations facilitated on our platform as having the same consequences for default as other credit obligations arising under more traditional circumstances, such as loans from banks or other commercial financial institutions. If a borrower defaults on his or her payment obligations on a loan or chooses not to repay his or her loan entirely, the investor funding the loan may not realize the expected return on its investment. This could discourage investors from lending on our marketplace, which could materially and adversely affect our business. If that happens, our business could be materially impacted.

You should further consider, among other factors, our prospects for success in light of the risks and uncertainties encountered by businesses that, like us, are in their early stages of development. For example, unanticipated expenses, challenges and technical difficulties may occur and they may result in material delays in the operation of our business, in particular with respect to the new products and services on our marketplace. We may not be able to successfully address these risks and uncertainties or successfully implement our operating strategies. If we fail to do so, such failure could materially harm our business to the point of having to cease operations and could impair the value of our ADSs.

Our recent, rapid growth in the number of loans facilitated on our platform may not be indicative of our future growth and, if we continue to grow rapidly, we may not be able to manage our growth effectively.

We have experienced significant growth since 2015, particularly with respect to our consumption loans, including the number of borrowers and investors and the total number of loans facilitated. However, our current rate of growth may not continue at the same pace, or at all. Our rapidly evolving business and, in particular, the relatively limited operating history of our consumption loan marketplace may not be an adequate basis for evaluating our business prospects and financial performance. Any slowdown in our growth could adversely affect our prospects, results of operations and financial condition.

 

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We have a limited operating history under our current business model, and we have encountered and will continue to encounter risks, uncertainties, expenses and difficulties as we continue to develop and expand our business, including:

 

    navigating complex and evolving regulatory and competitive environments;

 

    increasing the number of borrowers and investors utilizing our marketplace;

 

    increasing the volume of loans facilitated through our marketplace and transaction fees received through our marketplace;

 

    entering into new markets and introducing new loan and investment products;

 

    continuing to revise and update the effectiveness, scale and speed of our marketplace’s proprietary credit assessment technology;

 

    continuing to develop, maintain and scale our platform;

 

    continuing to scale our technology infrastructure to support the growth of our platform and higher transaction volume;

 

    further expanding our network of data verification centers and investor service centers;

 

    effectively using human and technology resources;

 

    effectively maintaining and scaling our financial and risk management controls and procedures;

 

    managing the increased general administrative experience of a growing public company, including legal, accounting and other compliance expenses;

 

    maintaining the security of our platform and the confidentiality of the information provided and utilized across platform; and

 

    attracting, integrating and retaining qualified employees.

If we are not able to timely and effectively address these requirements, our business and results of operations may be harmed.

We have incurred net losses in the past, and may incur them in the future.

We have incurred net losses in the past. We anticipate that our operating expenses will increase in the foreseeable future as we seek to continue to grow our business, attract potential borrowers, investors and partners and further enhance and develop the loan products available for investors and borrowers on our marketplace. These efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenues sufficiently to offset these higher expenses. See “—Our use of customer acquisition incentives has resulted and may continue to result in substantial reductions in our revenues.” Our “low and grow” strategy involves us initially offering smaller, shorter-term loans to borrowers and using our proprietary decisioning technology to selectively offer larger, longer-term loans to quality borrowers that exhibit good credit behavior, which generates high lifetime customer value. To the extent we are unable to execute our “low and grow” strategy or if we are unable to generate increased fees on repeat borrowers, we may not achieve the net income we expect. We may incur net losses and may be unable to achieve or maintain profitability on a quarterly or annual basis for the foreseeable future.

Our marketplace requires adequate funding from investors and access to adequate lending capital cannot be assured.

Our business involves the matching of borrowers and investors through our marketplace. The growth and success of our future operations depend on the availability of adequate lending capital to meet borrower demand

 

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for loans on our marketplace. A large portion of the lending capital for our platform is currently derived from affluent, high net worth, family office and institutional investors, but we have increased the amount derived from institutional investors in the recent past. In order to maintain the requisite level of funding for the loans facilitated on our marketplace to meet borrower demand, we will need to optimize the investor composition of our marketplace to include more investors generally and also a higher number of institutional investors, which usually invest larger amounts compared to individual investors. To the extent there is an insufficient number of investors willing to accept the risk of default posed by potential borrowers, our marketplace will be unable to fulfill all of the loan requests. In addition, if we offer lower first-time borrower incentives, investors on our marketplace may experience lower returns on their investments and potentially losses. If adequate funds are not available to meet borrowers’ demand for loans when they arise, the volume of loans facilitated on our marketplace may be significantly impacted. Also, to the extent that investors’ risk appetite changes, investors may choose to not invest in loans facilitated on our marketplace. To the extent that it is necessary to obtain additional lending capital from investors, such lending capital may not be available to our marketplace on acceptable terms or at all. If our marketplace is unable to provide potential borrowers with loans or fund the loans on a timely basis due to insufficient lending capital on our marketplace, we may experience a loss of market share or slower than expected growth, which would harm our business, financial condition and results of operations.

If our proprietary credit assessment technology is ineffective, our platform may be less attractive to potential borrowers and investors, our reputation may be harmed and our market share could decline.

Our ability to attract potential borrowers and investors to, and build trust in, our marketplace is significantly dependent on our ability to effectively evaluate a potential borrower’s credit profile and likelihood of default, and thus maintain low loss ratios for investors on our marketplace. We utilize our proprietary credit assessment technology, which encompasses our predictive selection technology, credit scoring technology and automated decisioning technology, to assign each potential borrower and loan offered on our marketplace a score. Our proprietary advanced credit assessment technology allows for the evaluation and analysis of a number of factors, including historical behavioral data, transactional data, social data, search and employment information, which may not effectively predict future loan losses.

We refine our proprietary credit assessment technology based on new data and changing macro and economic conditions. To the extent the credit assessment technology we use to assess the creditworthiness of potential customers does not adequately identify potential risks, is ineffective or the data provided by potential borrowers or third parties is incorrect or stale, our loan pricing and approval process could be negatively affected, resulting in mispriced or misclassified loans. The types of errors could make our platform less attractive to potential investors as well as potential borrowers, damage our reputation in the market and result in a decline in our market share.

We rely on data from third parties and prospective borrowers for the successful operation of our platform, and this data may be inaccurate or may not accurately reflect the potential borrower’s creditworthiness, which may cause us to inaccurately price loans facilitated through our marketplace and cause our reputation to be harmed.

Our ability to review and select quality potential borrowers and attract investors depends on credit, identification, employment and other relevant information that we receive from prospective borrowers and third parties, including our data channel partners, PBOC credit reporting platforms, credit bureaus, data vendors and social media and consumer transaction companies. In addition to traditional data points used to analyze potential borrowers’ creditworthiness, we also rely on other behavioral data, including online, social media, search, browsing and transactional data.

Unlike many developed countries, China does not have a well-developed centralized credit reporting system. Although we take steps to verify potential borrower data and identities as described elsewhere in this

 

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prospectus, the potential borrower information may nevertheless be inaccurate or incomplete. For example, for borrowers having a bank account, we rely on banks’ verification of identity. Moreover, investors do not, and will not, have access to financial statements of potential borrowers or to other detailed financial information about potential borrowers. Rather, investors rely on our technology to assign differentiated credit score and corresponding grades to potential borrowers in order to assess the creditworthiness of a potential borrower.

We use credit and other information about prospective borrowers to assign credit scores and corresponding grades to potential borrowers based on our proprietary advanced credit assessment technology. If this information becomes unavailable or becomes more expensive to access, it could cause us to have to seek alternative sources of information or increase our costs. If investors invest in loans through our marketplace based on information supplied by potential borrowers and third-parties that is inaccurate, misleading or incomplete, those investors may not receive their expected returns or may lose their investments entirely and our reputation may be harmed.

While our credit score serves to predict the likelihood of a potential borrower being able to repay a loan by taking into consideration hundreds of variables, it may not reflect that potential borrower’s actual creditworthiness because the credit score may be based on outdated, incomplete or inaccurate data, and we do not verify information obtained from third parties, other than as indicated elsewhere in this prospectus. Additionally, there is a risk that, following the date we obtain and review the information, a potential borrower may have:

 

    become delinquent in the payment of an outstanding obligation;

 

    defaulted on a pre-existing debt obligation;

 

    taken on additional debt; or

 

    sustained other adverse financial events.

Although we do not permit borrowers to have more than one loan facilitated on our platform outstanding at a time, borrowers on our marketplace are not restricted from incurring additional unsecured or secured debt, nor are they required to post collateral or be subject to any financial covenants during the term of the loan. We currently cannot determine whether borrowers have outstanding loans through other consumer finance marketplaces at the time they obtain a loan from us. This creates the risk that a borrower may borrow money through our platform in order to pay off loans on other consumer finance marketplaces and vice versa. If a borrower incurs additional debt before or after the date of the borrower’s loan, the additional debt may impair the ability of that borrower to make payments on his or her loan and the investor’s ability to receive the principal and interest payments that it expects to receive on the loan. In addition, the additional debt may adversely affect the borrower’s creditworthiness generally, and could result in the financial distress, insolvency, or bankruptcy of the borrower. To the extent that a borrower has or incurs other indebtedness and cannot pay all of his or her indebtedness, the obligations under the unsecured loans will rank pari passu to each other and the borrower may choose to make payments to other creditors rather than to the investor.

If investors do not receive returns that are satisfactory to them, they may be deterred from lending on our marketplace and our reputation may be harmed.

Our use of customer acquisition incentives has resulted and may continue to result in substantial reductions in our revenues.

Most of the growth in the number of borrowers on our marketplace in 2015 and 2016 was attributable to an increase in the number of consumption loans facilitated by our marketplace. However, the increased consumption loans did not result in a corresponding increase in revenue in 2015 and 2016 due to our use of customer acquisition incentives. Our customer acquisition cost for consumption loans, which primarily consists of customer acquisition incentives offered to investors of consumption loans for first-time consumption loan borrowers, was approximately US$17 per consumption loan borrower in 2016. These customer acquisition incentives are used as a marketing tool to attract new investors in consumption loans, and also to mitigate

 

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potential investment losses from first-time borrowers of consumption loans, which generally have higher credit losses than repeat borrowers. The customer acquisition incentives we pay to investors are made in advance of us being able to recoup the costs associated with these customer acquisition incentives, which recoupment typically requires borrowers to take out a number of subsequent loans or our platform, and are reflected in our financial statements as a reduction of revenue, as they are payments to our customers. Any excess amount during the period shall be expensed. Our revenues have been, and may in the future be, substantially reduced in some periods depending on the amount of customer acquisition incentives we have issued in such periods. This has caused us to incur and may in the future cause us to incur net losses and we may be unable to maintain profitability on a quarterly or annual basis. To the extent that we acquire a large amount of first-time borrowers or if we are unable to acheive increased borrowing volume for consumption loan borrowers on our platform, we may incur net losses. For a further description of our customer acquisition incentives, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Components of Results of Operations—Customer Acquisition Incentives.”

Failure to maintain relationships with our partners or implement our strategy to develop new relationships with other potential partners could have a material adverse effect on our business and results of operations.

Our relationships with our partners are important to our future success, particularly with respect to our consumption loans and the data sources for our predictive selection, credit scoring and automated decisioning technologies. However, our partners could choose to terminate their relationships with us or propose terms that we cannot accept.

One of our strategies is to continue to enter into new relationships with Internet companies, e-commerce platforms, online travel agencies, telecommunication service providers and payment service providers. We intend to explore additional forms of relationships with our existing partners and pursue additional relationships with other potential strategic partners, such as social media companies, consumer transaction companies, banks, asset managers and insurance companies. Identifying, negotiating and maintaining relationships with our partners requires significant time and resources as does integrating third-party data and services. Our current agreements with our partners also do not prohibit them from working with our competitors or from offering competing services. Our competitors may be effective in providing incentives to our partners to favor their products or services over ours, which could have the effect of reducing the volume of loans facilitated through our marketplace if our partners were to direct potential borrowers to other platforms or otherwise endorse our competitors’ products over ours. Also, our partners may choose to offer a competing marketplace and become a competitor themselves. In addition, these partners may not perform as expected under our agreements with them, the benefits to us may not be as favorable as we expect and we may have disagreements or disputes with such partners, any of which could adversely affect our brand and reputation as well as our business operations. If we cannot successfully enter into and maintain effective relationships with partners, our business and results of operations may be adversely affected.

If delinquencies or defaults on lifestyle loans facilitated through our marketplace increase, and the investors’ Safeguard Program does not adequately cover the delinquencies or defaults, the return on investment for investors funding those loans would be adversely affected, which may cause existing or potential investors to choose not to invest on our marketplace.

An investor will receive payments on its investments only if the borrowers to which it is matched make timely payments on the corresponding loans or, to the extent the investor has subscribed to the Safeguard Program, the Safeguard Program is able to adequately cover borrower defaults. The annualized average default rate of lifestyle loans on our marketplace has historically been 7 to 8%. Investors face the risk that the borrowers on our platform will fail to repay their loans in full. If borrowers do not make payments on a loan, the investor may not have its investment fully repaid under the terms of the investment, other than those payments received from the Safeguard Program (to the extent that it has subscribed to the Safeguard Program and sufficient funds remain in the Safeguard Program). We have established an evaluation process designed to determine the

 

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adequacy of the Safeguard Program contributions at the time each loan is originated. While this evaluation process uses historical and other objective information, the classification of loans and the forecasts of repayment are also dependent on our subjective assessment based upon our experience and judgment. To the extent that the Safeguard Program is not adequately funded at the time of loan origination for each loan to cover defaulting borrowers’ payment obligations in the future and an investor does not receive his or her expected return, the investor may become dissatisfied with our marketplace. As a result, our reputation may suffer and we may lose investor confidence, which could adversely affect investor participation on our marketplace.

If we are unable to maintain or increase the number of loans facilitated through our marketplace or if existing borrowers or investors do not continue to participate in our marketplace, our business and results of operations will be adversely affected.

We have experienced growth in the number of loans facilitated through our marketplace in recent periods, with the number of loans facilitated through our marketplace increasing from 63,251 in 2014 to 4,631,781 in 2015 and 6,005,679 in 2016, and with loan volumes totaling US$335.5 million in 2014, US$740.7 million in 2015 and US$1,062.0 million in 2016. Since we launched our marketplace’s consumption loans in February 2015, we have facilitated on average over 15,000 loans per day to borrowers identified by our predictive selection technology. Our “low and grow” strategy involves us initially offering smaller, shorter-term loans to borrowers and using our proprietary decisioning technology to selectively offer larger, longer-term loans to quality borrowers that exhibit good credit behavior, which generates high lifetime customer value. To continue to grow our business, we must continue to increase loan originations through our marketplace by attracting a large number of new borrowers who meet our lending standards and new and existing investors interested in investing in these loans. We must also continue to facilitate larger, longer-term loans to our existing borrowers as they demonstrate good credit behavior.

We have experienced a large number of inquiries from potential borrowers who do not meet the criteria for lifestyle loan approval. If there are not a sufficient number of qualified loan applicants that meet our criteria, investors may be unable to deploy their capital in a timely or efficient manner and may seek other investment opportunities. Furthermore, we have offered significant customer acquisition incentives to investors in consumption loans to first-time borrowers. If we cease offering those customer acquisition incentives or lower the amount of incentives we offer, our investors may decide to cease providing capital for lending on our marketplace. For a further description of our customer acquisition incentives, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Components of Results of Operations—Customer Acquisition Incentives” and “—Our use of customer incentives has resulted and may continue to result in substantial reductions in our revenues.” If there are insufficient investor commitments, borrowers may be unable to obtain lending capital for their loans and may stop using our marketplace for their borrowing needs and our business and results of operations will be adversely affected.

Fraudulent activity occurring on or through our marketplace could negatively impact our operating results, brand and reputation and cause the use of our marketplace’s loan products and services to decrease.

We are subject to the risk of fraudulent activity occurring on or through our marketplace, including but not limited to, borrowers fraudulently or illegally inducing investors to lend capital. Although we take significant fraud prevention measures, including through our 107 data verification centers, our resources, technologies and fraud prevention tools may be insufficient to accurately detect and prevent fraud. Furthermore, although we have not experienced any material business or reputational harm as a result of fraudulent activities on our marketplace in the past, high profile fraudulent activity or significant increases in fraudulent activity could lead to regulatory intervention, negatively impact our brand and reputation and loss of market share, and lead us to take additional steps to reduce fraud risk, which could increase our costs.

 

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The personal data and other confidential information of borrowers, investors and partners which we collect or are provided access to may subject us to liabilities imposed by relevant governmental regulations or expose us to risks of cyber-attacks, computer viruses, physical or electronic break-ins or similar disruptions.

We receive, transmit and store a large volume of personally identifiable information and other confidential data from borrowers, investors and our partners. There are numerous laws regarding privacy and the storing, sharing, use, disclosure and protection of personally identifiable information and user data. Specifically, personally identifiable and other confidential information is increasingly subject to legislation and regulations in numerous domestic and international jurisdictions, the intent of which is to protect the privacy of personal information that is collected, processed and transmitted in or from the governing jurisdiction. This regulatory framework for privacy issues in China and worldwide is currently evolving and is likely to remain uncertain for the foreseeable future. In addition, there may be limits on the cross-border transmission of user data even to the extent that such transmission is within our company. We could be adversely affected if legislation or regulations are expanded to require changes in business practices or privacy policies, or if governing jurisdictions interpret or implement their legislation or regulations in ways that negatively affect our business, financial condition and results of operations. In addition to laws, regulations and other applicable rules regarding privacy and privacy advocacy, industry groups or other private parties may propose new and different privacy standards. Because the interpretation and application of privacy and data protection laws and privacy standards are still uncertain, it is possible that these laws or privacy standards may be interpreted and applied in a manner that is inconsistent with our practices. Any inability to adequately address privacy concerns, even if unfounded, or to comply with applicable privacy or data protection laws, regulations and privacy standards, could result in additional cost and liability for us, damage our reputation, inhibit the use of our platform and harm our business.

In addition, the data we possess and the automated nature of our marketplace may make us an attractive target for and potentially vulnerable to, cyber attacks, computer viruses, physical or electronic break-ins or similar disruptions. Furthermore, some of the data we possess is stored on our servers, which are hosted by third parties. While we and our third-party hosting facilities have taken steps to protect confidential information to which we have access, our security measures may be breached in the future. Any accidental or willful security breaches or other unauthorized access to our marketplace could cause confidential borrower, investor and partner information to be stolen and used for criminal purposes. Security breaches or unauthorized access to confidential information could also expose us to liability related to the loss of the information, time-consuming and expensive litigation and negative publicity. If our security measures are breached because of third-party action, employee error, malfeasance or otherwise, or if design flaws in our software are exposed and exploited, our relationships with borrowers, investors and partners could be severely damaged, and we could incur significant liability.

Because techniques used to sabotage or obtain unauthorized access to systems change frequently and generally are not recognized until they are launched against a target, we and our third-party hosting facilities may be unable to anticipate these techniques or implement adequate preventative measures. In addition, the Administrative Measures for the Security of the International Network of Computer Information Network, effective on December 30, 1997 and amended on January 8, 2011, requires us to report any data or security breaches to the local offices of the PRC Ministry of Public Security within 24 hours of any such breach. Any security breach, whether actual or perceived, would harm our reputation, and could cause us to lose borrowers, investors and partners and adversely affect our business and results of operations.

If we are unable to maintain relationships with our third-party service providers, our business will suffer.

We rely on third-party service providers to operate various aspects of our business and marketplace. For instance, we rely on our depository bank to provide fund depository services and third-party payment companies to serve as payment channels to ensure compliance with various laws and regulations. Most of our agreements with third-party service providers are non-exclusive and do not prohibit the third-party service provider from working with our competitors or from offering competing services. Our third-party service providers could decide that working with us is not in their interests, could decide to enter into exclusive or more favorable

 

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relationships with our competitors or could themselves become our competitor. Although we have changed third-party service providers in the past without difficulty, switching to new third-party service providers could cause temporary disruptions to our business. In addition, our third-party service providers may not perform as expected under our agreements or we could in the future have disagreements or disputes with our third-party service providers, which could negatively impact our operations or threaten our relationships with our third-party service providers.

Third-party payment companies and depository banks in China, including a depository bank that takes deposits and transfers funds on our marketplace and the third-party payment company with which it works, are subject to oversight by the PBOC and must comply with complex rules and regulations, licensing and examination requirements, including, but not limited to, minimum registered capital, maintenance of payment business licenses, anti-money laundering regulations and management personnel requirements. Some third-party payment companies have been required by the PBOC to suspend their credit card pre-authorization and payment services in certain areas of China. If the third-party service providers that take deposits and transfer funds on, or serve as payment channels for, our marketplace were to suspend, limit or cease their operations, or if our relationships with our third-party service providers were to otherwise terminate, we would need to implement substantially similar arrangements with other third-party service providers. Negative publicity about our or other third-party service providers or the industry in general may also adversely affect investors’ or borrowers’ confidence and trust in the use of third-party payment companies and depository banks to carry out the payment and depository functions in connection with the origination of loans on our marketplace. If any of these were to happen, the operation of our platform could be materially impaired and our results of operations would suffer.

The recently published Guidelines to Promote the Healthy Growth of Internet Finance, or the Guidelines, require market lending platforms to use bank depository accounts to hold lending capital, which is further emphasized in the Interim Measures for the Administration of Business Activities of Online Lending Information Intermediaries, or the Interim Measures. In addition, the Administrative Measures of Non-Bank Payments Institutions Network Payment Service, or the Administrative Measures, which became effective from July 1, 2016, prohibit payment institutions from opening payment accounts for institutions engaging in the lending business and also set ceilings for the maximum deposits permitted into an account opened with a third-party payment company. In February 2017, the CBRC released the Guidance to the Operation of Depositing Online Lending Funds, or the Guidance. The Guidance further specifies that qualified commercial banks may act as depositories to hold online lending funds, and that other banking financial institutions are not qualified to set up individual accounts or provide settlement and payment functions. The Guidance also sets forth basic requirements for commercial banks, including maintaining separate accounts to hold online lending funds and private funds owned by online lending platforms and prohibits outsourcing or assigning such entities’ responsibilities for setting up capital accounts, dealing with transaction information, verifying trading passwords and various other services to third parties, provided, however, that certain cooperation regarding payment services with third-party payment companies is permitted in accordance with clarifications by the CBRC. However, CBRC’s remarks regarding the Guidance are not entirely clear regarding the definition and scope of the term “certain cooperation regarding payment services.” In addition, the Guidance imposes certain responsibilities on online lending intermediaries such as us, including requiring them to organize independent auditing on funds depository accounts of borrowers and investors. The Guidelines stipulated a 6-month grace period from the time of its announcement for online lending intermediaries to adjust their business models. See “Regulation—Regulations Related to the Marketplace Lending Industry.” In December 2016, prior to the announcement of the Guidance, we entered into, and modified our operations to be in compliance with, an agreement with Hengfeng Bank regarding the provision of funds depository services by Hengfeng Bank. The depository mechanism established by this agreement may not fully comply with the subsequently issued Guidance and we may need to amend the agreement to be in full compliance with the Guidance, including but not limited to setting up separate self-owned capital accounts with Hengfeng Bank and independent audit of funds in depository accounts of borrowers and investors. To the extent our current depository mechanism is not in full compliance with the Guidance, we may be required to make changes within the six-month grace period.

 

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To the extent our current arrangements with Hengfeng Bank are deemed non-compliant with the Guidelines, the Administrative Measures, the Interim Measures and the Guidance or if changes to these arrangements are required by future rules or regulations, a material change to our business model may be required and our business may be materially and adversely impacted.

Our quarterly results may fluctuate significantly and may not fully reflect the underlying performance of our business.

Our quarterly results of operations, including our operating revenue, expenses, number of loans and other key metrics, may vary significantly in the future and period-to-period comparisons of our operating results may not be meaningful. Accordingly, the results for any one quarter are not necessarily an indication of future performance. Our quarterly financial results may fluctuate due to a variety of factors, some of which are outside of our control and, as a result, may not fully reflect the underlying performance of our business. Fluctuation in quarterly results may adversely affect the price of our ADSs. Factors that may cause fluctuations in our quarterly results include:

 

    our ability to attract new investors and borrowers and maintain and strengthen relationships with existing borrowers and investors;

 

    our ability to execute our “low and grow” strategy;

 

    loan volumes, loan grades, loan product mix, fee rates and the channels through which the loans and corresponding borrowers or investors are sourced;

 

    the amount and timing of the incurrence of operating expenses and customer acquisition incentives related to acquiring borrowers and/or investors and the maintenance and expansion of our business, operations and infrastructure;

 

    network outages or security breaches;

 

    general economic, industry and market conditions, particularly with respect to interest rates, consumer spending and levels of disposable income;

 

    the timing of loan offerings to potential borrowers;

 

    the availability of sufficient lending capital for our marketplace;

 

    our emphasis on long-term growth of our platform instead of immediate profitability; and

 

    the timing of expenses related to the development or acquisition of technologies or businesses and potential future charges for impairment of goodwill from acquired technologies or businesses, if any.

In addition, we experience some seasonality in demand for consumer loans, which is generally higher in the third and fourth quarters due to the timing of national holidays as well as consumer spending patterns. While our rapid growth has somewhat masked this seasonality, our operating results could be affected by such seasonality in the future.

If we do not compete effectively in our target markets, our operating results could be harmed.

The PRC’s lending market is highly competitive and rapidly evolving. We compete with financial products and companies that attract potential borrowers, investors or both. With respect to borrowers, we primarily compete with other online marketplaces that facilitate consumer credits. With respect to investors, we primarily compete with other lending marketplaces, micro-lending investment products providers, wealth management centers and traditional banks in China.

Some of our current or potential competitors have significantly more financial, technical, marketing and other resources than we do and may be able to devote greater resources to the development, promotion, sale and

 

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support of their platforms and distribution channels. Their business models may also ultimately prove more successful or more adaptable to new regulatory, technological and other developments. Our current or potential competitors may also have longer operating histories, more extensive customer bases, more data and distribution channels, greater brand recognition and brand loyalty and broader customer and partnership relationships than we have. For example, established Internet companies, including social media companies that possess large, existing customer bases, substantial financial resources and established distribution channels have entered and may continue to enter the market. Our competitors may be better at developing new products, responding quickly to new technologies and undertaking more extensive marketing campaigns. If we are unable to compete with such companies or meet the need for innovation in our industry, the demand for our marketplace could stagnate or substantially decline, we could experience reduced revenue or our marketplace could fail to achieve or maintain more widespread market acceptance, any of which could harm our business.

When new competitors seek to enter our target market, or when existing market participants seek to increase their market share, they sometimes undercut the pricing and/or terms common place in that market, which could adversely affect our market share or ability to exploit new market opportunities. In addition, since the marketplace lending industry is a relatively recent development in China, potential investors and borrowers may not fully understand how our platform works and may not be able to fully appreciate the additional customer protections and features that we have invested in and adopted on our platform as compared to other marketplace lending platforms. Our pricing and terms could deteriorate if we fail to act to meet these competitive challenges. Further, to the extent that our competitors are able to offer more attractive terms to our partners, such cooperation partners may choose to terminate their relationships with us. All of the foregoing could adversely affect our business, results of operations, financial condition and future growth.

If negative publicity arises with respect to us, the marketplace lending industry or the Internet finance industry in general, our employees, our third-party service providers or our partners, our business and operating results could be adversely affected.

If negative publicity arises about the marketplace lending industry or the Internet finance industry in general in China or our company, including the quality, effectiveness and reliability of our marketplace, our proprietary advanced credit assessment technology, our ability to effectively manage and resolve borrower and investor complaints, privacy and security practices, litigation, regulatory challenges and the experience of borrowers and investors with our platform or services, even if inaccurate, could adversely affect our reputation and the confidence in, and the use of, our platform, which could harm our business and operating results. The PRC government has recently instituted general regulations and specific rules, including the Guidelines and Interim Measures, to develop a more transparent regulatory environment for the marketplace lending industry. See “Regulation—Regulations Related to the Marketplace Lending Industry.” Many companies in China’s marketplace lending industry have not been fully compliant with these regulations, which has adversely impacted the reputation of China’s marketplace lending industry as a whole. In addition, particularly in the last year, there have been an increasing number of business failures of, or accusations of fraud and unfair dealing against, companies in the marketplace lending industry in China. Although the market exits of these companies may result in more healthy and stable development of the marketplace lending industry, to the extent borrowers or investors associate our company with these failed companies, they may be less willing to participate on our marketplace. Harm to our reputation can also arise from many other sources, including employee misconduct, misconduct by our partners, outsourced service providers, including third-party payment companies, depository banks or other counterparties, failure by us, our partners or our outsourced services providers to meet minimum standards of service and quality, inadequate protection of borrower and investor information and compliance failures and claims. Additionally, negative publicity with respect to our partners or service providers could also affect our business and operating results to the extent that we rely on these partners or if borrowers and investors associate our company with these partners.

 

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If we are unable to increase the number of repeat borrowers on our platform, the credit quality, amount of transaction and service fees and overall profitability of our marketplace may be adversely affected.

Since inception, our marketplace has generally experienced an increase in repeat borrowing on our platform. Repeat borrowing is fundamental to our “low and grow” strategy, through which we offer small, shorter-term loans to quality EMMAs, and use our proprietary decisioning technology to proactively offer larger, longer-term to borrowers that demonstrate good credit histories. In addition, repeat borrowing generally contributes to a higher overall credit quality of borrowers on our marketplace as we only permit borrowers with positive repayment histories to become repeat borrowers. Additional loans facilitated to repeat borrowers contribute to an increase in our transaction and service fees. However, the growth in repeat borrowing rate may not immediately translate into profitability if we continue to pay large amounts of incentive payments as first-time consumption loan borrowers come onto our platform. Repeat borrowing tends to result in increases in average loan size as borrowers progressively borrow loans with higher principal amounts in subsequent loans on our marketplace. These repeat borrowers generally have higher credit quality than first-time borrowers on our marketplace. As repeat borrowers borrow larger amounts of loans over time, we expect to generate cumulative fees exceeding our customer acquisition costs and increase our overall profitability. While we expect the rate of repeat borrowing on our marketplace to continue to increase, if our repeat borrowing rate decreases in the future, if repeat borrowers do not borrow larger loans or if the repeat borrowing rate is not as high as our expectations, our overall profitability may be adversely affected.

Our business and operating results may be impacted by adverse economic and market conditions.

Many factors, including factors that are beyond our control, may have a detrimental impact on borrowers’ willingness to seek loans and investors’ ability and desire to lend, and consequentially have a negative effect on our business and results of operations. These factors include general economic conditions, the general interest rate environment, unemployment rates, residential home values and the availability of other investment opportunities. If any of these factors arise, our revenue and transactions on our marketplace would decline and our business would be negatively impacted.

There can be no assurance that economic conditions will remain favorable for our business or that demand for our loans will remain at current levels. Reduced demand for, or increase in the default rate of, our loans would negatively impact our growth and revenue. If an insufficient number of qualified individuals apply for our loans or our access to lending capital for loans on our platform decreases, our growth and revenue could decline.

Our success and future growth depend significantly on our marketing and brand promotion efforts, and if we are unable to attract new borrowers and investors to our marketplace, our business and financial results may be harmed.

We intend to continue to dedicate significant resources to our marketing and brand promotion efforts, particularly as we continue to grow our marketplace. Our ability to attract quality potential borrowers and sufficient numbers of investors to our marketplace depends in large part on the success of our marketing efforts, the success of the marketing channels we use to promote our marketplace and the experiences of borrowers and investors on our marketplace. Our marketing channels include social media, the traditional media, strategic relationships with key Internet companies, search engine optimization, search engine marketing, billboard and mail-to-web. If any of our current marketing channels become less effective, if we are unable to continue to use any of these channels, if the cost of using these channels were to significantly increase or if we are not successful in generating new channels, we may not be able to attract new borrowers and investors in a cost-effective manner or convert potential borrowers and investors into active borrowers and investors on our marketplace. In addition, we believe that developing and maintaining awareness of our brand in a cost-effective manner is critical to retaining existing borrowers and investors and attracting new ones to our marketplace. Our efforts to build our brand have required significant expenditures, and it is likely that our future marketing efforts will continue to require significant additional expenses. Any failure to successfully promote our brand and develop a broader base

 

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of borrowers and investors could result in a loss of market share or slower growth, which would harm our business, financial condition and results of operations.

If new loan products and enhancements of our marketplace do not achieve sufficient market acceptance, our financial results and competitive position will be harmed.

We incur expenses and expend resources upfront to develop, acquire and market new loan products and platform enhancements to our platform to incorporate additional features, improve functionality or otherwise make our platform more desirable to potential borrowers and investors. New loan products or platform enhancements must achieve high levels of market acceptance.

Any new loan products and changes to our marketplace could fail to attain sufficient market acceptance for many reasons, including:

 

    our failure to predict market demand accurately and launch loan products that meet this demand in a timely fashion;

 

    borrowers and investors using our marketplace may not like, find useful or agree with any changes;

 

    defects, errors or failures in our marketplace;

 

    negative publicity about the loan products facilitated on our marketplace or our marketplace or its performance or effectiveness;

 

    if the annual investment returns are lower than we and/or the investors expected;

 

    delays in releasing to the market new loan products or marketplace enhancements; and

 

    the introduction or anticipated introduction of competing products by our competitors.

If the new loan products facilitated on our marketplace or marketplace enhancements do not achieve adequate acceptance in the market, our competitive position, revenue and operating results could be harmed. The adverse effect on our financial results may be particularly acute because of the significant development, marketing, sales and other expenses we will have incurred in connection with the new loan products or marketplace enhancements.

If the total addressable market for the loans facilitated by our marketplace is smaller than we believe it is, our revenue may be adversely affected and our business may suffer.

It is very difficult to estimate the total addressable market for the loans facilitated by our marketplace due to factors such as market demand, PRC regulations of the credit industry, competition, general economic conditions and the relatively short history of the marketplace lending industry in China. We believe that our total addressable market of borrowers consists of EMMAs seeking unsecured affordable credit up to RMB100,000 (approximately US$14,400). However, if there is less demand than we anticipate for the loans facilitated on our marketplace, it would significantly and negatively impact our business, financial condition and results of operations.

Competition for our employees is intense, and we may not be able to attract and retain the highly skilled employees needed to support our business.

As we continue to experience rapid growth, we believe our success depends on the efforts and talents of our employees, including software engineers, financial personnel and marketing professionals. Our future success depends on our continued ability to attract, develop, motivate and retain highly qualified and skilled employees. Competition for highly skilled sales, technical and financial personnel is extremely intense. We may not be able to hire and retain these personnel at compensation levels consistent with our existing compensation and salary structure. Many of the companies with which we compete for experienced employees have greater resources than we have and may be able to offer more attractive terms of employment.

 

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In addition, we invest significant time and expense in training our employees, which increases their value to competitors who may seek to recruit them. If we fail to retain our employees, we could incur significant expenses in hiring and training their replacements, and the quality of our services and our ability to serve borrowers and investors could diminish, resulting in a material adverse effect on our business.

If we fail to retain our key personnel, we may not be able to achieve our anticipated level of growth and our business could suffer.

In addition to attracting and retaining highly skilled employees in general, our future performance depends, in part, on our ability to attract and retain key personnel, including our executive officers, senior management team and other key personnel, all of whom would be difficult to replace. In particular, Dr. Zhengyu (Zane) Wang, our founder, chairman and chief executive officer, is critical to the management of our business and operations and the development of our strategic direction. The loss of the services of Dr. Wang, our other executive officers or members of our senior management team, and the process to replace any of them, would involve significant time and expense and may significantly delay or prevent the achievement of our business objectives.

From time to time we may evaluate and potentially consummate acquisitions or alliances, which could require significant management attention, disrupt our business, adversely affect our financial results, be unsuccessful or fail to achieve the desired result.

Although not currently planned, in the future we may evaluate and consider strategic transactions, combinations, acquisitions or alliances to enhance our existing business or develop new loan products and services. These transactions could be material to our financial condition and results of operations if consummated. If we are able to identify an appropriate business opportunity, we may not be able to successfully consummate the transaction and, even if we do consummate the transaction, we may be unable to obtain the benefits or avoid the difficulties and risks of such transaction.

Any acquisition or alliance will involve risks commonly encountered in business relationships, including:

 

    difficulties in assimilating and integrating the operations, personnel, systems, data, technologies, products and services of the acquired business;

 

    inability of the acquired technologies, products or businesses to achieve expected levels of revenue, profitability, productivity or other benefits;

 

    difficulties in retaining, training, motivating and integrating key personnel;

 

    diversion of management’s time and resources from our normal daily operations;

 

    difficulties in successfully incorporating licensed or acquired technology and rights into our platform;

 

    difficulties in retaining relationships with customers, employees and suppliers of the acquired business;

 

    regulatory risks; and

 

    liability for activities of the acquired business before the acquisition, including patent, copyright and trademark infringement claims, violations of laws, commercial disputes, tax liabilities and other known and unknown liabilities.

We may not make any acquisitions or consummate any alliances, or any future acquisitions or alliances may not be successful, may not benefit our business strategy, may not generate sufficient revenue to offset the associated costs or may not otherwise result in the intended benefits. In addition, we cannot assure you that any future acquisition of, or alliance with respect to, new businesses or technology will lead to the successful development of new or enhanced loan products and services or that any new or enhanced loan products and services, if developed, will achieve market acceptance or prove to be profitable.

 

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High interest rates could negatively affect our ability to attract investors and borrowers to our marketplace.

A high interest rate environment may discourage investors and borrowers from participating in our marketplace and may reduce the number of loans facilitated on our platform, which may adversely affect our business. Therefore, our business could be adversely affected by potential interest rate increases in China.

Limited liquidity for loans facilitated through our marketplace may make these investments less attractive to investors.

A limited trading market currently exists for the loans facilitated on our marketplace. After the lapse of the contractually agreed lending deadline, investors are permitted to transfer their loans to other investors in any manner they deem appropriate. Investors can seek suitable transferees through their own means or they may request our assistance in transferring a loan. If the investor chooses to use our assistance in identifying a transferee, we will recommend the investor’s loans to other investors on our marketplace according to such other investors’ specific risk appetite. To the extent that an investor is not able to transfer a loan for adequate consideration in a timely manner or at all, the investor may be discouraged from investing on our marketplace in the future.

Any significant disruption in service on our, our third-party service providers’ or our partners’ computer systems, including events beyond our control, could prevent or delay the processing or posting of payments on loans, reduce the attractiveness of our marketplace and result in a loss of borrowers or investors.

A significant natural disaster, such as a fire, power outage, flood or other catastrophic event, or interruptions by strikes, terrorism or other man-made problems, could have a material adverse effect on our business, operating results and financial condition. Despite any precautions we may take, the occurrence of a natural disaster or other unanticipated problems at our data centers, data verification centers, investor service centers or the data centers of our third-party service providers or our partners could result in lengthy interruptions in our services. In addition, acts of strikes, terrorism and other geo-political unrest or hacking could cause disruptions in our business and lead to interruptions, delays or loss of critical data. Our operations also rely on the performance of the Internet infrastructure and fixed telecommunication networks in China. All of the aforementioned risks may be further increased if our disaster recovery plans prove to be inadequate. Although this program is functional, we do not currently serve network traffic equally from each data center. If our primary data center shuts down, there will be a period of time that our loan products or services, or certain of our loan products or services, will remain inaccessible to the borrowers and investors on our marketplace, such borrowers and investors may experience severe issues accessing the loan products and services.

In the event of an outage or physical data loss on our marketplace or the systems of our third-party service provider depositing or transferring funds on, or third-party payment channels for, our marketplace or partners, such third-party service provider’s or our partners’ ability to cooperate with us could be materially and adversely affected. The satisfactory performance, reliability and availability of our technology and our underlying network infrastructure are critical to our operations, customer service, reputation and our ability to attract new and retain existing borrowers and investors to our marketplace. Much of our system hardware is hosted in facilities located in Shanghai and Shenzhen that are partially owned by us and operated by our third-party vendors. Our operations depend on such vendors’ ability to protect their and our systems in their facilities against damage or interruption from natural disasters, power or telecommunications failures, air quality issues, environmental conditions, computer viruses or attempts to harm our systems, criminal acts and similar events. If there is a lapse of service or damage to our system hardware, we could experience interruptions in our service as well as delays and additional expense in arranging new facilities.

Any interruptions or delays in our service, whether as a result of third-party error, our error, natural disasters or security breaches, whether accidental or willful, could harm our relationships with borrowers and investors on our marketplace and our reputation. Additionally, in the event of damage or interruption, our insurance policies may not adequately compensate us for any losses that we may incur. We do not currently maintain business

 

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interruption insurance to compensate us for potentially significant losses, including potential harm to our business that may result from interruptions in our ability to facilitate the loan products and services. Our disaster recovery plan has not been tested under actual disaster conditions, and we may not have sufficient capacity to recover all data and services in the event of an outage. These factors could prevent us from processing or posting payments on the loans, damage our brand and reputation, divert our employees’ attention, subject us to liability and cause borrowers and investors to abandon our marketplace, any of which could adversely affect our business, financial condition and results of operations.

Our marketplace and internal systems rely on software that is highly technical, and if it contains undetected errors, our business could be adversely affected.

Our marketplace and internal systems rely on software licensed from third parties that is highly technical and complex. To the extent that such third parties also license the software or parts of the software, we rely on such third parties to maintain their licensing rights. In addition, our marketplace and internal systems depend on the ability of such software to store, retrieve, process and manage immense amounts of data. The software on which we rely has contained, and may now or in the future contain, undetected errors or bugs. Some errors may only be discovered after the code has been used in our operations. Errors or other design defects within the software on which we rely may result in a negative experience for borrowers and investors, delay introductions of new features or enhancements, result in errors or compromise our ability to protect borrower or investor data or our intellectual property. Any errors, bugs or defects discovered in the software on which we rely could result in harm to our reputation, loss of borrowers or investors or liability for damages, any of which could adversely affect our business and financial results.

Misconduct and errors by our employees and third-party service providers could harm our business and reputation.

We are exposed to many types of operational risks, including the risk of misconduct and errors by our employees and third-party service providers. Our business depends on our employees and third-party service providers to process a large number of increasingly complex transactions, including loan transactions that involve the use and disclosure of personal and business information. We could be materially adversely affected if personal and business information was disclosed to unintended recipients or an operational breakdown or failure in the processing of other transactions occurred, whether as a result of human error, a purposeful sabotage or a fraudulent manipulation of our operations or systems. Also, we could be materially adversely affected if our employees or third-party service providers absconded with our proprietary data or used our know-how to compete with us. In addition, the manner in which we store and use certain personal information and interact with borrowers and investors is governed by various laws. If any of our employees or third-party service providers take, convert or misuse funds, documents or data or fail to follow protocol when interacting with borrowers and investors, we could be liable for damages and subject to regulatory actions and penalties or suffer reputational damage. We could also be perceived to have facilitated or participated in the illegal misappropriation of funds, documents or data, or the failure to follow protocol, and therefore be subject to civil or criminal liability or suffer reputational damage. It is not always possible to identify and deter misconduct or errors by employees or third-party service providers, and the precautions we take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses. Although employees have left our company in the past and violated the non-compete and non-solicitation clauses in their employment agreements with little impact on our business, future violations of these clauses could have a material adverse effect on our business. Any of these occurrences could result in our diminished ability to operate our business, potential liability to borrowers and investors, inability to attract future borrowers and investors, reputational damage, regulatory intervention and financial harm, which could negatively impact our business, financial condition and results of operations.

 

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Any failure to protect our own intellectual property rights could impair our brand, negatively impact our business or both.

Our success and ability to compete also depend in part on protecting our own intellectual property. We rely on a combination of copyright, trade secret, trademark and other rights, as well as confidentiality procedures and contractual provisions to protect our proprietary technology, processes and other intellectual property. However, the steps we take to protect our intellectual property rights may be inadequate. Third parties may seek to challenge, invalidate or circumvent our copyright, trade secret, trademark and other rights or applications for any of the foregoing. In order to protect our intellectual property rights, we may be required to spend significant resources. Litigation brought to protect and enforce our intellectual property rights could be costly, time-consuming and distracting to management. Our failure to secure, protect and enforce our intellectual property rights could seriously adversely affect our brand and adversely impact our business.

We may be sued by third parties for alleged infringement of their proprietary rights, which could harm our business.

Our competitors, as well as a number of other entities and individuals, may own or claim to own intellectual property relating to our industry. From time to time, third parties may claim that we are infringing on their intellectual property rights. We may, however, be unaware of the intellectual property rights that others may claim cover some or all of our applications, technology or services. Any claims or litigation could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages or ongoing royalty payments, restrict us from conducting our business or require that we comply with other unfavorable terms. We may also be obligated to indemnify parties or pay substantial settlement costs, including royalty payments, in connection with any such claim or litigation and to obtain licenses, modify applications or refund fees, which could be costly. Even if we were to prevail in such a dispute, any litigation regarding our intellectual property could be costly and time-consuming and divert the attention of our management from our business operations.

Some aspects of our digital operations include open source software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business.

Some aspects of our digital operations include software covered by open source licenses. The terms of various open source licenses have not been interpreted by PRC courts, and there is a risk that such licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our online and mobile-based channels. If portions of our proprietary software are determined to be subject to an open source license, we could be required to publicly release the affected portions of our source code, re-engineer all or a portion of our technologies if required so by the license, or otherwise be limited in the licensing of our technologies, each of which could reduce or eliminate the value of our technologies and loan products. In addition to risks related to license requirements, usage of open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or controls on the origin of the software. Many of the risks associated with use of open source software cannot be eliminated, and could adversely affect our business.

We may need additional capital, and financing may not be available on terms acceptable to us, or at all.

Although we believe that our current cash and cash equivalents, anticipated cash flows from operating activities and the proceeds from this offering will be sufficient to meet our anticipated working capital requirements and capital expenditures in the ordinary course of business for at least 12 months following this offering, we may need additional cash resources in the future if we experience changes in business conditions or other developments. We may also need additional cash resources in the future if we find and wish to pursue opportunities for investment, acquisition, capital expenditure or similar actions. If we determine that our cash requirements exceed the amount of cash and cash equivalents we have on hand at the time, we may seek to issue

 

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equity or debt securities or obtain credit facilities. The issuance and sale of additional equity would result in further dilution to our shareholders. The incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.

We may incur substantial debt in the future, which may adversely affect our financial condition and negatively impact our operations.

Although we have not incurred substantial debt to date, we may decide to do so in the future. The incurrence of debt could have a variety of negative effects, including:

 

    default and foreclosure on our assets if our operating revenue is insufficient to repay debt obligations;

 

    acceleration of obligations to repay the indebtedness (or other outstanding indebtedness), even if we make all principal and interest payments when due, if we breach any covenants that require the maintenance of certain financial ratios or reserves without a waiver or renegotiation of that covenant;

 

    our inability to obtain necessary additional financing if the debt security contains covenants restricting our ability to obtain such financing while the debt security is outstanding;

 

    diverting a substantial portion of cash flow to pay principal and interest on such debt, which would reduce the funds available for expenses, capital expenditures, acquisitions and other general corporate purposes; and

 

    creating potential limitations on our flexibility in planning for and reacting to changes in our business and in the industry in which we operate.

The occurrence of any of these risks could adversely affect our operations or financial condition.

Because some borrowers and investors may come to our marketplace from referrals of third parties, it is possible that an unsatisfied borrower or investor could make a claim against us based on the content of any information provided by these third parties that could result in claims that are costly to defend and distracting to management.

Some borrowers and investors may come to our marketplace after reviewing information provided by a third party. We do not review, approve or adopt any information provided by third parties website and, while we do not believe we would have liability for such information, it is possible that an unsatisfied borrower or investor could bring claims against us based on such information. Such claims could be costly and time-consuming to defend and would distract management’s attention from the operation of our business and create negative publicity, which could affect our reputation.

If we fail to implement and maintain an effective system of internal controls or fail to remediate the material weaknesses in our internal control over financial reporting that have been identified, we may be unable to accurately report our results of operations or prevent fraud or fail to meet our reporting obligations, and investor confidence and the market price of our ADSs may be materially and adversely affected.

Prior to this offering, we were a private company with limited accounting personnel and other resources with which to address our internal controls and procedures. Our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. However, in preparing our consolidated financial statements as of and for the years ended December 31, 2014, 2015 and 2016, we and our independent registered public accounting firm identified two material weaknesses in our internal control over financial reporting, as defined in the standards established by the Public Company Accounting Oversight Board of the United States, or PCAOB, and other control deficiencies. The two material weaknesses identified related to a lack of accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting and compliance

 

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requirements, and a lack of sufficient documented financial closing policies and procedures. Following the identification of the material weaknesses and control deficiencies, we have taken and plan to continue to take remedial measures. For details of these remedies, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Control over Financial Reporting.” However, the implementation of these measures may not fully address the material weaknesses in our internal control over financial reporting. Our failure to correct the material weaknesses or our failure to discover and address any other material weaknesses or control deficiencies could result in inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis. As a result, our business, financial condition, results of operations and prospects, as well as the trading price of our ADSs, may be materially and adversely affected. Moreover, ineffective internal control over financial reporting significantly hinders our ability to prevent fraud.

Upon completion of this offering, we will become a public company in the United States subject to the Sarbanes-Oxley Act of 2002. Section 404 of this Act will require that we include a report of management on our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending December 31, 2017. In addition, once we cease to be an “emerging growth company,” as such term is defined in the JOBS Act, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm, after conducting its own independent testing, may issue a report that is qualified if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, after we become a public company, our reporting obligations may place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.

Certain data and information in this prospectus were obtained from third-party sources and were not independently verified by us.

This prospectus contains certain data and information that we obtained from various government and private entity publications including industry information from Oliver Wyman. Statistical data in these publications also include projections based on a number of assumptions. The Chinese credit industry, and marketplace lending in particular, may not grow at the rate projected by market data, or at all. Failure of this industry to grow at the projected rate may have a material adverse effect on our business and the market price of our ADSs. In addition, the new and rapidly changing nature of the credit and marketplace lending industry results in significant uncertainties for any projections or estimates relating to the growth prospects or future condition of our industry. Furthermore, if any one or more of the assumptions underlying the market data is later found to be incorrect, actual results may differ from the projections based on these assumptions.

We have not independently verified the data and information contained in such third-party publications and reports. Data and information contained in such third-party publications and reports may be collected using third-party methodologies, which may differ from the data collection methods used by us. In addition, these industry publications and reports generally indicate that the information contained therein was believed to be reliable, but do not guarantee the accuracy and completeness of such information.

If we cannot maintain our corporate culture as we grow, we could lose the innovation, collaboration and focus that contribute to our business.

We believe that a critical component of our success is our corporate culture, which we believe fosters innovation, encourages teamwork and cultivates creativity. As we develop the infrastructure of a public company and continue to grow, we may find it difficult to maintain these valuable aspects of our corporate culture. Any

 

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failure to preserve our culture could negatively impact our future success, including our ability to attract and retain employees, encourage innovation and teamwork and effectively focus on and pursue our corporate objectives.

We do not have any business insurance coverage.

Insurance companies in China currently do not offer as extensive an array of insurance products as insurance companies in more developed economies. Currently, we do not have any business liability or disruption insurance to cover our operations. We have determined that the costs of insuring for these risks and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Any uninsured business disruptions may result in our incurring substantial costs and the diversion of resources, which could have an adverse effect on our results of operations and financial condition.

If we are required to pay U.S. taxes, the value of your investment in our company could be reduced.

If, (1) pursuant to a plan or a series of related transactions, a non-U.S. corporation, such as our company, acquires substantially all of the properties constituting a trade or business of a U.S. partnership (including any trade or business conducted by such partnership directly or through entities treated as transparent for U.S. federal income tax purposes), (2) after the acquisition, 80% or more of the stock, by vote or value, of the non- U.S. corporation, excluding stock issued in a public offering related to the acquisition, is owned by former partners of the U.S. partnership by reason of their ownership of the U.S. partnership and (3) the non-U.S. corporation and certain of its affiliates do not have substantial business activities in the country in which the non-U.S. corporation is organized, then the non-U.S. corporation will be considered a U.S. corporation for U.S. federal income tax purposes. Prior to our conversion to a Cayman Islands company, we were a Delaware LLC treated as a partnership for U.S. federal income tax purposes. We do not believe that the Delaware LLC was engaged in a trade or business, either directly or through entities treated as transparent for U.S. federal income tax purposes. Based on our analysis of the facts related to our corporate restructuring (in particular, our conversion from a Delaware LLC to a Cayman Islands company), we do not believe that we should be treated as a U.S. corporation for U.S. federal income tax purposes. However, as there is no direct authority on how the relevant rules of the Internal Revenue Code might apply to us, the Internal Revenue Service could reach a different conclusion and seek to treat us as a U.S. corporation for U.S. federal income tax purposes. In addition, changes to the rules described above or the U.S. Treasury Regulations promulgated thereunder or other IRS guidance implementing such rules could adversely affect our status as a non-U.S. corporation for U.S. federal income tax purposes, and any such changes could have prospective or retroactive application to us or our shareholders.

A finding that we owe additional U.S. taxes could significantly reduce the value of your investment in our company. If we were to be treated as a U.S. corporation for U.S. federal income tax purposes, we would be subject to U.S. corporate income tax on our worldwide income, and the income of our non-U.S. subsidiaries would be subject to U.S. federal income tax when repatriated or when deemed repatriated under the U.S. federal income tax rules for controlled foreign corporations. Additionally, we may be subject to significant penalties for the failure to file certain tax returns and reports. Moreover, in such case, a non-U.S. shareholder would generally be subject to U.S. withholding tax on the gross amount of any dividends paid by us to such shareholder. You are urged to consult your tax advisor concerning the income tax consequences of purchasing, holding or disposing of ADSs or ordinary shares if we were to be treated as a U.S. corporation for U.S. federal income tax purposes.

Risks Related to the PRC Laws Regulating Our Business and Industry

As the regulatory framework for our business evolves, domestic and foreign governments may draft and propose new laws, regulations, notices or interpretive releases to regulate marketplace lending, including our online and mobile-based channels, which may negatively affect our business.

The marketplace lending industry in China has historically been largely unregulated. In July 2015, ten PRC central government ministries and regulators, including the PBOC, the CBRC, the Ministry of Finance, the

 

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Ministry of Public Security and the Cyberspace Administration of China, together released the Guidelines, which provide regulatory principles for Internet financing businesses, including those in the online marketplace lending industry. In August 2016, the CBRC and other regulators collectively announced the Interim Measures, which proposed the implementation of new requirements including, among others, filing, reporting, fund depository, risk and information disclosure, loan management and the permitted business scope for participants in the online marketplace lending industry. In November 2016, the CBRC, the MIIT and the Industry and Commerce Administration Department, jointly issued the Guidance to the Administration of Filling and Registration of Online Lending Information Intermediaries, or the Guidance of Administration, which provides general filing rules for online lending intermediaries, and authorizes local financial regulators to make detailed implementation rules regarding filing procedures according to their local practices. See “Regulation—Regulations Related to the Marketplace Lending Industry.” Since 2017, local financial regulators have been conducting thorough investigations and inspections of online lending intermediaries and require a rectification if any illegality is discovered. After local financing regulators have completed their investigation and examination, we may be permitted to submit a filing application. In February 2017, the CBRC released the Guidance to regulate funds depositories for online lending intermediaries, which defines several obligations and responsibilities of online lending intermediaries and commercial banks involved in the online funds depository business. See “Regulation—Regulations Related to the Marketplace Lending Industry.” Nevertheless, it is uncertain as to how the Interim Measures will be further interpreted and implemented. The relevant local authorities are also in the process of making detailed implementation rules regarding filing procedures. However, the final content and timing of the final implementation rules and other related new rules are uncertain. To the extent that we are not able to fully comply with the new regulations in the grace period of twelve months or any new regulations differ from our expectations, we may be materially and adversely affected. We are unable to predict with certainty the impact, if any, that future legislation, judicial precedents, or regulations relating to the marketplace lending industry will have on our business, financial condition and results of operations. Furthermore, the increasing growth in popularity of marketplace lending and borrowing increases the likelihood that the PRC government will seek to further regulate the marketplace lending industry.

In addition, the regulatory framework for Internet commerce, including online marketplaces such as our marketplace, with respect to our marketplace’s online and mobile-based channels, is evolving, and it is possible that new laws and regulations will be adopted domestically and internationally, or existing laws and regulations may be interpreted in new ways, which, along with possible changes needed to fully comply with any newly released regulation, could affect the operation of our marketplace and the way in which we interact with borrowers and investors. The cost to comply with such laws or regulations would increase our operating expenses, and we may be unable to pass those costs on to borrowers and investors in the form of increased fees. In addition, governmental or regulatory agencies may decide to impose taxes on services provided over the Internet or by online marketplaces. These taxes could discourage the use of our marketplace, which would adversely affect the viability of our business.

Changes in PRC regulations relating to interest rates for marketplace and micro-credit lending could have a material adverse effect on our business.

The interest rate permitted to be charged on loans facilitated by our marketplace is subject to limitations set forth in the Provisions of the Supreme People’s Court on Application of Laws to the Hearing of Private Lending Cases, or the Provisions on Private Lending Cases, which provide that (i) when the interest rate agreed between the borrower and investor does not exceed an annual interest rate of 24%, the People’s Court will uphold the interest rate charged by the investor, and (ii) when the interest rate agreed between the borrower and investor exceeds an annual interest rate of 36%, the portion in excess of 36% is void and the People’s Court will uphold the borrower’s claim for return of the excess portion to the borrower. For loans with interest rates per annum between 24% and 36%, if the interest on the loans has already been paid to the investor, and so long as such payment has not damaged the interest of the state, the community or any third parties, the courts will likely not enforce the borrower’s demand for the return of such interest payment.

 

 

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In addition, our subsidiary, Haidong CRF Micro-credit Co., Ltd., or Haidong, is subject to regulations applicable to micro-credit companies incorporated in Qinghai Province, which are set forth by the Finance Office of Qinghai Province. These regulations provide that: (i) if loans use a micro-credit company’s own capital, the interest rate and fees must be greater than 90% of the PBOC benchmark interest rate and less than four times the PBOC benchmark interest rate; and (ii) if loans use capital derived from certain financial institutions, the interest rate and fees must be greater than 90% of the PBOC benchmark interest rate and less than three times the PBOC benchmark interest rate. The loans facilitated by our marketplace and by Haidong will be subject to the aforementioned interest rate restrictions, which could affect our ability to facilitate loans to certain segments of our target market, and may have a material adverse effect on our business.

Our operations may need to be modified to comply with existing and future requirements set forth by the CBRC or laws or regulations promulgated by other PRC authorities regulating the marketplace lending industry in China.

In April 2014, the CBRC announced four principles regarding the marketplace lending industry in China: (i) marketplace lending platforms shall be treated as agencies, (ii) marketplace lending platforms shall not provide guarantee services, (iii) marketplace lending platforms shall not maintain a fund pool, and (iv) marketplace lending platforms shall not illegally conduct fundraising.

In July 2015, ten PRC central government ministries and regulators, including the PBOC, the CBRC, the Ministry of Finance, the Ministry of Public Security and the Cyberspace Administration of China, together released the Guidelines, which identified the CBRC as the supervisory regulator for the online lending industry. According to the Guidelines, online marketplace lending platforms may only serve as intermediaries to provide information services to borrowers and investors, and may not provide credit enhancement services or illegally conduct fundraising. The Guidelines also outlined certain regulatory propositions, which would require Internet finance companies, including online marketplace lending platforms, to (i) complete website filing procedures with the administrative departments overseeing telecommunications; (ii) use banking financial institutions’ depository accounts to hold lending capital, and engage an independent auditor to audit such accounts and publish audit results to customers; (iii) improve the disclosure of operational and financial information, provide sufficient risk disclosure, and set up thresholds for qualified investors to provide better protections to investors; (iv) enhance online security management to protect customers’ personal and transactional information; and (v) take measures against anti-money laundering and other financial crimes.

In August 2016, the CBRC and other regulators collectively announced the publication of the Interim Measures. The Interim Measures also stipulated a twelve-month transition period from the time of their effectiveness for online lending intermediaries to make necessary adjustments. Apart from what had already been emphasized in the Guidelines and other previously released principles, the Interim Measures also include: (i) general principles; (ii) filing administration; (iii) business rules and risk management guidelines; (iv) protection measures for investors and borrowers; (v) rules on information disclosure; (vi) supervision and administrative mechanisms; and (vii) legal liabilities. See “Regulation—Regulations Related to the Marketplace Lending Industry.”

In November 2016, the CBRC, the MIIT and the Industry and Commerce Administration Department, jointly issued the Guidance of Administration, which provides the general filing rules for online lending intermediaries and delegates the filing authority to the local financial authorities. See “Regulation—Regulations Related to the Marketplace Lending Industry.” Since 2017, local financial regulators have been conducting investigations on the online lending intermediaries, and if we failed to be in full compliance with any regulations, we may be required to rectify mistakes within a certain period as stipulated in the rectification order of local financial regulators. After local financing regulators have completed their investigation and examination, we may be permitted to submit a filing application.

 

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In February 2017, the CBRC released the Guidance to regulate funds depositories for online lending intermediaries, which defines several obligations and responsibilities of online lending intermediaries and commercial banks involved in the online funds depository business. See “Regulation—Regulations Related to the Marketplace Lending Industry.” To the extent our current arrangements with commercial banks are deemed to be not-compliant with any of the Guidance’s requirements, we may need to adjust our operations within the six-month grace period, and as a result, our business may be materially and adversely impacted. See “—Risks Related to Our Business and Industry-If we are unable to maintain relationships with our third-party service providers, our business will suffer.”

Some elements of our marketplace may not currently be operating in full compliance with the Guidelines, the Interim Measures, the Guidance and the other principles that have been announced in recent years. For example, the Guidelines, the Interim Measures, the Guidance and other regulations are not clear about the definition of “credit enhancement service,” nor do they address whether a marketplace lending platform’s affiliated enterprises could provide a “credit enhancement service.” To the extent that our Safeguard Program is classified as a “credit enhancement service” as such definition is clarified, and it is found that affiliated enterprises of a marketplace lending platform cannot provide “credit enhancement services,” we may be required to make changes within the specified twelve-month transition period to the way in which we conduct our business and, as a result, our business may be materially and adversely affected. Additionally, the Interim Measures provide upper limits on the loan balance of a single borrower. While our business mainly involves lending small amounts to a large number of borrowers, we still may not be in full compliance with the upper limits set forth in the Interim Measures. We plan to adjust the upper limits of our loans as necessary within the specified twelve-month transition period. However, any failure to adjust these limits within the specified twelve-month transition period may result in a violation of the Interim Measures. We may need to rely on the information provided by borrowers to determine whether their lending amounts from all intermediaries have reached the upper limits, and the information they provide us may contain misrepresentation or omission or otherwise be unreliable. Moreover, the Interim Measures require online lending intermediaries to file with the local financial regulators and to include serving as an Internet lending information intermediary in their business scope. We plan to make all requisite filings and changes to our business scope to the extent necessary when such filing procedures are clarified by the relevant authorities. Although we do not anticipate any material difficulties in making the requisite filings or changing our business scope, any failure to do so within the specified twelve-month transition period may result in the violation of the Interim Measures. In addition, the Interim Measures stipulate that online lending intermediaries shall not operate businesses other than risk management and necessary business processes such as information collection and confirmation, post-loan tracking and pledge management in accordance with online-lending regulations, via offline physical locations. However, the Interim Measures do not clearly set forth the types of business process that are not permitted to operate through offline physical locations. We have a network of offline facilities including six investor service centers, which focus on maintaining relationship with investors, and 107 data verification centers, which primarily serve the function of verifying data submitted by potential borrowers for loans with principal amounts greater than RMB6,000 (approximately US$865). The functions carried out by these offline facilities may be deemed to go beyond the scope of business processes permitted to be carried out via offline physical locations by the Interim Measures.

Furthermore, the Interim Measures proposed requirements including with respect to certain prohibited activities, risk disclosure, borrower information disclosure and online dispute resolution, examination and verification functions, anti-fraud measures, risk education and training, information reporting, anti-money laundering, anti-terrorist financing, systems, facilities and technologies, service fees, electronic signatures, loan management, risk assessment, auditing and authentication, reporting obligations and information security. To the extent that our business is deemed to be non-compliant with any of these requirements of the Interim Measures, we may need to make necessary adjustments to comply within the specified twelve-month transition period and, as a result, our business may be materially and adversely affected.

For a further description of the laws and regulations applicable to us, see “Regulation.”

 

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The facilitation of loans through our marketplace could give rise to liabilities under PRC laws and regulations that prohibit illegal fundraising.

PRC laws and regulations prohibit persons and companies from raising funds through advertising to the public a promise to repay premium or interest payments over time through payments in cash or in kind except with the prior approval of the applicable government authorities. Failure to comply with these laws and regulations may result in penalties imposed by the PBOC, the Administration for Industry and Commerce, or AIC, and other governmental authorities, and can lead to civil or criminal lawsuits.

To date, our marketplace has not been subject to any fines or other penalties under any PRC laws and regulations that prohibit illegal fundraising. As advised by our PRC counsel, our marketplace does not violate the PRC laws and regulations prohibiting illegal fundraising because our marketplace only acts as a service provider in the facilitation of loans between borrowers and investors. In this capacity, we do not raise funds or promise repayment of premium or interest obligations. Nevertheless, considerable uncertainties exist with respect to the PBOC, AIC and other governmental authorities’ interpretations of the fundraising-related laws and regulations. While our agreements with investors require investors to guarantee the legality of all funds investors put on our marketplace, we do not verify the source of investors’ funds separately, and therefore, to the extent that investors’ funds are obtained through illegal fundraising, we may be negligently liable as a facilitator of illegal fundraising. In addition, while our loan agreements contain provisions that require borrowers to use the proceeds for purposes listed in their loan applications, we do not monitor the borrowers’ use of funds on an on-going basis, and therefore, to the extent that borrowers use proceeds from the loans for illegal activities, we may be negligently liable as a facilitator of an illegal use. Although we have designed and implemented procedures to identify and eliminate instances of fraudulent conduct on our marketplace, as the number of borrowers and investors on our platform increases, we may not be able to identify all fraudulent conduct that may violate illegal fundraising laws and regulations.

The facilitation of loans through our marketplace could give rise to liabilities under PRC laws and regulations that prohibit unauthorized public offerings.

The PRC Securities Law stipulates that no organization or individual is permitted to issue securities for public offering without obtaining prior approval in accordance with the provisions of the law. The following offerings are deemed the be public offerings under the PRC Securities Law: (i) offering of securities to non-specific targets; (ii) offering of securities to more than 200 specific targets; and (iii) other offerings provided by the laws and administrative regulations. Additionally, private offerings of securities shall not be carried out through advertising, open solicitation and disguised publicity campaigns. If any transaction between one borrower and multiple investors on our marketplace is identified as a public offering by PRC government authorities, we may be subject to sanctions under PRC laws and our business may be adversely affected.

Changes in foreign exchange regulations may materially adversely affect our results of operations.

Our marketplace currently receives all of its lending capital from investors in RMB. The PRC government regulates the conversion between RMB and foreign currencies. Over the years, the PRC government has significantly reduced its control over routine foreign exchange transactions under current accounts, including trade and service related foreign exchange transactions. There can be no assurance that these PRC laws and regulations on foreign exchange transactions will not cast uncertainties on foreign investors’ ability to convert foreign currencies to RMB and provide lending capital for our marketplace. While the adjustments related to foreign exchange transactions were relatively small in 2014, 2015 and 2016, the adjustments may be significant going forward if the RMB depreciates. Changes in PRC foreign exchange policies might have a negative impact on our ability to attract foreign investors to our marketplace and could result in foreign investors choosing to provide their lending capital to our non-Chinese competitors, both of which would materially adversely affect our results of operations.

 

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We may be required to obtain a value-added telecommunication business certificate and be subject to foreign investment restrictions.

PRC regulations impose sanctions for engaging in Internet information services of a commercial nature without having obtained an Internet content provider, or ICP, certificate. PRC regulations also impose sanctions for engaging in the operation of online data processing and transaction processing without having obtained an online data processing and transaction processing, or ODPTP, certificate (ICP and ODPTP are both sub-sets of value-added telecommunication business certificates). These sanctions include corrective orders and warnings from the PRC communication administration authority, fines and confiscation of illegal gains and, in the case of significant infringements, the websites may be ordered to cease operation. Nevertheless, the PRC regulatory authorities’ enforcement of such regulations in the context of marketplace lending platforms remains unclear. The Interim Measures provide that online lending information intermediaries must apply for value-added telecommunications business licenses in accordance with the relevant provisions of telecommunications authorities after filing with a local financial regulator. However, PRC regulatory authorities to date have not explicitly stipulated whether the operator of a marketplace lending platform (including in the form of a website or mobile Internet application) is engaging in Internet information services requiring an ICP certificate or an ODPTP certificate. If we could not obtain such value-added telecommunication certificates pursuant to the relevant regulations, we may not be able to conduct online lending intermediaries’ services, but it is unclear whether online lending intermediaries would be deemed to be engaged in a commercial information provider business or online data processing and transaction processing business or whether an ICP certificate or an ODPTP certificate is required. To the extent that the PRC regulatory authorities require such value-added telecommunication certificate to be obtained or set forth rules that impose additional requirements, and we do not obtain such certificate, we may be subject to the sanctions described above. We plan to apply for filing immediately after the filing procedures are clarified by the relevant authorities, and apply for the corresponding value-added telecommunication business certificates after completing the filing, provided that the relevant telecommunication authority clarify which sub-set of telecommunication business certificates need to be obtained by market lending platforms and how to apply for such certificate.

According to the Provisions on the Administration of Foreign-invested Telecommunication Enterprises, the ratio of investment by foreign investors in a foreign-invested telecommunication enterprise that engages in the operation of a value-added telecommunication business shall not exceed 50%. Foreign investors are only permitted to invest up to 50% of the registered capital in a foreign-invested telecommunication enterprise that engages in the operation of commercial Internet information services or general online data processing and transaction processing services.

As an exception, the Circular of Ministry of Industry and Information Technology concerning Lifting Restrictions on the Proportion of Foreign Equity in Online Data Processing and Transaction Processing Business (E-commerce), or Circular 196, which was promulgated on June 19, 2015, provides that foreign investors are permitted to invest up to 100% of the registered capital in a foreign-invested telecommunication enterprise engaging in the operation of online data processing and transaction processing (E-commerce). While Circular 196 permits foreign ownership, in whole or in part, of online data processing and transaction processing businesses (E-commerce), a sub-set of value-added telecommunications services, there is still uncertainty regarding whether foreign investment restrictions may be applied to our business and industry.

Further, under either circumstance, the largest foreign investor will be required to have a satisfactory business track record and operational experience in the value-added telecommunication business. If regulatory authorities were to treat marketplace lending businesses as Internet information services of a commercial nature, which is a form of a value-added telecommunication business, our platform may be subject to such foreign investment restrictions and we may be required to restructure our operations by establishing a joint venture with foreign capital equal to no more than 50% of its total capital or a domestic enterprise with no foreign capital through variable interest entities to obtain a telecommunication business certificate. Any such restructuring may be costly and may involve interruptions to our business. If we are unable to obtain the telecommunication business certificate in a timely fashion, our business may be materially and adversely affected.

 

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We may be subject to risks if we have to restructure as a variable interest entity to obtain a telecommunication business license.

If we are required to establish a variable interest entity, or VIE, to serve as the operator of our marketplace lending platform, the PRC government including local financial regulators may determine that the contractual arrangements necessary to form and control the VIE, or the Contractual Arrangements, do not comply with PRC licensing, registration, policies, legal or regulatory requirements, or with requirements or policies that may be adopted in the future and we could be subject to severe penalties, material difficulties in making the requisite filings or registrations, or be forced to relinquish our interests in certain operations. Accordingly, we cannot assure you that if any such Contractual Arrangements we may implement were to be challenged in a PRC court that these Contractual Arrangements would be enforced and upheld.

In January 2015, MOFCOM published a consultation draft of the Foreign Investment Law soliciting the public’s comments, or the Draft Foreign Investment Law, which expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign-invested enterprise. Under the Draft Foreign Investment Law, a VIE would be deemed to be a foreign-invested enterprise if it is ultimately “controlled” by foreign investors, and accordingly it would be subject to restrictions on foreign investments. However, the Draft Foreign Investment Law does not address what actions will be taken with respect to the existing companies with structures similar to VIEs, whether or not these companies are controlled by Chinese parties. It is uncertain when the draft will become law and whether the final version will differ from the draft. If any Contractual Arrangements we may implement are found to be in violation of any existing or future PRC laws or regulations, or if we fail to obtain or maintain any of the required permits or approvals, the relevant governmental authorities would have broad discretion in dealing with such violation, including levying fines, confiscating our income or the income of our PRC subsidiary or consolidated VIE, revoking the business licenses or operating licenses of our PRC subsidiaries or consolidated VIE, prohibiting our use of proceeds from this offering to finance our business and operations in the PRC, and taking any other regulatory or enforcement actions that could be harmful to our business. Any of these actions could cause significant disruption to our operations and adversely affect our business. If any of these occurrences results in our inability to direct the activities of a consolidated VIE and/or our failure to receive economic benefits from a consolidated VIE, we may not be able to consolidate its results into our consolidated financial statements in accordance with U.S. GAAP.

Furthermore, we may be required to conduct our telecommunication certificate-related business in China under Contractual Arrangements and generate our revenues through a VIE. In such case, we would need to rely on the Contractual Arrangements that we implement for a portion of our PRC operations, which may not be as effective in providing us with control over such operations as we would have with direct ownership of such VIE. Additionally, any failure by a VIE or its shareholders to perform its and their obligations under the Contractual Arrangements that we implement may have a material adverse effect on our business and our legal remedies under PRC law.

Moreover, the shareholders of a consolidated VIE that we implement may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition. The shareholders of a VIE may breach or refuse to renew the Contractual Arrangements with us that allow us to effectively control such VIE, and receive economic benefits from its operations. There is a risk that they would not always act in the best interests of our company. We may not have effective arrangements to address potential conflicts of interest between these individuals and our company. We would rely on these individuals to abide by the contract laws of China and honor their contracts with us in order for us to effectively control the VIE and to receive the economic benefits deriving from our contracts with them. If we are unable to resolve any conflicts of interest or disputes between us and the shareholders of a VIE or if the shareholders of the VIE breach our agreements with them, we would have to rely on legal proceedings, which may result in disruption to our business. There is also substantial uncertainty as to the outcome of any such legal proceedings. In addition, Contractual Arrangements in relation to a consolidated VIE may be subject to scrutiny by the PRC tax authorities, which may determine that we or the consolidated VIE owe additional taxes, which could negatively affect our financial condition and the value of

 

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your investment. In the event of bankruptcy, dissolution or liquidation of a VIE, we may lose the ability to use certain assets held by the VIE that are material to our business.

The micro-credit business in which our subsidiary, Haidong, operates is heavily regulated and any failure by us to adhere to the relevant laws, regulations or measures may have a significant impact on our business, results of operations and financial condition.

The micro-credit business of our subsidiary, Haidong, is heavily regulated by PRC laws and regulations, including requirements in respect of approvals and licensing, maintenance of minimum capital reserves, the maximum interest rates that can be charged, methods of fundraising and the amount permitted to be raised. In addition, these laws and regulations are subject to change, which may impose significant costs or limitations on the way we conduct or expand our business, including the way in which we can charge fees. There may be uncertainties regarding the interpretation and application of new laws and regulations and other governmental policies. Moreover, as we develop new loan products, we may be subject to additional laws and regulations. Any material breach of such laws and regulations, if not remedied, could have an adverse impact on our business, financial condition and results of operations. To the extent laws and regulations change or we become subject to different laws and regulations, the way in which we operate the micro-credit portion of our business may be materially impacted, and we may not be able to adapt to the new regulatory environment on a timely basis. Failure to comply with the applicable laws, regulations or measures may result in fines, restrictions on our activities or revocation of our licenses, which could have a significant impact on our micro-credit business.

Haidong obtained an approval of operation and business license from the relevant authorities in Qinghai Province in 2012, and will apply for the Microfinance Company Business Qualification Certificate pursuant to a new regulation issued in 2014 after the relevant authority in Qinghai Province begins to accept applications from microfinance companies. We cannot assure you that we will be able to obtain such certificate. Failure to obtain such certificate may have adverse effect on our micro-credit business.

The Several Opinions Regarding the Promotion of Healthy Development of Micro-credit Lending Companies, issued by the Qinghai Financial Office, require the balance of operating loans with terms less than six months that are issued by micro-lending companies to comprise at least 70% of the balance of all loans issued by such micro-lending company. We may need to adjust our business model with respect to the ratio of loans with terms less than six months for Haidong’s operations to be in compliance with relevant requirements. In addition, it is not clear whether Haidong’s facilitation of consumption loans across China through online platforms will be deemed to be a violation of current or future regulations and we may be required to adjust our business model for Haidong’s operations accordingly.

According to the Interim Measures for the Administration of Micro-credit Companies of Qinghai Province issued by the Finance Office of Qinghai Province, as amended, or the Interim Measures of Qinghai Province, the total aggregate shareholding of the largest shareholder and its affiliates in a micro-credit company in Qinghai Province may not exceed 40% of the registered capital of the micro-credit company. Some other provinces in China do not impose limits on shareholding concentrations of micro-credit companies. 30% of Haidong’s shares are held directly by Shanghai CRF and 70% of Haidong’s shares are held by five individuals as nominees of Shanghai CRF through entrustment agreements. Pursuant to these entrustment agreements, we are the sole beneficial owner of all of Haidong’s shares and have the ability to exercise all related shareholder’s rights, including the rights to receive distributions and dividends and exercise voting rights. The relevant county government authority has issued a letter acknowledging its consent to such arrangement. According to our PRC counsel, Haiwen & Partners, these entrustment agreements are legal, valid and enforceable. As also advised by our PRC legal counsel, the local administrative authorities could change their position or impose more stringent requirements in the future, in which case we will make other arrangements to meet relevant requirements.

We also plan, collectively with other third parties, to apply for the establishment of an online micro-credit company that would have the ability to lend directly to online micro-credit borrowers in China. However, the likelihood and timing of the approval for the establishment of such online micro-credit company is uncertain.

 

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Our payment management services may need to be modified to comply with future PRC laws and regulations regarding the debt collection industry in China.

In 2000, the State Economic and Trade Commission, the Ministry of Public Security and the State Administration for Industry and Commerce issued the Notice on Prohibition of All Types of Debt Collection Companies and Raids on Illegal Debt Collection Activities (GuoJingMaoZong He (2000) 568), or the Notice on Prohibition, which regulates the activities on debt collection companies, including the prohibition on the use of threats, intimidation, harassment or disclosure of private information in collection efforts. While we believe that our payment management services team, which engages in collection efforts primarily by means of phone calls, is in compliance with the Notice on Prohibition, we may need to modify our payment management services in the future to comply with changes to debt collection regulations.

Risks Related to Doing Business in China

Uncertainties in the interpretation and enforcement of PRC laws and regulations could limit the legal protections available to you and us.

The PRC legal system is based on written statutes. Unlike common law legal systems, prior court decisions may be cited for reference but have limited precedential value. The PRC legal system evolves rapidly, and the interpretations of many laws, regulations and rules may contain inconsistencies and enforcement of these laws, regulations and rules involves uncertainties.

From time to time, we may have to resort to administrative and court proceedings to enforce our legal rights. However, since PRC judicial and administrative authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to predict the outcome of a judicial or administrative proceeding than in more developed legal systems. Furthermore, the PRC legal system is based, in part, on government policies and internal rules, some of which are not published in a timely manner, or at all, but which may have retroactive effect. As a result, we may not always be aware of any potential violation of these policies and rules. Such unpredictability towards our contractual, property (including intellectual property) and procedural rights could adversely affect our business and impede our ability to continue our operations.

In January 2015, the Ministry of Commerce of the PRC, or MOFCOM, published a consultation draft of the Draft Foreign Investment Law. If and when enacted, this would replace the existing laws regulating foreign investment in China, namely, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law and the Wholly Foreign-Invested Enterprise Law, along with their implementation rules and ancillary regulations. The draft Foreign Investment Law embodies an expected PRC regulatory trend of rationalizing the foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. MOFCOM is currently soliciting comments on this draft and substantial uncertainties exist with respect to its timetable for enactment, interpretation and implementation. If enacted as proposed, the Foreign Investment Law may materially impact our corporate governance practices and increase our compliance costs, for example, through the imposition of stringent ad hoc and periodic information reporting requirements.

Changes in economic and political policies of the PRC government may have a material and adverse effect on overall economic growth in China, which could materially and adversely affect our business.

Our revenues are substantially sourced from China. Accordingly, our results of operations, financial condition and prospects are influenced by economic, political and legal developments in China. Economic reforms begun in the late 1970s have resulted in significant economic growth. However, any economic reform policies or measures in China may from time to time be modified or revised. For instance, if interest rates are liberalized, our competition with traditional banks could be intensified. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While

 

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the PRC economy has experienced significant growth in the past 30 years, growth has been uneven across different regions and between economic sectors. The PRC government exercises significant control over China’s economic growth through strategically allocating resources, controlling the payment of foreign currency-denominated obligations, setting monetary policies and providing preferential treatment to particular industries or companies. Although the Chinese economy has grown significantly in the past decade, that growth may not continue, as evidenced by the slowing of the growth of the Chinese economy since 2012. Any adverse changes in economic conditions in China, in the policies of the PRC government or in the laws and regulations in China could have a material adverse effect on the overall economic growth of China. Such developments could adversely affect our business and operating results, lead to reduction in demand for our services and adversely affect our competitive position.

Under the PRC Enterprise Income Tax Law, we may be classified as a PRC “resident enterprise,” which could result in unfavorable tax consequences to us and our ADS holders and shareholders and have a material adverse effect on our results of operations and the value of your investment.

While we currently do not generate revenue outside of China, under the PRC Enterprise Income Tax Law, or the EIT Law, which became effective on January 1, 2008, an enterprise established outside the PRC with “de facto management bodies” within the PRC is considered a “resident enterprise” for PRC enterprise income tax purposes and is generally subject to a uniform 25% enterprise income tax rate on its worldwide income. In 2009, the State Administration of Taxation, or the SAT, issued the Notice Regarding the Determination of Chinese-Controlled Overseas Incorporated Enterprises as PRC Tax Resident Enterprise on the Basis of De Facto Management Bodies, or SAT Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. Further to SAT Circular 82, in 2011, the SAT issued the Administrative Measures for Enterprise Income Tax of Chinese-Controlled Offshore Incorporated Resident Enterprises (Trial), or SAT Bulletin 45, to provide more guidance on the implementation of SAT Circular 82.

According to SAT Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be considered a PRC resident enterprise by virtue of having its “de facto management body” in China and will be subject to PRC enterprise income tax on its worldwide income only if all of the following conditions are met: (a) the senior management and core management departments in charge of its daily operations function have their presence mainly in the PRC; (b) its financial and human resources decisions are subject to determination or approval by persons or bodies in the PRC; (c) its major assets, accounting books, company seals, and minutes and files of its board of directors and shareholders’ meetings are located or kept in the PRC; and (d) more than half of the enterprise’s directors or senior management with voting rights habitually reside in the PRC.

Although SAT Circular 82 and SAT Bulletin 45 only apply to offshore-incorporated enterprises controlled by PRC enterprises or PRC enterprise groups and not those controlled by PRC individuals or foreigners, the determination criteria set forth therein may reflect the SAT’s general position on how the term “de facto management body” could be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by PRC enterprises, individuals or foreigners.

If the PRC tax authorities determine that we or any of our non-PRC subsidiaries is a PRC resident enterprise for PRC enterprise income tax purposes, then we or any such non-PRC subsidiary could be subject to PRC tax at a rate of 25% on our worldwide income, which could materially reduce our net income. In addition, we also would be subject to PRC enterprise income tax reporting obligations.

If the PRC tax authorities determine that our company is a PRC resident enterprise for PRC enterprise income tax purposes, gains realized on the sale or other disposition of ADSs or ordinary shares and dividends distributed to our non-PRC shareholders may be subject to PRC withholding tax, at a rate of 10% in the case of non-PRC enterprises or 20% in the case of non-PRC individuals (in each case, subject to the provisions of any

 

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applicable tax treaty or similar arrangement), if such gains are deemed to be from sources within the PRC. Any such tax may reduce the returns on your investment in the ADSs.

We may not be able to obtain certain benefits under relevant tax treaty on dividends paid by our PRC subsidiaries to us through our Hong Kong subsidiary.

We are a holding company existing under the laws of the Cayman Islands and as such rely on dividends and other distributions on equity from our PRC subsidiaries to satisfy part of our liquidity requirements. Pursuant to the PRC Enterprise Income Tax Law, a withholding tax rate of 10% currently applies to dividends paid by a PRC “resident enterprise” to a foreign enterprise investor, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for preferential tax treatment. Pursuant to the Arrangement between the Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Tax Evasion on Income, or the Double Tax Avoidance Arrangement, such withholding tax rate may be lowered to 5% if a Hong Kong resident enterprise owns no less than 25% of a PRC enterprise. However, the 5% withholding tax rate does not automatically apply and certain requirements must be satisfied, including without limitation that (a) the Hong Kong enterprise must be the beneficial owner of the relevant dividends; and (b) the Hong Kong enterprise must directly hold no less than 25% share ownership in the PRC enterprise during the 12 consecutive months preceding its receipt of the dividends.

In addition, the SAT promulgated the Circular on Comprehension and Recognition of “Beneficial Owner” under Tax Treaties, or SAT Circular 601, on October 27, 2009, which provides that tax treaty benefits will be denied to “conduit” or shell companies without business substance, and that “substance over form” principles will be used to determine beneficial ownership for purposes of receiving tax treaty benefits. For this purpose, a conduit company is a company that is set up for the purpose of avoiding or reducing taxes or transferring or accumulating profits. As a result, we will not be able to enjoy the 5% withholding tax rate with respect to any dividends or distributions made by our PRC subsidiaries to its parent company in Hong Kong if our Hong Kong subsidiary is regarded as a “conduit company.” Furthermore, in current practice, a Hong Kong enterprise must obtain a tax resident certificate from the Hong Kong tax authority to apply for the 5% lower PRC withholding tax rate. As the Hong Kong tax authority will issue such a tax resident certificate on a case-by-case basis, we cannot assure you that we will be able to obtain the tax resident certificate from the relevant Hong Kong tax authority and enjoy the preferential withholding tax rate of 5% under the Double Taxation Arrangement with respect to dividends to be paid by our PRC subsidiaries to CRF China Holding Co. Limited, our Hong Kong subsidiary.

The PRC tax authorities’ heightened scrutiny over acquisition transactions may have a negative impact on our business operations or our acquisitions or the value of your investment in us.

The State Administration of Taxation has promulgated several rules and notices to tighten the scrutiny over acquisition transactions in recent years, including the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises in 2009 with retroactive effect from January 1, 2008, or SAT Circular 698, the Notice on Several Issues Regarding the Income Tax of Non-PRC Resident Enterprises in 2011, or SAT Circular 24, and the Notice on Certain Corporate Income Tax Matters on Indirect Transfer of Properties by Non-PRC Resident Enterprises in February 2015, or SAT Circular 7. Pursuant to these rules and notices, if a non-PRC resident enterprise transfers its equity interests in a PRC tax resident enterprise, such non-PRC resident transferor must report to the tax authorities at the place where the PRC tax resident enterprise is located and is subject to a PRC withholding tax of up to 10%. In addition, if a non-PRC resident enterprise indirectly transfers so-called PRC Taxable Properties, referring to properties of an establishment or a place of business in China, real estate properties in China and equity investments in a PRC tax resident enterprise, by disposition of the equity interests in an overseas non-public holding company without a reasonable commercial purpose and resulting in the avoidance of PRC enterprise income tax, the transfer will be re-characterized as a direct transfer of the PRC Taxable Properties and gains derived from the transfer may be subject to a PRC withholding tax of up to 10%. SAT Circular 7 has listed several factors to be taken into consideration by the tax authorities in determining if an indirect transfer has a reasonable commercial purpose.

 

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However, regardless of these factors, an indirect transfer satisfying all the following criteria will be deemed to lack a reasonable commercial purpose and be taxable in the PRC: (i) 75% or more of the equity value of the intermediary enterprise being transferred is derived directly or indirectly from PRC Taxable Properties; (ii) at any time during the one year period before the indirect transfer, 90% or more of the asset value of the intermediary enterprise (excluding cash) is comprised directly or indirectly of investments in the PRC, or 90% or more of its income is derived directly or indirectly from the PRC; (iii) the functions performed and risks assumed by the intermediary enterprise and any of its subsidiaries that directly or indirectly hold the PRC Taxable Properties are limited and are insufficient to prove their economic substance; and (iv) the foreign tax payable on the gain derived from the indirect transfer of the PRC Taxable Properties is lower than the potential PRC tax on the direct transfer of those assets. On the other hand, indirect transfers falling into the scope of the safe harbors under SAT Circular 7 may not be subject to PRC tax. The safe harbors include qualified group restructurings, public market trades and exemptions under tax treaties.

Under SAT Circular 7 and other PRC tax regulations, in the case of an indirect transfer, entities or individuals obligated to pay the transfer price to the transferor must act as withholding agents and are required to withhold the PRC tax from the transfer price. If they fail to do so, the seller is required to report and pay the PRC tax to the PRC tax authorities. If neither party complies with the tax payment or withholding obligations under SAT Circular 7, the tax authority may impose penalties such as late payment interest on the seller. In addition, the tax authority may also hold the withholding agents liable and impose a penalty of 50% to 300% of the unpaid tax on them. The penalty imposed on the purchasers may be reduced or waived if the withholding agents have submitted the relevant materials in connection with the indirect transfer to the PRC tax authorities in accordance with SAT Circular 7.

We have conducted and may conduct acquisitions or restructurings which may be governed by the aforesaid tax regulations, as well as any possible future acquisition of us. We cannot assure you that the PRC tax authorities will not, at their discretion, impose tax return filing obligations on us or our subsidiaries, require us or our subsidiaries to provide assistance to an investigation by PRC tax authorities with respect to these transactions or adjust any capital gains. Any PRC tax imposed on a transfer of our shares, or equity interests in our PRC subsidiary or any adjustment of such gains would cause us to incur additional costs and may have a negative impact on our results of operations.

Any limitation on the ability of our PRC subsidiaries to pay dividends or other distributions to us and repay their debts to creditors could limit our ability to distribute profits to our shareholders and fulfill our repayment obligations.

We are a holding company incorporated in the Cayman Islands, and we rely on dividends or other distributions paid by our PRC subsidiaries for our cash requirements, including the funds necessary to pay dividends and other cash distributions to our shareholders, to service any debt we may incur, and to pay our operating expenses. PRC regulations currently permit payments of dividends only out of accumulated profits, as determined in accordance with the accounting standards and regulations in China, which differ in many aspects from generally accepted accounting principles in other jurisdictions. Our PRC subsidiaries are required to allocate certain percentages of any accumulated profits after tax each year to their statutory common reserve fund as required under the PRC Company Law until the aggregate accumulated statutory common reserve funds exceed fifty percent (50%) of its registered capital. Such reserve funds cannot be distributed as cash dividends. In addition, if our PRC subsidiaries incur debt on their own or enter into certain agreements in the future, the instruments governing the debt or such other agreements may restrict their ability to pay dividends or make other distributions to us. Therefore, these restrictions on the availability and usage of our major source of funding may materially and adversely affect our ability to pay dividends to our shareholders and to service our debts.

Our PRC subsidiaries receive substantially all of their revenue in Renminbi, which is not freely convertible into other currencies. As a result, any restriction on currency exchange may limit the ability of our PRC subsidiaries to use their Renminbi revenues to pay dividends to us.

 

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In response to the persistent capital outflow in China and RMB’s depreciation against U.S. dollar in the fourth quarter of 2016, the PBOC and the State Administration of Foreign Exchange, or SAFE, have implemented a series of capital control measures over recent months, including stricter vetting procedures for China-based companies to remit foreign currency for overseas acquisitions, dividend payments and shareholder loan repayments. For instance, on January 26, 2017, SAFE issued the Notice of State Administration of Foreign Exchange on Improving the Check of Authenticity and Compliance to further Promote Foreign Exchange Control, or the SAFE Circular 3, which stipulates several capital control measures with respect to the outbound remittance of profit from domestic entities to offshore entities, including (i) under the principle of genuine transaction, banks shall check board resolutions regarding profit distribution, the original version of tax filing records and audited financial statements; and (ii) domestic entities shall hold income to account for previous years’ losses before remitting the profits. The PRC government may continue to strengthen its capital controls, and more restrictions and substantial vetting process may be put in place by SAFE for cross-border transactions falling under both the current account and the capital account. Any limitation on the ability of our PRC subsidiaries to pay dividends or make other kinds of payments to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends, or otherwise fund and conduct our business.

China’s M&A Rules and certain other PRC regulations establish complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.

The Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Lenders, or the M&A Rules, and other recently adopted regulations and rules concerning mergers and acquisitions established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time consuming and complex. For example, the M&A Rules require that MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise, if (i) any important industry is concerned, (ii) such transaction involves factors that impact or may impact national economic security, or (iii) such transaction will lead to a change in control of a domestic enterprise which holds a famous trademark or PRC time-honored brand. Moreover, the Anti-Monopoly Law promulgated by the Standing Committee of the National People’s Congress on August 30, 2007 and effective as of August 1, 2008 requires that transactions which are deemed concentrations and involve parties with specified turnover thresholds must be cleared by MOFCOM before they can be completed. In addition, on February 3, 2011, the General Office of the State Council promulgated a Notice on Establishing the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Lenders, or Circular 6, which officially established a security review system for mergers and acquisitions of domestic enterprises by foreign investors. Further, on August 25, 2011, MOFCOM promulgated the Regulations on Implementation of Security Review System for the Merger and Acquisition of Domestic Enterprises by Foreign Lenders, or the MOFCOM Security Review Regulations, which became effective on September 1, 2011, to implement Circular 6. Under Circular 6, a security review is required for mergers and acquisitions by foreign investors having “national defense and security” concerns and mergers and acquisitions by which foreign investors may acquire the “de facto control” of domestic enterprises with “national security” concerns. Under the MOFCOM Security Review Regulations, MOFCOM will focus on the substance and actual impact of the transaction when deciding whether a specific merger or acquisition is subject to security review. If MOFCOM decides that a specific merger or acquisition is subject to security review, it will submit it to the Inter-Ministerial Panel, an authority established under the Circular 6 led by the National Development and Reform Commission, or NDRC, and MOFCOM under the leadership of the State Council, to carry out the security review. The regulations prohibit foreign investors from bypassing the security review by structuring transactions through trusts, indirect investments, leases, loans, control through contractual arrangements or offshore transactions. There is no explicit provision or official interpretation stating that the merger or acquisition of a company engaged in the marketplace lending business requires security review.

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time-consuming, and any required approval processes, including obtaining approval from MOFCOM or its local counterparts may delay or inhibit our ability to complete such transactions. It is unclear whether our business would be deemed to be in an industry that raises “national defense and security” or “national security” concerns. However, MOFCOM or other government agencies may publish explanations in the future determining that our business is in an industry subject to the security review, in which case our future acquisitions in the PRC, including those by way of entering into contractual control arrangements with target entities, may be closely scrutinized or prohibited.

PRC regulations relating to offshore investment activities by PRC residents and PRC entities may limit our PRC subsidiaries’ ability to increase their registered capital or distribute profits to us or otherwise expose us to liability and penalties under PRC law.

SAFE promulgated the Circular on Relevant Issues Relating to Domestic Resident’s Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, in July 2014 that requires PRC residents or entities to register with SAFE or its local branch in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing. In addition, such PRC residents or entities must update their SAFE registrations when the offshore special purpose vehicle undergoes material events relating to any change of basic information (including change of such PRC citizens or residents, name and operation term), increases or decreases in investment amount, transfers or exchanges of shares, or mergers or divisions.

SAFE Circular 37 was issued to replace the Notice on Relevant Issues Concerning Foreign Exchange Administration for PRC Residents Engaging in Financing and Roundtrip Investments via Overseas Special Purpose Vehicles, or SAFE Circular 75. SAFE further enacted the Notice on Further Simplifying and Improving the Foreign Exchange Management Policies for Direct Investment effective from June 1, 2015, or SAFE Circular 13, which allows PRC residents or entities to register with qualified banks in connection with their establishment or control of an offshore entity established for the purpose of overseas investment or financing.

If our shareholders who are PRC residents or entities do not complete their registration with the local SAFE branches or qualified banks as required by SAFE Circular 37 and other related rules, our PRC subsidiaries may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to us, and we may be restricted in our ability to contribute additional capital to our PRC subsidiaries. Moreover, failure to comply with the SAFE registration described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.

We have requested PRC residents whom we know hold direct or indirect interests in our company to make the necessary applications, filings and amendments as required under SAFE Circular 37 and other related rules. However, we cannot assure you that the registration will be duly and timely completed with the local SAFE branch or qualified banks. In addition, we may not be informed of the identities of all of the PRC residents holding direct or indirect interests in our company. As a result, we cannot assure you that all of our shareholders or beneficial owners who are PRC residents or entities have complied with, and will in the future make or obtain any applicable registrations or approvals required by, SAFE regulations. Failure by such shareholders or beneficial owners to comply with SAFE regulations, or failure by us to amend the foreign exchange registrations of our PRC subsidiary, could subject us to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

Besides, outbound investments by any PRC entities may require approvals, filings or registration procedures with NDRC, MOFCOM and SAFE, or their local counterparts, which may limit PRC entities’ ability to invest in us.

 

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Failure to comply with PRC regulations regarding the registration requirements for foreign loans may subject us to fines and other legal or administrative sanctions.

Pursuant to the Provisional Measures on Administration of Foreign Loans promulgated on January 8, 2003, the Administrative Measures on Registration of Foreign Loans effective on May 13, 2014 and its operational guidelines (collectively, the “Foreign Loan Measures”), any domestic entities shall complete the SAFE registration within 15 business days after entering into a foreign loan contract. Any domestic entity’s failure to register foreign loans with SAFE may subject such entity to registration requirements, warning and a penalty of not more than RMB300,000. However, it is not clear whether a RMB loan borrowed from non-resident individual requires registration with SAFE. We have borrowed a loan of the RMB equivalent of US$20,000,000 from Dr. Zhengyu (Zane) Wang who holds US citizenship. To the extent that the registration of such loan with SAFE is required, any failure to do so may result in penalties on us.

Failure to comply with PRC regulations regarding the registration requirements for employee share ownership plans or share option plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.

On February 15, 2012, SAFE promulgated the Notices on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plans of Overseas Publicly-Listed Companies, or the Stock Option Rules, which replaced the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plans or Stock Option Plans of Overseas Publicly-Listed Companies issued by SAFE on March 28, 2007. Under the Stock Option Rules and other relevant rules and regulations, PRC residents who participate in a stock incentive plan in an overseas publicly listed company are required to register with SAFE or its local branches and complete certain other procedures. Participants of a stock incentive plan who are PRC residents must retain a qualified PRC agent, which could be a PRC subsidiary of such overseas publicly listed company or another qualified institution selected by such PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the stock incentive plan on behalf of its participants. Such participants must also retain an overseas entrusted institution to handle matters in connection with their exercise of stock options, the purchase and sale of corresponding shares or interests and fund transfers. In addition, the PRC agent is required to amend the SAFE registration with respect to our share incentive plans if there are any material changes to the share incentive plans, the PRC agent or the overseas entrusted institution or other material changes. Also, Circular 37 stipulates that PRC residents who participate in a share incentive plan of an overseas unlisted special purpose company may register with SAFE before they exercise the share options. We and our PRC employees who have been granted share options will be subject to these regulations. Failure of our PRC share option holders to complete their SAFE registrations may subject these PRC residents to fines and legal sanctions and may also limit our ability to contribute additional capital into our PRC subsidiary, limit our PRC subsidiary’s ability to distribute dividends to us, or otherwise materially adversely affect our business.

PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency conversion may restrict or prevent us from using the proceeds of this offering to make loans to our PRC subsidiaries and their subsidiaries, or to make additional capital contributions to our PRC subsidiaries.

We are an offshore holding company conducting our operations in China through our PRC subsidiaries and their subsidiaries. We may make loans or additional capital contributions to our PRC subsidiaries and their subsidiaries or we may establish new PRC subsidiaries or acquire offshore entities with business operations in China in an offshore transaction. However, loans by us to our PRC subsidiaries to finance their activities cannot exceed statutory limits and must be registered with the local counterpart of SAFE and capital contributions to our PRC subsidiaries are subject to the requirement of making necessary filings in the Foreign Investment Comprehensive Management Information System, or FICMIS, and registration with other governmental authorities in China. Due to the restrictions imposed on loans in foreign currencies extended to any PRC

 

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domestic companies, we are not likely to make such loans to Qianhai Shouhang Guarantee (Shenzhen) Co., Ltd., Haidong, Shanghai CRF Financial Information Service Co., Ltd., or CRF Wealth Management Co., Ltd., which are PRC domestic companies.

SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming the Administration of Foreign Exchange Settlement of Capital of Foreign-invested Enterprises, or Circular 19, effective on June 1, 2015, in replacement of the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, or SAFE Circular 142, the Notice from the State Administration of Foreign Exchange on Relevant Issues Concerning Strengthening the Administration of Foreign Exchange Businesses, or Circular 59, and the Circular on Further Clarification and Regulation of the Issues Concerning the Administration of Certain Capital Account Foreign Exchange Businesses, or Circular 45. According to Circular 19, the flow and use of the RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company is regulated such that RMB capital may not be used for the issuance of RMB entrusted loans, the repayment of inter-enterprise loans or the repayment of banks loans that have been transferred to a third party. Although Circular 19 allows RMB capital converted from foreign currency-denominated registered capital of a foreign-invested enterprise to be used for equity investments within the PRC, it also reiterates the principle that RMB converted from the foreign currency-denominated capital of a foreign-invested company may not be directly or indirectly used for purposes beyond its business scope. Thus, it is unclear whether SAFE will permit such capital to be used for equity investments in the PRC in actual practice. SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or Circular 16, effective on June 9, 2016, which reiterates some of the rules set forth in Circular 19, but changes the prohibition against using RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue RMB entrusted loans to a prohibition against using such capital to issue loans to non-associated enterprises. Violations of SAFE Circular 19 and Circular 16 could result in administrative penalties. Circular 19 and Circular 16 may significantly limit our ability to transfer any foreign currency we hold, including the net proceeds from this offering, to our PRC subsidiaries, which may adversely affect our liquidity and our ability to fund and expand our business in the PRC.

In light of the various requirements imposed by PRC regulations on loans to, and direct investment in, PRC entities by offshore holding companies, we cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans or capital contributions by us to our PRC subsidiaries. If we fail to complete such registrations or obtain such approvals, our ability to use the proceeds we receive from this offering and to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

Fluctuation in the value of the RMB may have a material adverse effect on the value of your investment.

The value of the RMB against the U.S. dollar and other currencies is affected by changes in China’s political and economic conditions and China’s foreign exchange policies, among other things. On July 21, 2005, the PRC government changed its decades-old policy of pegging the value of the RMB to the U.S. dollar, and the RMB appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the RMB and the U.S. dollar remained within a narrow band. The PRC government subsequently allowed the RMB to appreciate slowly against the U.S. dollar again, although there also have been periods when it depreciated against the U.S. dollar. For example, in August 2015, the RMB depreciated by more than 4% against the U.S. dollar. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the RMB and the U.S. dollar in the future. In addition, there remains significant international pressure on the PRC government to substantially liberalize its currency policy, which could result in further appreciation in the value of the RMB against the U.S. dollar.

 

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Our revenues and costs are mostly denominated in RMB, whereas our reporting currency is the U.S. dollar. Any significant depreciation of the RMB may materially and adversely affect our revenues, earnings and financial position as reported in U.S. dollars. To the extent that we need to convert U.S. dollars we receive from this offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we would receive from the conversion. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us.

Our leased property interests may be defective and our right to lease the properties affected by such defects may be challenged, which could cause significant disruption to our business.

Under PRC laws, all lease agreements are required to be registered with the local housing authorities. We presently lease around 170 premises in China, and the landlords of these premises have not completed the registration of their ownership rights or the registration of our leases with the relevant authorities. Failure to complete these required registrations may expose our landlords, lessors and us to potential monetary fines or may require us to relocate our offices and incur the associated losses. In addition, for part of our leased premises, the lessors have not provided us with their ownership certificate. If there is a third-party claim with respect to ownership of the premises, our business may be affected.

In the event of failure to use the PRC state-owned lands in accordance with the approved use, PRC land administration authorities may order the lessor to return the land use right and may impose penalties on the lessor. Additionally, under applicable PRC laws, construction companies are required to act in accordance with the applicable land use rights. Lessors are required to obtain approval from administrative authorities prior to changing the approved usage of a particular plot of PRC state-owned land. With respect to our PRC leased units, the actual use of certain leased units may not be entirely consistent with the approved uses for the corresponding land. We may be ordered by the PRC land administration authorities to return the land use right under relevant lease contracts.

The audit report included in this prospectus is prepared by an auditor who is not inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection.

Our independent registered public accounting firm that issues the audit reports included in our prospectus filed with the U.S. Securities and Exchange Commission, or the SEC, as auditors of companies that are traded publicly in the United States and a firm registered with the U.S. Public Company Accounting Oversight Board, or the PCAOB, is required to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditors are located in the PRC, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB.

Inspections of other firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor’s audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

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Proceedings instituted by the SEC against the “big four” PRC-based accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act.

In late 2012, the SEC commenced administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act against the Chinese affiliates of the “big four” accounting firms (including our auditors). The Rule 102(e) proceedings initiated by the SEC relate to these firms’ inability to produce documents, including audit work papers, in response to the request of the SEC pursuant to Section 106 of the Sarbanes-Oxley Act, as the auditors located in the PRC are not in a position lawfully to produce documents directly to the SEC because of restrictions under PRC law and specific directives issued by the China Securities Regulatory Commission, or the CSRC. The issues raised by the proceedings are not specific to our auditors or to us, but affect equally all audit firms based in China and all China-based businesses with securities listed in the United States.

In January 2014, the administrative judge reached an Initial Decision that the “big four” accounting firms should be barred from practicing before the SEC for six months. Thereafter, the accounting firms filed a Petition for Review of the Initial Decision, prompting the SEC Commissioners to review the Initial Decision, determine whether there had been any violation and, if so, determine the appropriate remedy to be placed on these audit firms.

In February 2015, the Chinese affiliates of the “big four” accounting firms (including our auditors) each agreed to censure and pay a fine to the SEC to settle the dispute and avoid suspension of their ability to practice before the SEC and audit U.S. listed companies. The settlement requires the firms to follow detailed procedures and to seek to provide the SEC with access to the Chinese firms’ audit documents via the CSRC. If future document productions fail to meet the specified criteria, the SEC retains the authority to impose a variety of additional measures (e.g., imposing penalties such as suspensions, restarting the administrative proceedings, etc.).

In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, and could result in delisting. Moreover, any negative news about the proceedings against these audit firms may cause investor uncertainty regarding China-based, United States-listed companies and the market price of our shares may be adversely affected. If our independent registered public accounting firm was denied, temporarily, the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined to not be in compliance with the requirements of the Exchange Act.

The approval of the CSRC may be required in connection with this offering under PRC law.

The M&A Rules, which were adopted in 2006 by six PRC regulatory agencies, including the CSRC, purport to require offshore special purpose vehicles that are controlled by PRC domestic companies or individuals and that have been formed for the purpose of seeking a public listing on an overseas stock exchange through acquisitions of PRC domestic companies or assets to obtain CSRC approval prior to publicly listing their securities on an overseas stock exchange. The interpretation and application of the regulations remain unclear, and the CSRC has not issued any definitive rule of interpretation concerning whether offerings like ours under this prospectus are subject to CSRC approval procedures under the M&A Rules. This offering may ultimately require approval from the CSRC. If CSRC approval is required, it is uncertain how long it will take us to obtain the approval and any failure to obtain or delay in obtaining CSRC approval for this offering would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies, which could include fines and penalties on our operations in China, restrictions or limitations on our ability to pay dividends outside of China, and other

 

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forms of sanctions that may materially and adversely affect our business, results of operations and financial condition.

Our PRC counsel, Haiwen & Partners, has advised us that, based on its understanding of the current PRC laws and regulations, we are not required to obtain approval from the CSRC for listing and trading of our ADSs on the NYSE because (i) our controlling shareholders or controllers are not PRC domestic companies or individuals, and (ii) our wholly owned PRC subsidiaries were established by foreign direct investment or the acquisition of a PRC domestic company before the effective date of the M&A Rules, rather than through merger or acquisition of domestic companies as defined under the M&A Rules. However, we cannot assure you that relevant PRC government agencies, including the CSRC, would reach the same conclusion as our PRC counsel, and hence we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in China, limit our operating privileges in China, delay or restrict the repatriation of the proceeds from this offering into China or take other actions that could have a material adverse effect on our business, financial condition, results of operations and prospects, as well as the trading price of our ADSs. The CSRC or other PRC regulatory agencies also may take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ADSs offered hereby. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur. In addition, if the CSRC or other regulatory agencies later promulgate new rules or explanations requiring that we obtain their approvals for this offering, we may be unable to obtain a waiver of such approval requirements. Any uncertainties and/or negative publicity regarding such approval requirement could have a material adverse effect on the trading price of our ADSs.

The future development of money laundering and anti-terrorism regulations in the PRC may increase our obligations to supervise and report transactions between borrowers and investors on our marketplace, thereby increasing our costs and exposing us to the risk of criminal or administrative sanctions.

PRC laws and regulations relating to money laundering and anti-terrorism have undergone considerable development over recent years. The Guidelines and the Interim Measures require us to take effective measures to verify customer identities, monitor and report suspicious transactions and keep client information and transaction records safe. We are also required to assist in investigations by judicial authorities and the public security bureau. We currently rely primarily on the depository bank and third-party payment companies transferring funds on our marketplace to carry out anti-money laundering due diligence of our customers. Current PRC laws stipulate specific obligations and steps that the banks and third-party payment companies should follow for anti-money laundering due diligence. While the Guidelines and the Interim Measures do not stipulate explicit standards for our anti-money laundering obligations, any new requirement under money laundering laws to supervise and report transactions with our customers could have the effect of increasing our costs, and may expose us to potential criminal or administrative sanctions if we fail to comply.

In January 2016, the Standing Committee of the National People’s Congress announced the Anti-Terrorism Law of the People’s Republic of China, or the Anti-Terrorism Law. According to this law, telecommunications operators and Internet service providers shall implement supervision systems for network security and information content as well as technical safety precautions in accordance with the relevant laws and administrative regulations to prevent the dissemination of information involving terrorism and extremism. If such information is found, the corresponding data transmission will be immediately stopped, relevant records will be saved, relevant information will be deleted and a report shall be made to the public security organizations or related departments. Furthermore, telecommunications, Internet, finance, accommodations, long-distance passenger transportation and motor vehicle leasing business operators and service providers shall check the identities of their customers. No services are permitted to be provided to unidentified customers or those who refuse to comply with identification checks. While we believe that we are in compliance with the Anti-Terrorism Law, to the extent that our operations are not in compliance, we may be exposed to potential criminal or administrative sanctions.

 

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The PRC Labor Contract Law, any labor shortages, increased labor costs or other factors affecting our labor force may adversely affect our business, profitability and reputation.

We engage third-party employment agencies to provide contract workers to save costs. On December 28, 2012, the PRC Labor Contract Law was amended with effect on July 1, 2013 to impose more stringent requirements on labor dispatch. Under such law, the number of contract workers that an employer hires may not exceed a certain percentage of its total number of employees as determined by the Ministry of Human Resources and Social Security. Additionally, contract workers are only permitted to engage in temporary, auxiliary or substitute work. According to the Interim Provisions on Labor Dispatch promulgated by the Ministry of Human Resources and Social Security on January 24, 2014, which became effective on March 1, 2014, the number of contract workers hired by an employer shall not exceed 10% of the total number of its employees (including both directly hired employees and dispatched contract workers). The Interim Provisions on Labor Dispatch require employers not in compliance with the PRC Labor Contract Law in this regard to create a plan to reduce the number of its contract workers to below 10% of the total number of its employees prior to March 1, 2016. In addition, an employer is not permitted to hire any new contract worker until the number of its contract workers has been reduced to below 10% of the total number of its employees.

As of the date of this prospectus, the number of contract workers of three of our PRC operating entities exceeded the 10% cap and some contract workers are not engaged in temporary, auxiliary or substitute positions. Accordingly, we are required to reduce the number of our contract workers and replace them with directly hired employees, which may result in an increase in labor and administrative costs. While we expect to formulate and implement a plan and reduce the percentage of our contract workers to below 10% as soon as possible, we cannot assure you that we will be able to locate replacements for our contract workers on a timely basis and without incurring increased labor and administrative costs.

The application and interpretation of the new requirements under the amended Labor Contract Law are limited and uncertain. If we are found to be in violation of the new rules regulating contract workers, we may be ordered by the labor authority to rectify the noncompliance by entering into written employment contracts with the contract workers. Furthermore, our failure to rectify this issue within the time period specified by the labor authority, may result in us being subject to penalties ranging from RMB5,000 to RMB10,000 per contract worker.

We may be subject to penalties under relevant PRC laws and regulations due to failure to make full social security and housing fund contributions for some of our employees.

In the past, contributions by some of our PRC subsidiaries for some of their employees to the social security and housing funds may not have been in compliance with relevant PRC regulations. Pursuant to the Regulation on the Administration of Housing Accumulation Funds, as amended in 2002, the relevant housing fund authority may order an enterprise to pay outstanding contributions within a prescribed time limit. Pursuant to the PRC Social Insurance Law promulgated in 2010, the social security authority may order an enterprise to pay the outstanding contributions within a prescribed time limit, and may impose penalties if there is a failure to do so. Although we have made what we believe to be sufficient accruals to address these risks, some of our PRC subsidiaries may be required to pay outstanding contributions and penalties to the extent they did not make full contributions to the social security and housing funds.

Risks Related to Our ADSs and This Offering

An active trading market for our Class A ordinary shares or our ADSs may not develop and the trading price for our ADSs may fluctuate significantly.

Our ADSs have been approved for listing on the NYSE. Prior to the completion of this offering, there has been no public market for our ADSs or our Class A ordinary shares, and we cannot assure you that a liquid public market for our ADSs will develop. If an active public market for our ADSs does not develop following the

 

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completion of this offering, the market price and liquidity of our ADSs may be materially and adversely affected. The initial public offering price for our ADSs was determined by negotiation between us and the underwriters based upon several factors, and we can provide no assurance that the trading price of our ADSs after this offering will not decline below the initial public offering price. As a result, investors in our securities may experience a significant decrease in the value of their ADSs.

The trading price of our ADSs may be volatile, which could result in substantial losses to investors.

The trading price of our ADSs may be volatile and could fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, like the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States. A number of Chinese companies have listed or are in the process of listing their securities on U.S. stock markets. The securities of some of these companies have experienced significant volatility, including price declines in connection with their initial public offerings. The trading performances of these Chinese companies’ securities after their offerings may affect the attitudes of investors toward Chinese companies listed in the United States in general and consequently may impact the trading performance of our ADSs, regardless of our actual operating performance.

In addition to market and industry factors, the price and trading volume for our ADSs may be highly volatile for factors specific to our own operations, including the following:

 

    variations in our revenues, earnings, cash flow and data related to our user base or user engagement;

 

    announcements of new investments, acquisitions, strategic partnerships or joint ventures by us or our competitors;

 

    announcements of new products, services and expansions by us or our competitors;

 

    announcements of changes to regulations;

 

    changes in financial estimates by securities analysts;

 

    detrimental adverse publicity about us, our services or our industry;

 

    additions or departures of key personnel;

 

    release of lock-up or other transfer restrictions on our outstanding equity securities or sales of additional equity securities; and

 

    potential litigation or regulatory investigations.

Any of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade.

In the past, shareholders of public companies have often brought securities class action suits against those companies following periods of instability in the market price of their securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations and require us to incur significant expenses to defend the suit, which could harm our results of operations. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

If securities or industry analysts do not publish research or reports about our business, or if they adversely change their recommendations regarding our ADSs, the market price for our ADSs and trading volume could decline.

The trading market for our ADSs will be influenced by research or reports that industry or securities analysts publish about our business. If one or more analysts who cover us downgrade our ADSs, the market price

 

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for our ADSs would likely decline. If one or more of these analysts cease to cover us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause the market price or trading volume for our ADSs to decline.

The sale or availability for sale of substantial amounts of our ADSs could adversely affect their market price.

Sales of substantial amounts of our ADSs in the public market after the completion of this offering, or the perception that these sales could occur, could adversely affect the market price of our ADSs and could materially impair our ability to raise capital through equity offerings in the future. The ADSs sold in this offering will be freely tradable without restriction or further registration under the Securities Act of 1933, as amended, or the Securities Act, and shares held by our existing shareholders may also be sold in the public market in the future subject to the restrictions in Rule 144 and Rule 701 under the Securities Act and the applicable lock-up agreements. There will be ADSs (equivalent to              Class A ordinary shares) outstanding immediately after this offering, or              ADSs (equivalent to              Class A ordinary shares) if the underwriters exercise their option to purchase additional ADSs in full. In connection with this offering, we and our officers, directors, existing shareholders and the holders of our incentive shares have agreed not to sell any ordinary shares or ADSs for 180 days after the date of this prospectus without the prior written consent of the underwriters, subject to certain exceptions. However, the underwriters may release these securities from these restrictions at any time, subject to applicable regulations of the Financial Industry Regulatory Authority, Inc. We cannot predict what effect, if any, market sales of securities held by our significant shareholders or any other shareholder or the availability of these securities for future sale will have on the market price of our ADSs. See “Underwriting” and “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling our securities after this offering.

Because we do not expect to pay dividends in the foreseeable future after this offering, you must rely on price appreciation of our ADSs for return on your investment.

We currently intend to retain most, if not all, of our available funds and any future earnings after this offering to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.

Our board of directors has complete discretion as to whether to distribute dividends. Our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our directors. Under Cayman Islands law, dividends may be declared and paid only out of funds legally available therefor, namely out of either profits or our share premium account, provided that a dividend may not be paid if this would result in our company being unable to pay its debts as they fall due in the ordinary course of business. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value after this offering or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment.

Because the initial public offering price is substantially higher than the pro forma net tangible book value per share, you will experience immediate and substantial dilution.

If you purchase ADSs in this offering, you will pay more for each ADS than the corresponding amount paid by existing shareholders for their ordinary shares. As a result, you will experience immediate and substantial dilution of US$             per ADS. This number represents the difference between the assumed initial public

 

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offering price of US$             per ADS, the midpoint of the estimated range of the offering price, and our pro forma as adjusted net tangible book value per ADS of US$             as of December 31, 2016, after giving effect to this offering, at the assumed initial public offering price of US$             per ADS, the midpoint of the estimated offering price range shown on the front cover page of this prospectus. See “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon the completion of this offering.

We have not determined a specific use for a portion of the net proceeds from this offering, and we may use these proceeds in ways with which you may not agree.

We have not determined a specific use for a portion of the net proceeds of this offering, and our management will have considerable discretion in deciding how to apply these proceeds. You will not have the opportunity to assess whether the proceeds are being used appropriately before you make your investment decision. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. We cannot assure you that the net proceeds will be used in a manner that would improve our results of operations or increase our ADS price, nor that these net proceeds will be placed only in investments that generate income or appreciate in value.

We may be classified as a passive foreign investment company for U.S. federal income tax purposes, which could result in adverse U.S. federal income tax consequences to U.S. Holders of our ADSs or ordinary shares.

Depending upon the value of our assets, which is determined in part by the market value of our ADSs or ordinary shares, and the composition of our assets and income over time, we could be classified as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. Based on the projected composition of our assets and income, we do not anticipate becoming a PFIC for our taxable year ending December 31, 2017. While we do not anticipate becoming a PFIC, fluctuations in the market price of our ADSs or ordinary shares may cause us to become a PFIC for the current or any subsequent taxable year.

A non-U.S. corporation, such as our company, will be classified as a PFIC for U.S. federal income tax purposes for any taxable year, if either (i) 75% or more of its gross income for such year consists of certain types of “passive” income or (ii) 50% or more of the value of its assets (determined on the basis of a quarterly average) during such year produce or are held for the production of passive income. Whether we are a PFIC is a factual determination and we must make a separate determination each taxable year as to whether we are a PFIC (after the close of each taxable year). Accordingly, we cannot assure you that we will not be a PFIC for our taxable year ending December 31, 2017 or any future taxable year. The determination of whether we will become a PFIC will depend, in part, on how, and how quickly, we use our liquid assets and the cash raised in this offering.

If we were to be classified as a PFIC for any taxable year during which a U.S. Holder (as defined in “Taxation—U.S. Federal Income Tax Considerations”) holds an ADS or an ordinary share, such U.S. Holder would generally be subject to reporting requirements and might incur significantly increased U.S. federal income tax on gain recognized on the sale or other disposition of the ADSs or ordinary shares and on the receipt of distributions on the ADSs or ordinary shares to the extent such gain or distribution is treated as an “excess distribution” under the applicable U.S. federal income tax rules. Further, if we were to be classified as a PFIC for any year during which a U.S. Holder holds our ADSs or ordinary shares, we generally would continue to be treated as a PFIC for all succeeding years during which such U.S. Holder holds our ADSs or ordinary shares even if we cease to qualify as a PFIC under the rules set forth above. You are urged to consult your tax advisor concerning the U.S. federal income tax consequences of acquiring, holding, and disposing of ADSs or ordinary shares if we were to be classified as a PFIC. For more information see “Taxation—U.S. Federal Income Tax Considerations—PFIC Rules.”

Our memorandum and articles of association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares and ADSs.

We have adopted fourth amended and restated memorandum and articles of association that will become effective immediately upon completion of this offering. Our fourth amended and restated memorandum and

 

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articles of association will contain provisions to limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, in the form of ADSs or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.

Our proposed dual-class voting structure will limit your ability to influence corporate matters and could discourage others from pursuing any change of control transactions that holders of our Class A ordinary shares and ADSs may view as beneficial.

Our ordinary shares will be divided into Class A ordinary shares and Class B ordinary shares immediately prior to the completion of this offering. Holders of Class A ordinary shares will be entitled to one vote per share, while holders of Class B ordinary shares will be entitled to 10 votes per share, subject to the limitations set forth in “Description of Share Capital—Ordinary Shares.” We will issue Class A ordinary shares represented by our ADSs in this offering. All of the outstanding ordinary, preferred and incentive shares held by the Class B Holders as of the date of this prospectus will be automatically redesignated or converted into Class B ordinary shares immediately prior to the completion of this offering. All other ordinary, preferred and incentive shares that are outstanding as of the date of this prospectus will be automatically redesignated or converted into Class A ordinary shares immediately prior to the completion of this offering. We intend to maintain the dual-class voting structure after the completion of this offering. Each Class B ordinary share is convertible into one Class A ordinary share at any time by the holder thereof. Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances. Upon any transfer of Class B ordinary shares by a holder thereof to any person or entity which is not an affiliate of such holder, such Class B ordinary shares shall be automatically and immediately converted into an equal number of Class A ordinary shares.

Due to the disparate voting powers attached to these two classes of ordinary shares, the Class B Holders will own approximately             % of our total issued and outstanding ordinary shares and             % of the voting power of our outstanding shares immediately after this offering, assuming no exercise of the underwriters’ over-allotment option. Therefore, the Class B Holders will have decisive influence over matters requiring shareholders’ approval, including election of directors and significant corporate transactions, such as a merger or sale of our company. This concentrated voting interest will limit your ability to influence corporate matters and could discourage others from pursuing any potential merger, takeover or other change of control transactions that holders of Class A ordinary shares and ADSs may view as beneficial.

Our directors, officers and principal shareholders have substantial influence over our company. To the extent that they align together, their interests may differ from those of our other shareholders, and they could prevent or cause a change of control or other transactions.

As of the date of this prospectus, DLB CRF Holdings, LLC holds 25.5% of our share capital on an as-converted basis. In addition, our chairman and chief executive officer, Dr. Zhengyu (Zane) Wang, his brother, Gary Wang, and Andrew Mason, our director, are the Class B Holders and hold 9.5%, 5.0% and 2.4%, respectively, of our share capital on an as-converted basis, and will hold             %,             % and             %, respectively, of the voting interests of our company following the completion of this offering. To the extent that Class B Holders align together, they would collectively hold a majority of the voting interests of our company

 

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following the completion of this offering. Accordingly, in instances when their interests are aligned and they vote together, these parties could have significant influence in determining the outcome of any corporate transaction or other matter submitted to the shareholders for approval, including mergers, consolidations, election of directors and other significant corporate actions, and would also have the power to prevent or cause a change in control. In addition, without the consent of some or all of these shareholders, we may be prevented from entering into transactions that could be beneficial to us or our minority shareholders. The interests of our directors, officers and principal shareholders could differ from the interests of our other shareholders. The concentration in ownership and voting power of our ordinary shares in our directors, officers and principal shareholders may cause a material decline in the value of our ADSs. For more information regarding our principal shareholders and their affiliated entities, see “Principal Shareholders.”

You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are registered under Cayman Islands law.

We are an exempted company limited by shares registered under the laws of the Cayman Islands. Our corporate affairs are governed by our memorandum and articles of association, the Companies Law (2016 Revision) of the Cayman Islands and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by minority shareholders and the fiduciary duties of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.

Shareholders of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our articles of association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders (other than our memorandum and articles of association and any special resolutions passed by our shareholders). This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

Certain corporate governance practices in the Cayman Islands, which is our home country, differ significantly from requirements for companies incorporated in other jurisdictions such as the U.S. Currently, we do not plan to rely on home country practice with respect to any corporate governance matter. However, if we choose to follow home country practice in the future, our shareholders may be afforded less protection than they otherwise would under rules and regulations applicable to U.S. domestic issuers.

As a result of all of the above, public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States. For a discussion of significant differences between the provisions of the Companies Law of the Cayman Islands and the laws applicable to companies incorporated in the United States and their shareholders, see “Description of Share Capital—Differences in Corporate Law.”

 

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Certain judgments obtained against us by our shareholders may not be enforceable.

We are a Cayman Islands company and substantially all of our assets are located outside of the United States. Substantially all of our current operations are conducted in China. As a result, it may be difficult or impossible for you to bring an action against us in the United States in the event that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain reduced reporting requirements.

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from requirements applicable to other public companies that are not emerging growth companies including, most significantly, not being required to comply with the auditor attestation requirements of Section 404 for so long as we are an emerging growth company.

The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We are a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are exempt from certain provisions applicable to United States domestic public companies.

Because we are a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities rules and regulations in the United States that are applicable to U.S. domestic issuers, including:

 

    the rules under the Exchange Act requiring the filing of quarterly reports on Form 10-Q or current reports on Form 8-K with the SEC;

 

    the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act;

 

    the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and

 

    the selective disclosure rules by issuers of material non-public information under Regulation FD.

We will be required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly basis through press releases, distributed pursuant to the rules and regulations of the NYSE. Press releases relating to financial results and material events will also be furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. As a result, you may not be afforded the same protections or information, which would be made available to you, were you investing in a U.S. domestic issuer.

We may not remain qualified as a foreign private issuer after this offering. In such event, the exemptions noted above would not apply and we would be required to comply with the reporting and other rules applicable to U.S. issuers.

 

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The voting rights of holders of ADSs are limited by the terms of the deposit agreement, and you may not be able to exercise any right to vote the Class A ordinary shares which are represented by your ADSs.

As a holder of our ADSs, you will only be able to direct the exercise of the voting rights attaching to the Class A ordinary shares which are represented by your ADSs in accordance with the provisions of the deposit agreement. Under the deposit agreement, you must vote by giving voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will use its best endeavors to vote the Class A ordinary shares which are represented by your ADSs in accordance with your instructions. You will not be able to directly exercise any right to vote with respect to the shares represented by your ADSs unless you withdraw the shares from the depositary. Under our fourth amended and restated memorandum and articles of association that will become effective immediately upon completion of this offering, the minimum notice period required for convening a general meeting is 15 calendar days. When a general meeting is convened, you may not receive sufficient advance notice to withdraw the shares represented by your ADSs to allow you to vote with respect to any specific resolution or matter to be considered and voted upon at such general meeting. If we give notice to our shareholders of any general meeting, the depositary will notify you of the upcoming vote and will arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote the shares represented by your ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of carrying out your voting instructions. Also, as a party to the deposit agreement, you waive your right to trial by jury in any legal proceedings arising out of the deposit agreement or the ADSs against us and/or the depositary. This means that you may not be able to exercise your right to vote and you may have no legal remedy if the shares underlying your ADSs are not voted as you requested.

The depositary for our ADSs will give us a discretionary proxy to vote the Class A ordinary shares represented by your ADSs if you do not vote at shareholders’ meetings, except in limited circumstances, which could adversely affect your interests.

Under the deposit agreement for the ADSs, if you do not give proper or timely voting instructions to the depositary, the depositary will give us a discretionary proxy to vote the Class A ordinary shares represented by your ADSs at shareholders’ meetings unless:

 

    we have failed to timely provide the depositary with notice of meeting and related voting materials;

 

    we have instructed the depositary that we do not wish a discretionary proxy to be given;

 

    we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting; or

 

    a matter to be voted on at the meeting would have a material adverse impact on shareholders.

The effect of this discretionary proxy is that if you do not give proper or timely voting instructions to the depositary as to how to vote at shareholders’ meetings, you cannot prevent the Class A ordinary shares represented by your ADSs from being voted, except under the circumstances described above. This may make it more difficult for shareholders to influence the management of our company. Holders of our Class A ordinary shares are not subject to this discretionary proxy.

You may not receive dividends or other distributions on our ordinary shares and you may not receive any value for them if it is illegal or impractical to make them available to you.

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on Class A ordinary shares or other deposited securities which are represented by your ADSs, after deducting its fees and expenses. You will receive these distributions in proportion to the number of Class A ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to

 

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make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive distributions we make on our Class A ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may cause a material decline in the value of our ADSs.

You may experience dilution of your holdings due to inability to participate in rights offerings.

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

You may be subject to limitations on transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, or on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our share register or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

We will incur significantly increased costs and devote substantial management time as a result of the listing of our ADSs.

We will incur additional legal, accounting and other expenses as a public reporting company, particularly after we cease to qualify as an emerging growth company. For example, we will be required to comply with additional requirements of the rules and regulations of the SEC and requirements of the NYSE, including applicable corporate governance practices. We expect that compliance with these requirements will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. In addition, we expect that our management and other personnel will need to divert attention from operational and other business matters to devote substantial time to these public company requirements. We cannot predict or estimate the amount of additional costs we may incur as a result of becoming a public company or the timing of such costs.

In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time-consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as

 

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new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may also initiate legal proceedings against us and our business may be adversely affected.

 

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LOGO

LETTER FROM DR. ZHENGYU (ZANE) WANG

FOUNDER, CHAIRMAN & CHIEF EXECUTIVE OFFICER

My personal journey began with a vision and desire to bring affordable consumer credit to the emerging middle class in China. This vision did not arise overnight, but instead grew over years of study, work and life experiences in the consumer credit market, both in the U.S. and China.

I was born and raised in China and spent my graduate school and early working years in the U.S. Through my doctoral studies in the field of Statistics and early work experience at Sears Credit in Chicago, I came to understand how credit markets function and credit risks are analyzed in developed economies, and I began to consider how similar principles could be applied in China.

In 1995, when I became Head of Analytics for Sears Credit, which had the largest consumer credit portfolio in the world at the time, access to affordable credit was a natural expectation of middle-class Americans. Over time, I began to see how this should also be possible in China, and I started to focus my efforts on making this a reality. So after a ten-year career in the U.S., in 2001, I sold my house in Illinois and returned to China with my family to help build the country’s first consumer credit infrastructure.

Over the following ten years in China, my team and I learned a great deal while helping China’s largest banks to underwrite, score or originate over 100 million credit cards. I also came to a startling realization—that, for a variety of reasons, banks in China do not or cannot serve the credit needs of a key demographic group—China’s emerging middle class. This vibrant group includes 500 million people who are active users of mobile technology, but have no access to affordable credit. We believe these people, whom we call EMMAs (Emerging Middle-class, Mobile Active consumers), represent the future of China. I saw this as an inspiring opportunity to use technology and innovation to improve the lives of millions of people by offering them affordable credit for the first time in their lives.

We founded our business with the simple idea of using our marketplace and our unique technology developed over 16 years to bring affordable consumer credit to China’s EMMAs and meet the lifetime credit needs of this economically active group. Over the past few years, we have collaborated with leading companies in China, including the top Chinese banks and Internet companies, who have validated our unique know-how and technology, and have trusted us to leverage the information on their vast customer bases to create a vibrant consumer credit market in China.

We have made great strides towards our goals, but still have much work to do to achieve my vision of bringing affordable credit to China’s emerging middle class, one of the world’s largest untapped consumer credit markets. We hope you will join us on our journey.

Sincerely,

Zane

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

This prospectus contains forward-looking statements that reflect our current expectations and views of future events. The forward-looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and “Regulation.” Known and unknown risks, uncertainties and other factors, including those listed under “Risk Factors,” may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

You can identify some of these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “is/are likely to,” “potential,” “continue” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include statements relating to:

 

    our goals and strategies;

 

    our future business development, financial condition and results of operations;

 

    the expected growth of the credit industry, and marketplace lending in particular, in China;

 

    our expectations regarding demand for and market acceptance of our marketplace’s products and services;

 

    our expectations regarding our marketplace’s bases of borrowers and investors;

 

    our plans to invest in our platform;

 

    our relationships with our partners;

 

    competition in our industry; and

 

    relevant government policies and regulations relating to our industry.

These forward-looking statements involve various risks and uncertainties. Although we believe that our expectations expressed in these forward-looking statements are reasonable, our expectations may later be found to be incorrect. The forward-looking statements made in this prospectus relate only to events or information as of the date on which the statements are made in this prospectus. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should thoroughly read this prospectus and the documents that we refer to herein with the understanding that our actual future results may be materially different from and worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements.

This prospectus contains certain data and information that we obtained from various government and private publications including industry data and information from Oliver Wyman. Statistical data in these publications also include projections based on a number of assumptions. The Chinese credit industry, and marketplace lending in particular, may not grow at the rate projected by market data, or at all. Failure of this industry to grow at the projected rate may have a material and adverse effect on our business and the market price of our ADSs. In addition, the new and rapidly changing nature of the credit and marketplace lending industry results in significant uncertainties for any projections or estimates relating to the growth prospects or future condition of our industry. Furthermore, if any one or more of the assumptions underlying the market data are later found to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately US$             million, or approximately US$             million if the underwriters exercise their over-allotment option in full, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us. These estimates are based upon an assumed initial public offering price of US$             per ADS, the midpoint of the price range shown on the front cover page of this prospectus. A US$1.00 increase (decrease) in the assumed initial public offering price of US$             per ADS would increase (decrease) the net proceeds to us from this offering by US$             million, assuming the underwriters do not exercise their over-allotment option to purchase additional ADSs and the number of ADSs offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

The primary purposes of this offering are to increase our capitalization and financial flexibility, create a public market for our shares, retain talented employees by providing them with equity incentives and enable access to the public equity markets for us and our shareholders. As of the date of this prospectus, we intend to use the net proceeds from this offering to acquire more EMMA customers to further penetrate our total addressable market, test and roll-out additional products to meet the lifetime credit needs of EMMAs and invest in our technology platform. We may also use a portion of the net proceeds for general corporate purposes, including working capital, operating expenses, capital expenditures and potential strategic investments. Accordingly, our management will have discretion in the application of net proceeds to us from this offering.

 

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DIVIDEND POLICY

Our board of directors has discretion regarding whether to declare or pay dividends. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our directors. In either case, all dividends are subject to certain restrictions under Cayman Islands law, namely that our company may only pay dividends out of profits or share premium, and provided always that we are able to pay our debts as they fall due in the ordinary course of business. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.

We have never declared or paid cash dividends on our shares. We do not have any present plan to pay any cash dividends on our ordinary shares in the foreseeable future after this offering. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and grow our business.

We are a holding company registered in the Cayman Islands. We may rely on dividends from our subsidiaries in China for our cash requirements, including any payment of dividends to our shareholders. PRC regulations may restrict the ability of our PRC subsidiaries to pay dividends to us. See “Risk Factors—Risks Related to Doing Business in China—Any limitation on the ability of our PRC subsidiaries to pay dividends or other distributions to us and repay their debts to creditors could limit our ability to distribute profits to our shareholders and fulfill our repayment obligations.” and “Risk Factors—Risks Related to Doing Business in China—The PRC tax authorities’ heightened scrutiny over acquisition transactions may have a negative impact on our business operations or our acquisitions or the value of your investment in us.”

If we pay any dividends, we will pay such dividends on the shares represented by ADSs to the depositary, and the depositary will pay such dividends to our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

 

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EXCHANGE RATE INFORMATION

Our business is primarily conducted in China, and the financial records of our subsidiaries in China are maintained in RMB, their functional currency. However, we use the U.S. dollar as our reporting and functional currency; therefore, periodic reports made to shareholders will include current period amounts translated into U.S. dollars using the then-current exchange rates, for the convenience of the readers. Our financial statements have been translated into U.S. dollars in accordance with ASC Topic 830, “Foreign Currency Matters.” The financial information is first prepared in RMB and then is translated into U.S. dollars at period-end exchange rates as to assets and liabilities and average exchange rates as to revenue and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income in shareholders’ equity.

We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. We do not currently engage in currency hedging transactions.

The following table sets forth, for the periods indicated, information concerning exchange rates between the RMB and the U.S. dollar based on the exchange rates set forth in the H.10 statistical release of the Federal Reserve Board. These rates are provided solely for your reference and convenience. Unless otherwise stated, all translations of Renminbi into U.S. dollars in this prospectus were made at the rate of RMB6.9430 to US$1.00, the noon buying rate on December 31, 2016, as set forth in the H.10 statistical release of the U.S. Federal Reserve Board. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. On March 24, 2017, the noon buying rate for Renminbi was RMB6.8803 to US$1.00.

 

     Midpoint of Buy and Sell Prices for U.S.
Dollars per RMB
 

Period

   Period-End      Average(1)      Low      High  

2012

     6.2301        6.2990        6.2221        6.3879  

2013

     6.0537        6.1410        6.0537        6.2438  

2014

     6.2046        6.1702        6.0402        6.2591  

2015

     6.4778        6.2869        6.1980        6.4778  

2016

           

August

     6.6774        6.6466        6.6239        6.6778  

September

     6.6685        6.6702        6.6600        6.6790  

October

     6.7735        6.7303        6.6685        6.7819  

November

     6.8837        6.8402        6.7534        6.9195  

December

     6.9430        6.9198        6.8771        6.9580  

2017

           

January

     6.8768        6.8907        6.8360        6.9575  

February

     6.8665        6.8694        6.8517        6.8821  

March (through March 24, 2017)

     6.8803        6.8976        6.8785        6.9132  

 

(1) Annual averages are calculated using the average of the rates on the last business day of each month during the relevant year. Monthly averages are calculated using the average of the daily rates during the relevant month.

 

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CAPITALIZATION

The following table sets forth cash and cash equivalents, as well as our capitalization, as of December 31, 2016 as follows:

 

    on an actual basis;

 

    on a pro forma basis to reflect the automatic conversion of all of our outstanding Series A, Series B and Series C preferred shares, assuming such conversions take place on a one-for-one basis, into              Class A ordinary shares, in the case of all shareholders other than the Class B Holders, and              Class B ordinary shares, in the case of the Class B Holders, immediately upon the completion of this offering; and

 

    on a pro forma as adjusted basis to reflect (i) the automatic conversion of all of our outstanding Series A, Series B and Series C preferred shares, assuming such conversions take place on a one-for-one basis, into              Class A ordinary shares, in the case of all shareholders other than the Class B Holders, and              Class B ordinary shares, in the case of the Class B Holders, and (ii) the sale of              Class A ordinary shares in the form of ADSs by us in this offering at an assumed initial public offering price of              per ADS, the midpoint of the estimated range of the initial public offering price shown on the front cover of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, assuming the underwriters do not exercise the over-allotment option.

You should read this table together with the consolidated financial statements and related notes, and the sections titled “Selected Consolidated Financial and Other Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are included in this prospectus.

 

     As of December 31, 2016  
     Actual     Pro forma(1)     Pro forma
As
Adjusted(2)(3)
 
          

US$
(in thousands)

       

Cash and cash equivalents

     18,983       18,983    
  

 

 

   

 

 

   

 

 

 

Mezzanine equity

      

Series A preferred shares (US$0.0001 par value; 4,912,934 shares issued and outstanding as of December 31, 2016; no shares outstanding on a pro forma basis as of December 31, 2016; and no shares outstanding on a pro forma as adjusted basis)

     6,796          

Series B preferred shares (US$0.0001 par value; 14,084,239 shares issued and outstanding as of December 31, 2016; no shares outstanding on a pro forma basis as of December 31, 2016; and no shares outstanding on a pro forma as adjusted basis)

     35,132          

Series C preferred shares (US$0.0001 par value; 2,858,394 shares issued and outstanding as of December 31, 2016; no shares outstanding on a pro forma basis as of December 31, 2016; and no outstanding on a pro forma as adjusted basis)

     78,290          

Receivable for issuance of Series C preferred shares

     (4,000        
  

 

 

   

 

 

   

 

 

 

Total mezzanine equity

     116,218          
  

 

 

   

 

 

   

 

 

 

Shareholders’ (deficit) equity

      

Ordinary shares, US$0.0001 par value, 50,000,000 shares authorized, 16,508,037 shares issued and outstanding as of December 31, 2016; 30,236,507 Class A ordinary shares and 6,756,488 Class B ordinary shares outstanding on a pro forma basis as of December 31, 2016; and              shares outstanding on a pro forma as adjusted basis

     2       4    

Additional paid-in capital

           116,216    

Accumulated other comprehensive income

     (913     (913  

Accumulated deficit

     (101,299     (101,299  
  

 

 

   

 

 

   

 

 

 

Total shareholders’ (deficit) equity

     (102,210     14,008    
  

 

 

   

 

 

   

 

 

 

Total liabilities, mezzanine equity and shareholders’ (deficit) equity

     58,468       58,468    
  

 

 

   

 

 

   

 

 

 

 

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(1) Immediately prior to the completion of this offering, all of the preferred shares held by the existing shareholders other than the Class B Holders will be automatically converted into Class A ordinary shares and all preferred shares held by the Class B Holders will be automatically converted into Class B ordinary shares.

Pro forma balance sheet information as of December 31, 2016 assumes the automatic conversion of all of the outstanding preferred shares held by the existing shareholders other than the Class B Holders into Class A ordinary shares on a one-for-one basis and all preferred shares held by the Class B Holders into Class B ordinary shares on a one-for-one basis, as if the conversion had occurred as of December 31, 2016.

Pro forma basic and diluted net income per share is presented assuming the automatic conversion of each outstanding series of preferred shares occurred as of the beginning of the period or the issuance date of the respective series, whichever is later.

(2) A US$1.00 change in the assumed initial public offering price of US$             per share, or US$             per ADS, the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase, in the case of an increase, or decrease, in the case of a decrease, each of additional paid-in capital, total shareholders’ deficit and total liabilities and equity by approximately US$             million.
(3) The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing.

In March 2017, we issued an additional unsecured convertible promissory note, or the 2017 Note, with similar terms to the 2016 Notes and in the aggregate principal amount of US$500,000. The 2017 Note automatically converted into 19,707 Series C preferred shares later on March 30, 2017 upon a subsequent private placement of Series C preferred shares. In addition, on March 30, 2017, we issued and sold 569,858 Series C redeemable convertible preferred shares to fifteen investors at a price of $26.64 per share for total consideration of US$15,180,978. The above mentioned 589,565 redeemable convertible preferred shares are not included in the “Actual,” “Pro forma” or “Pro forma as Adjusted” amounts included in the table presented on Page 66.

 

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DILUTION

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our pro forma, as adjusted, net tangible book value per ADS after giving effect to (i) the automatic conversion of our preferred shares into ordinary shares and (ii) this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the pro forma, as adjusted, net tangible book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares.

Our net tangible book value as of December 31, 2016 was approximately US$13 million, or US$0.80 per ordinary share as of that date and US$              per ADS. Net tangible book value represents the amount of our total consolidated tangible assets, less the amount of our total intangible assets and the amount of our total consolidated liabilities. Pro forma as adjusted net tangible book value per ordinary share represents our net tangible book value divided by our total number of outstanding ordinary shares, each after giving effect to (i) the automatic conversion of our preferred shares into ordinary shares, assuming such conversions take place on a one-for-one basis, and (ii) this offering. Dilution is determined by subtracting net tangible book value per ordinary share and preferred shares on an as-converted basis, after giving effect to the additional proceeds we will receive from this offering, from the assumed initial public offering price of $             per ordinary share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus adjusted to reflect the ADS-to-ordinary share ratio, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

Without taking into account any other changes in net tangible book value after December 31, 2016, other than to give effect to (i) the automatic conversion of all of our preferred shares that are issued and outstanding into ordinary shares immediately prior to the completion of this offering, assuming such conversions take place on a one-for-one basis, and (ii) the sale of the ADSs offered in this offering at the assumed initial public offering price of US$             per ADS, the midpoint of the estimated range of the offering price, after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of December 31, 2016 would have been approximately US$             million, or US$             per ordinary share and US$             per ADS. This represents an immediate increase in net tangible book value of US$             per ordinary share and US$             per ADS to the existing shareholders and an immediate dilution in net tangible book value of US$             per ordinary share and US$     per ADS to investors purchasing ADSs in this offering. The following table illustrates such dilution:

 

     Per Ordinary Share      Per ADS  
     (US$)  

Assumed initial public offering price per Class A ordinary share

   $      $  

Net tangible book value as per ordinary share of December 31, 2016

   $ 0.80      $           

Pro forma net tangible book value per ordinary share after giving effect to the automatic conversion of our preferred shares into ordinary shares

   $      $  

Pro forma as adjusted net tangible book value per ordinary share after giving effect to (i) the automatic conversion of our preferred shares into ordinary shares, and (ii) this offering

   $      $  

Amount of dilution in net tangible book value per ordinary share to new investors in this offering

   $      $  

A US$1.00 change in the assumed public offering price of US$             per ADS would increase (decrease), in the case of an increase (decrease), our pro forma as adjusted net tangible book value after giving effect to this offering by approximately US$             million, the pro forma as adjusted net tangible book value per ordinary share and per ADS after giving effect to this offering by US$             per ordinary share and US$             per ADS and the dilution in pro forma as adjusted net tangible book value per ordinary share and per ADS to new investors in this offering by US$             per ordinary share and US$             per ADS, assuming no change to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and other offering expenses.

 

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The following table summarizes, on a pro forma as adjusted basis as of December 31, 2016, the differences between existing shareholders and the new investors with respect to the number of Class A ordinary shares (in the form of ADSs or shares) purchased from us in this offering, the total consideration paid and the average price per ordinary share and per ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include Class A ordinary shares underlying the ADSs issuable upon the exercise of the over-allotment option granted to the underwriters.

 

     Ordinary Shares
Purchased
    Total Consideration     Average
Price Per
Ordinary
Share
(in US$)
     Average
Price Per
ADS
(in US$)
 
     Number      Percent     Amount
(in US$
thousands)
     Percent       

Existing shareholders

                   $                                $                   $               

New investors

                   $                                $                   $               

Total

                   $                                  

The pro forma as adjusted information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

As of the date of this prospectus, we had granted 1,835,437 options to our employees under our 2016 Equity Incentive Plan, which options have an exercise price of $19.98 and vest 25% annually for four years, and 25,000 options to an advisor with an exercise price of $26.64 per share.

For a description of the conversion rates of our Series C preferred shares, please see “Description of Share Capital—History of Securities Issuances—Preferred Shares.”

 

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ENFORCEMENT OF CIVIL LIABILITIES

We are incorporated in the Cayman Islands to take advantage of certain benefits associated with being a Cayman Islands exempted company, such as:

 

    political and economic stability;

 

    an effective judicial system;

 

    a favorable tax system;

 

    the absence of exchange control or currency restrictions; and

 

    the availability of professional and support services.

However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include, but are not limited to:

 

    the Cayman Islands has a less developed body of securities laws as compared to the United States and these securities laws provide significantly less protection to investors as compared to the United States; and

 

    Cayman Islands companies may not have standing to sue before the federal courts of the United States.

Substantially all of our operations are conducted in China, and substantially all of our assets are located in China. Some of our directors and executive officers are nationals or residents of jurisdictions other than the United States and some of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.

We have appointed Corporation Service Company as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

Maples and Calder, our legal counsel as to Cayman Islands law, and Haiwen & Partners, our legal counsel as to PRC law, have advised us, respectively, that there is uncertainty as to whether the courts of the Cayman Islands and China, respectively, would:

 

    recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or

 

    entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

There is uncertainty with regard to Cayman Islands law relating to whether a judgment obtained from the United States courts under civil liability provisions of the securities laws of the United States will be determined by the courts of the Cayman Islands as penal or punitive in nature. If such a determination is made, the courts of the Cayman Islands will not recognize or enforce the judgment against a Cayman Islands company. Because the courts of the Cayman Islands have yet to rule on whether such judgments are penal or punitive in nature, it is uncertain whether they would be enforceable in the Cayman Islands. Maples and Calder has advised us that although there is no statutory enforcement in the Cayman Islands of judgments obtained in the federal or state courts of the United States, a judgment obtained in such jurisdiction will be recognized and enforced in the courts of the Cayman Islands at common law, without any re-examination of the merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided such judgment (a) is given by a foreign court of competent jurisdiction; (b) imposes on the judgment debtor a liability

 

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to pay a liquidated sum for which the judgment has been given; (c) is final; (d) is not in respect of taxes, a fine or a penalty; and (e) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or the public policy of the Cayman Islands.

Haiwen & Partners has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedure Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements, public policy considerations and conditions set forth in applicable provisions of the PRC laws relating to the enforcement of civil liability, including without limitation to the PRC Civil Procedure Law based either on treaties between China and the jurisdiction where the judgment is rendered or on reciprocity between the jurisdictions. In addition, according to the PRC Civil Procedure Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. As of the date of this prospectus, no treaty or other form of reciprocity exists between China and the United States or the Cayman Islands governing the recognition and enforcement of judgments. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States or the Cayman Islands.

 

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HISTORY AND REORGANIZATION

Our Company

We were formed in Delaware on July 12, 2004 as China Risk Finance LLC. Prior to that, we operated through our subsidiaries, Capital Financial Co., Ltd. and Shanghai Shouhang Business Management Co., Ltd. or Shanghai Shouhang, which were established in 1997 and 2002, respectively. Substantially all of our business activities are undertaken by our wholly owned subsidiaries organized in China. We began our credit analytics service provider business in 2001. We developed our proprietary, advanced technology over the past 16 years, during which our founders and management team advised many of China’s largest banks in analyzing consumer credit to issue over one hundred million credit cards to consumers. During this time, we believe that we were China’s leading credit analytics service provider, and provided a wide range of services to China’s credit market participants, including credit analytics, underwriting strategies, modeling, credit scoring, development of marketing channels, decisioning, processing and risk management services. We provided these services to issuers of approximately 100 million credit cards, which represented approximately half of the active credit cards issued in China at that time. As a result, our management team acquired intimate knowledge of China’s credit market, which they used in the development of our predictive selection, credit scoring and automated decisioning technologies to address China’s unique demographics. We believe that due to our unparalleled experience as a credit analytics service provider in China, our marketplace is among the most sophisticated and advanced in China.

In 2005, we established our advisory board to provide guidance to and assist our management team. Our advisory board currently consists of some of the most experienced innovators in the credit industry, including Nigel Morris, co-founder of Capital One, and Phillip Riese, former president of the consumer card group of American Express. See “Management—Advisor Biographies.” Since the establishment of our advisory board, all of our advisors have held an equity stake in our company. We report to and receive input from our advisory team on a regular basis.

In 2010, we capitalized on our 10 years of experience as a consumer credit service provider to form our marketplace lending platform to facilitate lifestyle loans. Thereafter, we achieved the following milestones:

 

    In 2012, we increased the scale of our operations through the implementation of a centralized sales management team and automated decisioning technology.

 

    In 2013, Dr. Zhengyu (Zane) Wang drafted the first self-regulatory documents for the marketplace lending industry in China for the China Association of Microfinance.

 

    In 2014, we were invited by the PBOC to be a founding member of the Chinese Internet Finance Association.

 

    In November 2014, we launched our consumption loans using our predictive selection technology.

 

    In December 2014, we established a technology development center in Mountain View, California, which has allowed us to stay at the forefront of emerging trends in big data and analytics.

 

    In January 2015, we implemented variable pricing based on four years of statistically significant loan data for lifestyle loans.

 

    In February 2015, our consumption loans achieved large-scale utilization.

 

    In August 2015, we implemented variable pricing based on the data aggregated from three million consumption loans facilitated on our platform.

 

    In October 2016, we reached a cumulative number of over one million borrowers.

 

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Our Structure Immediately Prior to the Reorganization

The following chart depicts our organizational structure immediately prior to the reorganization.

 

LOGO

 

(1) 30% of Haidong’s shares are held directly by China Risk Finance LL (China) Co., Ltd, or Shanghai CRF. 70% of Haidong’s shares are indirectly owned by Shanghai CRF through nominee shareholders.

Our Structure Immediately Following the Reorganization

On February 11, 2015, we formed CRF China Holding Co. Limited in Hong Kong as a wholly owned subsidiary of China Risk Finance LLC. In October and November 2015, China Risk Finance LLC completed the transfer of its entire equity interests in China Risk Finance LL (China) Co., Ltd. and CRF Finance Lease Co., Ltd. to CRF China Holding Co. Limited and China Capital Financial LLC completed the transfer of its entire equity interests in Shanghai Shouhang to CRF China Holding Co. Limited. Such transfers have all been approved by the appropriate governmental departments.

On May 6, 2015, we formed CRF China Limited in the British Virgin Islands as a wholly owned subsidiary of China Risk Finance LLC.

On August 18, 2015 China Risk Finance LLC was converted from a Delaware limited liability company to a Cayman Islands exempted company by way of continuation, and in conjunction therewith, our name was changed to China Rapid Finance Limited. Following our registration in the Cayman Islands on August 18, 2015, our company continued for all purposes as if originally incorporated and registered as an exempted company under and subject to the Companies Law of the Cayman Islands, the provisions of which shall apply to our company and all persons and matters associated with us as if we had been so originally incorporated and registered.

In October 2015, China Risk Finance LL (China) Co., Ltd. changed its name to “Shanghai CRF Business Management Co., Ltd.”

 

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The following chart depicts our organizational structure as of the date of this prospectus.

 

LOGO

 

(1) 30% of Haidong’s shares are held directly by Shanghai CRF. 70% of Haidong’s shares are indirectly owned by Shanghai CRF through nominee shareholders.

In connection with the reorganization, (i) all of China Risk Finance LLC’s common shares representing membership interests were exchanged for ordinary shares of China Rapid Finance Limited with equivalent rights and preferences and (ii) the Series A, Series B and Series C preferred shares of China Risk Finance LLC representing membership interests were cancelled in exchange for an equivalent number of Series A, Series B and Series C preferred shares of China Rapid Finance Limited.

The following is a brief description of each of our subsidiaries in China:

 

    CRF Wealth Management Co., Ltd. provides customer support services to investors on our marketplace lending platform.

 

    Shanghai CRF Business Management Co., Ltd. provides borrower services, including data verification, and loan matching and payment management services, and holds an ICP filing for our marketplace.

 

    Shanghai Shouhang manages the Safeguard Program for the investors on our marketplace, which is accounted for in accordance with ASC Topics 450 and 460. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” for a more detailed discussion.

 

    Haidong provides micro-credit loan products, tests new loan products and facilitates consumption loans.

 

    Capital Financial Co., Ltd. provides data analytics and technical support services to institutions, including banks, and is a holder of certain of our company’s intellectual property.

 

    Shanghai CRF Financial Information Service Co. provides information services.

 

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    CRF Technology Corporation manages our data lab in Mountain View, California.

 

    We currently do not conduct operations under Qianhai Shouhang Guarantee (Shenzhen) Co., Ltd. (whose business scope includes providing guarantee (financial guarantee excluded)), CRF Finance Lease Co., Ltd. and Shanghai HML Assets Management Co., Ltd. (which was established to accept international funding in the Shanghai Free Trade Zone).

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data for the three years ended December 31, 2014, 2015 and 2016, and as of December 31, 2015 and 2016, have been derived from our audited consolidated financial statements included elsewhere in this prospectus.

Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results do not necessarily indicate results expected for any future periods. You should read this Summary Consolidated Financial Data section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

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The following table presents our selected consolidated statement of comprehensive income for the three years ended December 31, 2014, 2015 and 2016.

 

    For the Year Ended December 31,  
    2014     2015     2016  
    US$     US$     US$  
    (in thousands, except share data and per share data)  
                   

Selected Consolidated Statement of Comprehensive Income:

     

Revenue

     

Transaction and service fees (net of customer acquisition incentive)

    60,281       62,535       55,891  

Other revenue

    1,027       946       1,092  
 

 

 

   

 

 

   

 

 

 
    61,308       63,481       56,983  
 

 

 

   

 

 

   

 

 

 

Provision for loan losses

    (580     (3,924      

Business related taxes and surcharges

    (2,960     (3,424     (1,122
 

 

 

   

 

 

   

 

 

 

Net revenue

    57,768       56,133       55,861  
 

 

 

   

 

 

   

 

 

 

Operating expenses

     

Servicing expenses

    (7,465     (13,484     (13,889

Sales and marketing expenses

    (27,347     (34,182     (29,954

General and administrative expenses

    (23,739     (36,030     (45,372
 

 

 

   

 

 

   

 

 

 

Total operating expenses

    (58,551     (83,696     (89,215

Other income (expense)

     

Other income (expense), net

    1,267       (2,456     (9
 

 

 

   

 

 

   

 

 

 

Profit (loss) before income tax expense

    484       (30,019     (33,363

Income tax expense

    (353     (7     (3
 

 

 

   

 

 

   

 

 

 

Net profit (loss)

    131       (30,026     (33,366

Accretion on Series A convertible redeemable preferred shares to redemption value

    (288     (288     (288

Accretion on Series B convertible redeemable preferred shares to redemption value

    (1,621     (1,621     (1,621

Accretion of Series C convertible redeemable preferred shares to redemption value

          (1,292     (4,468

Deemed dividend to Series C convertible redeemable preferred shares at modification of Series C convertible redeemable preferred shares

                (635
 

 

 

   

 

 

   

 

 

 

Net loss attributable to ordinary shareholders

    (1,778     (33,227     (40,378
 

 

 

   

 

 

   

 

 

 

Net profit (loss)

    131       (30,026     (33,366

Foreign currency translation adjustment, net of nil tax

    1       (533     (1,885
 

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

    132       (30,559     (35,251
 

 

 

   

 

 

   

 

 

 

Weighted average number of ordinary shares used in computing net profit (loss) per share

     

Basic

    16,084,124       16,232,433       16,437,946  

Diluted

    16,084,124       16,232,433       16,437,946  

Loss per share attributable to ordinary shareholders

     

Basic

    (0.11     (2.05     (2.46

Diluted

    (0.11     (2.05     (2.46

 

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The following table presents our selected consolidated balance sheet data as of December 31, 2015 and 2016.

 

     As of December 31,  
     2015     2016     2016  
    

US$

    US$     US$  
                 Pro forma(1)(2)  
     (in thousands)  

Selected Consolidated Balance Sheet Data:

      

Cash and cash equivalents

     25,045       18,983       18,983  

Restricted cash(3)

     11,890       12,685       12,685  

Total assets

     68,272       58,468       58,468  

Safeguard Program payable

     18,555       19,511       19,511  

Total liabilities

     44,907       44,460       44,460  

Total mezzanine equity

     84,950       116,218        

Total shareholders’ (deficit) equity

     (61,585     (102,210     14,008  

 

(1) Immediately prior to the completion of this offering, all of the preferred shares held by the existing shareholders other than the Class B Holders will be automatically converted into Class A ordinary shares and all preferred shares held by the Class B Holders will be automatically converted into Class B ordinary shares.
(2) Assumes the automatic conversion of all of the outstanding preferred shares held by the existing shareholders other than the Class B Holders into Class A ordinary shares on a one-for-one basis and all preferred shares held by the Class B Holders into Class B ordinary shares on a one-for-one basis, as if the conversion had occurred as of December 31, 2016.
(3) Restricted cash represents funds received from investors and borrowers of lifestyle loans for the Safeguard Program, which is only available to lifestyle loan investors.

Key Operating and Financial Metrics

We regularly review a number of metrics to evaluate our business, measure our performance, identify trends, formulate financial projections and make strategic decisions. The main metrics we consider are set forth in the table below.

 

     As of or for the Year Ended
December 31,
 
     2014     2015     2016  

Number of loans facilitated(1)

      

Consumption loans

     21,046       4,593,591       5,967,785  

Lifestyle loans

     42,205       38,190       37,894  
  

 

 

   

 

 

   

 

 

 

Total

     63,251       4,631,781       6,005,679  

Number of borrowers(2)

     101,384       701,019       1,419,746  

Repeat borrower rate(3)

     10     65     67

Loan volume (in US$ millions)(4)

      

Consumption loans

     1.5       349.1       611.5  

Lifestyle loans

     334.0       391.6       450.5  
  

 

 

   

 

 

   

 

 

 

Total

     335.5       740.7       1,062.0  

Gross billings on transaction and service fee (in US$ millions)(5)

      

Consumption loans

     0       5.6       9.8  

Lifestyle loans

     60.3       60.5       58.1  
  

 

 

   

 

 

   

 

 

 

Total

     60.3       66.0       67.9  

 

(1) Number of loans facilitated is defined as the total number of loans facilitated on our marketplace during the relevant period.
(2) Number of borrowers is defined as the total number of borrowers on our marketplace since our inception as measured as of the relevant date.

 

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(3) Repeat borrower rate is defined as the total number of borrowers who borrowed more than one loan on our marketplace since our inception divided by the total number of borrowers on our marketplace since our inception as measured, each as of the relevant date.
(4) Loan volume is defined as the total principal amount of loans facilitated on our marketplace during the relevant period.
(5) Gross billings on transaction and service fee is defined as transaction and service fee billed to customers, inclusive of related value added tax, before deduction of customer acquisition incentive. For the importance of gross billings on transaction and service fees, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Key Operating and Financial Metrics.”

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section headed “Selected Consolidated Financial Data” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We operate one of China’s largest consumer lending marketplaces in terms of total number of loans, having facilitated more than 10.7 million loans to more than 1.4 million borrowers at significantly lower borrowing costs than many of our competitors. Our technology-driven marketplace facilitates loans between borrowers and investors, providing borrowers with accessible, affordable credit and investors with attractive risk-adjusted returns. We view prime and near-prime EMMAs (Emerging Middle-class, Mobile Active consumers) as our target market. We believe EMMAs constitute one of the largest untapped consumer credit market opportunities in the world.

We have built a marketplace to reach and serve EMMAs via mobile devices. We acquire quality borrowers through multiple channels, including social networks, online travel agencies, e-commerce platforms and payment service providers. We use predictive selection technology to assess and select quality borrowers. Our data channel partners provide us with valuable information regarding the behavioral and transactional data of potential borrowers in a market where approximately 75% of consumers do not have a credit history. We analyze this non-traditional and unstructured data using our proprietary predictive models powered by machine learning, big data algorithms, and unique scoring technologies to assess creditworthiness. As we accumulate more credit behavioral data, we continuously refine our algorithms based on the repayment history of our borrowers.

Our management team provided credit analytic and consulting services to some of China’s largest banks for over 16 years and helped them develop credit scoring models and risk management systems to issue over 100 million credit cards. In 2010, we began to facilitate direct sales lifestyle loan products. Beginning in November 2014, we launched a mobile-based loan product known as consumption loans and began acquiring customers on a large scale.

We offer flexible products to serve the lifetime credit needs of EMMAs. Our consumption loans are loans with terms of between two weeks to three months, which have principal amounts generally in the range of RMB500 (approximately US$72) to RMB6,000 (approximately US$865). Our lifestyle loans are loans with terms of between three months and three years, which have principal amounts generally in the range of RMB6,000 (approximately US$865) to RMB100,000 (approximately US$14,400).

Our “low and grow” business strategy focuses on first facilitating initial loans to higher quality borrowers that we selectively target using our predictive selection technology and then retaining them as borrowers by offering them more loan products and charging lower borrowing cost. We apply automated decisioning technology on a loan-by-loan basis to determine qualified borrowers for larger loans, the loan amount, fees, interest rates and term of these loans. For loans above RMB6,000 (approximately US$865), the process is supplemented with data verification through our nationwide network of data verification centers. Under this strategy, as repeat borrowers qualify for larger consumption loans and, eventually, lifestyle loans, we expect to be able to generate increased transaction fees.

We have built a diverse investor base consisting of affluent, high net worth, family offices and institutional investors. These investors are attracted to our marketplace because of the range of loan durations available on our

 

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platform, including short-term loans, our marketplace’s risk-adjusted investment returns, our track record, the intrinsic diversification on our platform and our corporate governance standards.

We generate revenues primarily from transaction fees and service fees paid by borrowers and investors on our marketplace. We do not assume credit risk for the loans facilitated on our marketplace.

In order to encourage investors to make consumption loans to first-time borrowers on our marketplace, we offer customer acquisition incentives. The customer acquisition cost for consumption loans on an average per borrower basis was approximately US$17 in 2016. Under U.S. GAAP, these customer acquisition incentives are netted from our transaction and service fees. As borrowers pay off their initial loans and undertake repeat borrowing, we offer them larger loans based on more credit data, and we are able to generate more transaction fees to offset these customer acquisition incentives.

We have achieved significant growth in recent years. Our total number of loans facilitated on our marketplace increased from 63,251 in 2014 to 4.6 million in 2015, and further to 6.0 million in 2016. Our number of borrowers increased from 101,384 in 2014 to 701,019 in 2015, and further to 1.4 million in 2016. Our gross billings on transaction and service fees, increased by 9.5%, or US$5.7 million, from US$60.3 million in 2014 to US$66.0 million in 2015, and by 2.8%, or US$1.9 million, from US$66.0 million in 2015 to US$67.9 million in 2016. We had net profit (loss) of US$131,000, US$(30.0) million and US$(33.4) million in 2014, 2015 and 2016, respectively.

Key Operating and Financial Metrics

We regularly review a number of metrics to evaluate our business, measure our performance, identify trends, formulate financial projections and make strategic decisions. The main metrics we consider are set forth in the table below.

 

     As of or for the Year Ended
December 31,
 
     2014     2015     2016  

Number of loans facilitated(1)

      

Consumption loans

     21,046       4,593,591       5,967,785  

Lifestyle loans

     42,205       38,190       37,894  
  

 

 

   

 

 

   

 

 

 

Total

     63,251       4,631,781       6,005,679  

Number of borrowers(2)

     101,384       701,019       1,419,746  

Repeat borrower rate(3)

     10     65     67

Loan volume (in US$ millions)(4)

      

Consumption loans

     1.5       349.1       611.5  

Lifestyle loans

     334.0       391.6       450.5  
  

 

 

   

 

 

   

 

 

 

Total

     335.5       740.7       1,062.0  

Gross billings on transaction and service fee (in US$ millions)(5)

      

Consumption loans

     0       5.6       9.8  

Lifestyle loans

     60.3       60.5       58.1  
  

 

 

   

 

 

   

 

 

 
     60.3       66.0       67.9  

 

(1) Number of loans facilitated is defined as the total number of loans facilitated on our marketplace during the relevant period.
(2) Number of borrowers is defined as the total number of borrowers on our marketplace since our inception as measured as of the relevant date.
(3) Repeat borrower rate is defined as the total number of borrowers who borrowed more than one loan on our marketplace since our inception divided by the total number of borrowers on our marketplace since our inception as measured as of the relevant date.
(4) Loan volume is defined as the total principal amount of loans facilitated on our marketplace during the relevant period.
(5) Gross billings on transaction and service fee is defined as transaction and service fee billed to customers, inclusive of related value added tax, before deduction of customer acquisition incentive.

We believe gross billings on transaction and service fees is a key operating metric and an important indicator of our growth and business performance. Gross billings on transaction and service fees are directly

 

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related to the loan volume that is successfully matched on our marketplace, thus showing a correlation between gross billings on transaction and service fees and loan volume. Presentation of gross billings on transaction and service fees helps illustrate growth rates and trends of our business and the collection of fees.

The number of loans facilitated on our marketplace increased from 63,251 in 2014 to 4,631,781 in 2015 and to 6,005,679 in 2016. The loan volume facilitated on our marketplace increased from US$335.5 million in 2014 to US$740.7 million in 2015 to US$1,062.0 million in 2016. The cumulative number of borrowers increased from 101,384 as of December 31, 2014 to 701,019 as of December 31, 2015, and to 1,419,746 as of December 31, 2016.

In February 2015, we started to facilitate consumption loans on a large scale. We facilitated 4.6 million and 6.0 million consumption loans in 2015 and 2016, respectively, which represented 47% and 58% of the total loan volume on our marketplace in 2015 and 2016, respectively. Because repeat consumption loan borrowers on our platform have access to larger loans with longer terms and we only pay customer acquisition incentives with respect to first-time borrowers, we expect to generate more recurring gross billings from existing borrowers.

Key Factors Affecting Our Results

We believe the key factors affecting our financial condition and results of operations include the following:

Demand for Consumer Credit in China, Borrower Acquisition and Repeat Borrowers

The effectiveness of our marketplace is largely dependent on the demand for consumer credit in China and our ability to make our marketplace accessible to a large number of potential borrowers. According to Oliver Wyman, China’s consumer credit market is one of the most underpenetrated markets in the world. We intend to make our marketplace accessible to as many qualified EMMA borrowers as possible in a cost-effective manner. According to the PBOC, as of December 31, 2015, approximately 75% of China’s consumers did not have a credit history. We believe this is because banks in China do not lend to EMMAs due to the absence of credit data, the costs associated with data collection and the inability of banks to engage in variable pricing. Our proprietary technology creates the significant advantage of a highly scalable borrower acquisition platform for accessing these underserved EMMAs. Through our “low and grow” strategy, we initially offer smaller, shorter-term loans to these EMMAs and then use our proprietary decisioning technology to proactively offer them larger, longer-term loans as they demonstrate positive credit behavior, allowing us to retain high quality EMMAs with significant lifetime customer value. We believe our ability to attract a large number of quality borrowers to our marketplace at a lower cost, which in turn facilitates investor acquisition and retention, differentiates us from our competitors in the Chinese consumer credit market.

PRC Regulatory Environment

The regulatory environment for the consumer lending industry in China is evolving and creating opportunities that could affect our results of operations. Most recently, multiple PRC governmental authorities have published and promulgated various new laws and rules to further regulate the marketplace lending industry in China. See “Regulations.” We have closely tracked the development and implementation of new rules and regulations likely to affect us. These requirements have created entry barriers for many consumer lending companies in China and further differentiated us from our competitors. We will continue to ensure timely compliance with new rules, and believe that such timely compliance with these newly promulgated rules will provide us with a competitive advantage in the PRC consumer lending industry. We expect that our operations will need to be further modified to comply with relevant PRC laws and regulations on consumer lending as the regulatory regime for this sector continues to evolve. See “Risk Factors—Risks Related to the PRC Laws Regulating Our Business and Industry—Our operations may need to be modified to comply with existing and future requirements set forth by the CBRC or laws or regulations promulgated by other PRC authorities regulating the marketplace lending industry in China.” Such compliance may increase our operating costs, but may also drive increased loan volume to our marketplace, thereby increasing our revenue.

 

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Effectiveness of Our Proprietary Credit Assessment Technology

We are a technology-driven company, and we have made and will continue to make substantial investment in research and development of proprietary and innovative technology and know-how to operate our marketplace. Leveraging our decade-long history of creating credit solutions for Chinese financial institutions and over five years of “test and learn” experience in facilitating marketplace lending, we have developed proprietary predictive selection technology that addresses credit data limitations in China. We utilize predictive selection technology to pre-screen potential borrowers for consumption loans. We evaluate our proprietary credit assessment technology on a regular basis and leverage the additional data on loan history experience, borrower behavior, economic factors and prepayment trends that we accumulate to continually improve our technology. Our loan volumes and financial performance will continue to be dependent on our ability to effectively evaluate potential borrowers’ credit profiles and forecast default rates. For the years ended December 31, 2014, 2015 and 2016, we spent US$1.0 million, US$2.3 million and US$3.4 million, respectively, on research and development activities.

Average Annual Investment Return

The ability of our marketplace to continue to attract potential borrowers and investors is largely dependent on our marketplace’s effectiveness. A key measure in assessing effectiveness is average annual investment return, which is calculated as the return to investors on our marketplace net of credit losses and, in the case of lifestyle loans, taking into account payments from the Safeguard Program. For consumption loans, annual investment return is calculated as total interest income received by the investors, plus customer acquisition incentives we pay to investors, less service fees investors pay to us, less credit losses from consumption loans borne by the investors, all divided by the weighted average balance of capital that the investors have made available for lending on our platform. For lifestyle loans, annual investment return is calculated as total interest income received by the investors, less service fees the investors pay to us, less subsequent contributions to the Safeguard Program borne by the investors, all divided by the weighted average balance of capital that the investors have made available for lending on our platform. Annual investment return for investors of consumption loans was 12.8% and 10.4% per annum for the years ended December 31, 2015 and 2016, respectively. In the years ended December 31, 2014, 2015 and 2016, average annual investment return for investors of lifestyle loans was 11.9%, 11.5% and 11.3%, respectively. To the extent that our competitors or other investment opportunities have higher average annual investment returns, investors may lend their capital on other marketplaces or other investment opportunities.

Seasonality

Our operating results are influenced by seasonal factors, including the timing of national holidays, as well as consumer spending habits and patterns. Demand for lifestyle loans facilitated by our marketplace is generally higher in the third and fourth quarters, due to general consumer spending habits. As a result, we earn a higher portion of our revenue during the third and fourth quarters. However, as we only have a relatively short operating history for our consumption loan program, the seasonal impact of such loan program on our financial results is unclear. Therefore, while the seasonality of borrowing habits in China has an impact on our financial results, this impact may change depending on changes in consumer spending habits and the relative rates of growth in the volumes of our different loan products.

Ability to Retain Existing Borrowers as Repeat Borrowers

We believe the number of repeat borrowers on our platform is important to our financial results. As of December 31, 2016, 67% of the borrowers on our marketplace were repeat borrowers. Repeat borrowing reduces our average cost of acquiring borrowers, which are predominantly associated with the acquisition of first-time borrowers. Our repeat borrowers tend to increase their loan sizes with each subsequent loan, thereby increasing the amount of fees generated per loan. We believe our increasing number of repeat borrowers is primarily due to the continued improvement in loan products and our customer services. Our ability to continue to retain existing borrowers as repeat borrowers, and thereby increasing their lifetime customer value, will be an important factor in our continued revenue growth and profitability.

 

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Key Components of Results of Operations

Revenue

The table below sets forth the breakdown our revenue for the periods indicated:

 

    For the Year
Ended December 31,
 
    2014     2015     2016  
    US$     US$     US$  
    (in thousands)  

Revenue

     

Transaction and service fees (net of customer acquisition incentive)

    60,281       62,535       55,891  

Other revenue

    1,027       946       1,092  
 

 

 

   

 

 

   

 

 

 
    61,308       63,481       56,983  
 

 

 

   

 

 

   

 

 

 

Provision for loan losses

    (580     (3,924      

Business related taxes and surcharges

    (2,960     (3,424     (1,122
 

 

 

   

 

 

   

 

 

 

Net revenue

    57,768       56,133       55,861  
 

 

 

   

 

 

   

 

 

 

We generate revenue primarily from transaction and service fees by providing lending-related services on our marketplace. Our services include (i) loan matching services through which we match investors to borrowers on our marketplace and facilitate the execution of loan agreements between the investor and the borrower; (ii) loan repayment services through which we assist investors in collecting loan payment from borrowers; and (iii) management of a Safeguard Program under which a fund is maintained and used in the event of borrowers’ defaults to repay investors who opt into the Safeguard Program. Prior to approving potential borrowers for lifestyle loans, we verify data submitted by the borrower, including his or her name, age, residential address, government identification number, place of employment, bank account information and other information.

We categorize the vast majority of loans facilitated on our marketplace as either consumption loans or lifestyle loans. Consumption loans are loans with maturities between two weeks and three months, which have principal amounts generally in the range of RMB500 (approximately US$72) to RMB6,000 (approximately US$865). Consumption loans are made either using our proprietary predictive selection technology or based on the historical repayment records and other behavior of borrowers on our marketplace. Lifestyle loans are loans with maturities of between three months and three years, which have principal amounts generally in the range of RMB6,000 (approximately US$865) to RMB100,000 (approximately US$14,400). Borrowers of loans with principal amounts greater than RMB6,000 (approximately US$865) are required to submit their data for verification at one of our data verification centers prior to the loan being issued. Other than consumption and lifestyle loans, certain loans are sourced from our micro-lending operations by our subsidiary, Haidong. Such loans accounted for less than 1% of the total loans facilitated on our marketplace as of December 31, 2016. Set forth below is a table showing the interest rates and transaction fee rates of each type of loan.

 

        2014   2015   2016

Type of loans

 

Maturity
Length

  Average
interest
rate
(p.a.)
 

Average
rate of

transaction
fee

 

Average
service
fee

  Average
interest
rate
(p.a.)
 

Average
rate of
transaction
fee

 

Average
service
fee

  Average
interest
rate
(p.a.)
 

Average
rate of
transaction
fee

 

Average
service
fee

Consumption loans

  Less than 3 months   21%   1% of loan principal  

0.35% of loan principal

  21%   1-2% of loan principal  

0.35% of loan principal

  21%   1-2% of loan principal  

0.35% of loan principal

Lifestyle loans

  3 months to 3 years   16%   16% of loan principal  

0.8% of loan principal

  15%   14% of loan principal  

1.6% of loan principal

  15%   11% of loan principal  

1.6% of loan principal

Micro-credit loans

  1 year to 3 years   18%   1% of loan principal  

  18%   1% of loan principal  

  18%   1% of loan principal  

We generate revenue from transaction fees and service fees. For consumption loans, the transaction fees can only be recognized upon collection because they are contingent until that time. For lifestyle loans, we recognize

 

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transaction fees from borrowers upon successful loan matching, when the loan agreement is executed and the loan amount is provided by the investor to the borrower. The service fees earned from investors are recognized over the loan term as services are provided and upon collection. Transaction fees of US$57.6 million, US$55.5 million and US$48.9 million, and service fees of US$2.7 million, US$7.0 million and US$7.0 million, were recognized during the years ended December 31, 2014, 2015 and 2016, respectively. The decrease in total transaction fees was mainly due to the decrease in average transaction fees for lifestyle loans from 16% in 2014 to 14% in 2015 and 11% in 2016 as a result of different loan product mix and improved borrower quality, while the increase in service fees in 2015 reflects an increase in the amount of outstanding loans as compared to the prior year, and the increase in service fee charge rate from 0.8% of loan principal in 2014 to 1.6% of loan principal in 2015.

Our marketplace offers loan types with various maturities and rates in order to meet the needs of borrowers. In February 2015, we introduced consumption loans on our marketplace on a large scale. The transaction fees for these consumption loans are 1-2% of the principal amount while transaction fees for lifestyle loans have been on average 11% of the principal amount in 2016. This difference in transaction fee percentages of principal amounts for consumption and lifestyle loans is a function of the differing origination models, differing maturities and data verification procedures of these two types of loans. We generally charge higher transaction fees on lifestyle loans.

Our gross billings on transaction and service fees were US$60.3 million, US$66.0 million and US$67.9 million, for the years ended December 31, 2014, 2015 and 2016, respectively. Gross billings on transaction and service fees arising from lifestyle loans represented 18.1%, 15.4% and 12.9% of the lifestyle loan volume amounts in the years ended December 31, 2014, 2015 and 2016, respectively. The gross billings on transaction and service fees arising from lifestyle loans did not increase in proportion to the increase in loan volume mainly because of the reduced average rate of transaction fees as a result of improved borrower quality and the change in loan product mix.

Under our business model, we seek to facilitate more loans to higher quality borrowers and gradually lower borrowing costs. We believe that higher quality borrowers are correlated to lower fee rates because they are more price-sensitive. We can offer lower rates and larger loans to borrowers who have demonstrated their repayment history and other favorable behavioral data on our platform. We believe that we will be able to generate increasing fee revenue from increased loan volumes from these higher quality borrowers even as our fee rates decrease.

Our gross billings on consumption loans were 1.5% and 1.6% of the consumption loan volume amount in the years ended December 31, 2015 and 2016, respectively. Because consumption loan borrowers have high repeat borrowing patterns and we only pay customer acquisition incentives with respect to first-time borrowers of consumption loans, we expect to generate repeat gross billings without significant additional acquisition cost.

The total number of consumption loans facilitated on our marketplace was 21,046, 4,593,591 and 5,967,785 in 2014, 2015 and 2016, respectively. The average size of consumption loans facilitated on our marketplace was US$70, US$76 and US$102 in 2014, 2015 and 2016, respectively. Consumption loans were launched in the fourth quarter of 2014 with average transaction fees of approximately 1% to 2% of the principal amount. The average size of lifestyle loans facilitated on our marketplace increased from US$7,914 in 2014 to US$10,254 in 2015 and US$11,887 in 2016. The total number of lifestyle loans facilitated on our marketplace was 42,205, 38,190 and 37,894 during each of the years ended December 31, 2014, 2015 and 2016, respectively. The total number of loans facilitated on our marketplace increased from 63,251 in 2014 to 4,631,781 in 2015 and 6,005,679 in 2016. However, since in 2015 most of this growth was attributable to lower fee-generating consumption loans, our gross billings on transaction and service fees, which were predominantly derived from lifestyle loans, did not increase proportionally during the same periods.

In addition, we generate a small portion of other revenue, which consists of (i) interest income on micro-credit loans provided by Haidong in connection with its micro-credit loan business, and (ii) credit

 

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consulting fees collected by our subsidiary, Capital Financial Co., Ltd., in connection with its credit consulting services provided to Chinese banks. Our other revenue amounted to US$1.0 million, US$0.9 million and US$1.1 million, representing 1.7%, 1.5% and 1.9% of our revenue, for the years ended December 31, 2014, 2015 and 2016, respectively.

Customer Acquisition Incentives

In order to encourage investors to make consumption loans to first-time borrowers on our marketplace, we offer customer acquisition incentives. Customer acquisition incentives, approximately US$17 per new borrower for the year ended December 31, 2016, are only paid when an investor funds a loan facilitated on our platform for a first-time consumption loan borrower. Customer acquisition incentives are both a marketing tool and an incentive to help us penetrate the consumption loan business and maximize the portion of the overall fees that we may retain from these borrowers by mitigating potential financial losses from first-time borrowers of consumption loans. Although we pay customer acquisition incentives to investors, we do not assume any credit risk for investors. Investors bear ultimate credit losses for loans they fund, and this amount could be in excess of any customer acquisition incentives they receive. These incentives amounted to US$7.1 million and US$9.0 million in 2015 and 2016, respectively, of which US$3.5 million and US$8.3 million, respectively, was recorded as a reduction of revenue and US$3.6 million and US$0.7 million, respectively, was recognized as sales and marketing expenses. When recording these incentives as a reduction in revenue results in negative revenue on a cumulative basis from an investor, the cumulative shortfall is re-characterized as an expense in accordance with ASC 605-50-45-9 given the inherent uncertainties with the consumption loan program, which may not result in sufficient probable future revenue to recover such shortfall. Customer acquisition incentive payments are settled on a quarterly basis with participating consumption loan investors. We believe our payments of customer acquisition incentives help us to increase the pool of capital available to make loans to new borrowers on our marketplace, which in turn help us to increase the number of new borrowers.

While there are inherent uncertainties with our consumption loan business, based on cohort data we expect to recover the customer acquisition incentive payments from recurring transaction and service fees from repeat borrowers of consumption loans within 15 to 24 months from the funding of these borrowers’ initial consumption loans based on our historical data. We believe that our customer acquisition incentives are a cost-effective customer acquisition tool, and we expect to continue this business strategy during our market-penetration stage of growth.

Operating Expenses

Our primary operating expenses consist of (i) servicing expenses, (ii) sales and marketing expenses, and (iii) general and administrative expenses. The table below sets forth the breakdown of our operating expenses for the periods indicated:

 

    For the Year Ended December 31,  
    2014     2015     2016  
    Amount
(US$)
    % of Total
Operating
Expenses
    Amount
(US$)
    % of Total
Operating
Expenses
    Amount
(US$)
    % of Total
Operating
Expenses
 
    (in thousands, except percentages)  
                                     

Operating expenses

           

Servicing expenses

    7,465       12.7     13,484       16.1     13,889       15.5

Sales and marketing expenses

    27,347       46.7       34,182       40.8      
29,954
 
    33.6  

General and administrative expenses

    23,739       40.5       36,030       43.0    

 

45,372

 

    50.9  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    58,551       100.0     83,696       100.0     89,215       100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Our servicing expenses consist primarily of data verification costs, including the salaries and benefits and other expenses incurred by our data verification centers, which are responsible for credit assessment and related

 

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customer support for lifestyle loans. We incur data verification costs on all loans with principal amounts greater than RMB6,000 (approximately US$865), the application and initial vetting of which are processed through our data verification centers. Our servicing expenses amounted to US$7.5 million, US$13.5 million and US$13.9 million for the years ended December 31, 2014, 2015 and 2016, respectively. The increase in servicing expenses in 2014, 2015 and 2016 was primarily driven by the expansion in the number of data verification centers from 70 as of December 31, 2014 to 103 as of December 31, 2015 and further to 107 as of December 31, 2016, as we set up additional centers, which resulted in higher data verification costs.

Our sales and marketing expenses consist primarily of salaries and benefits and other expenses incurred by our sales and marketing personnel. Our sales and marketing expenses increased from US$27.3 million in the year ended December 31, 2014 to approximately US$34.2 million in the year ended December 31, 2015. This increase was primarily due to the addition of new sales persons at both new and existing data verification centers as well as the introduction of customer acquisition incentive payments in relation to our new consumption loan business. Our sales and marketing expenses decreased from US$34.2 million in the year ended December 31, 2015 to US$30.0 million in the year ended December 31, 2016 despite the increase in loan volume, which is attributable to increased operating efficiency, optimization of our sales force and the reduction in the amount of acquisition costs being recognized in sales and marketing expenses in 2016 as compared to 2015.

Our general and administrative expenses consist primarily of salaries and benefits (including share-based compensation) for general management, finance and administrative personnel, rental, office administration and utility expenses, fees to third-party payment processors, professional service fees and other management expenses such as traveling costs. General office and administration expenses totaled US$9.3 million, US$12.8 million and US$15.8 million accounting for 39%, 35% and 35% of total general and administrative expenses, for the years ended December 31, 2014, 2015 and 2016, respectively. Salaries and employee benefits (excluding data verification center personnel) increased by US$4.7 million, or 78%, to US$10.7 million, and rental expense increased by US$2.0 million, or 51%, to US$6.0 million in 2015 as compared to the prior year. These increases were mainly driven by the addition of back-office and administrative personnel and key management positions to support our expanded business operations. Salaries and employee benefits (excluding data verification center personnel) increased by US$0.1 million, or 1.0%, to US$10.8 million, and rental expense increased by US$0.7 million, or 11.5%, to US$6.7 million in 2016 as compared to the prior year. These expenses remained relatively stable despite the substantial increase in loan volume facilitated on our marketplace as a result of improved operating efficiency. The amount of fees we paid to the third-party payment processors for servicing borrower payments on loans facilitated on our platform were US$260,000, US$403,000 and US$1,360,000 for the years ended December 31, 2014, 2015 and 2016, respectively. The increase in the fees paid to the third-party payment processors was a combined result of (i) the introduction of new mobile-based third-party payment processing companies to enhance user experience; (ii) higher service rates charged by certain of our third-party payment companies; and (iii) the increase in consumption loan transaction volume. Our total general and administrative expenses amounted to US$23.7 million, US$36.0 million and US$45.4 million for the years ended December 31, 2014 2015 and 2016, respectively. These increases were primarily due to the increase in research and development expenses relating to the issuance of consumption loans starting in the fourth quarter of 2014, as well as the increase in related corporate-level operational functions such as product management, customer service, call centers and data analytics, as well as technology infrastructure. As part of our general and administrative expenses, we recognized share-based compensation expense for incentive shares of US$180 thousand, US$592 thousand and US$1,003 thousand in the consolidated statements of comprehensive income (loss) for the years ended December 31, 2014, 2015 and 2016, respectively.

 

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Other income (expense), net

Our other income consists primarily of (i) loss on convertible promissory notes, (ii) government grants, (iii) fair value changes of financial instrument, (iv) interest income and expenses, (v) foreign exchange loss, and (vi) other expenses. The table below sets forth the breakdown of other income for the periods indicated:

 

     For the Year Ended December 31,  
     2014     2015     2016  
     US$     US$     US$  
     (in thousands)  

Government grants

     864       597       560  

Fair value changes of financial instrument

     339       199       33  

Interest income

     75       144       29  

Interest expenses

     (80     (1,201      

Foreign exchange loss

     (44     (392     (246

Loss on convertible promissory notes

           (2,232     (271

Others

     113       429       (114
  

 

 

   

 

 

   

 

 

 

Total other income (expense), net

     1,267       (2,456     (9

Our government grants represent grants we received from the local government from time to time at the discretion of the relevant government authorities. These grants are for general corporate purposes and to support our ongoing operations in the region. There are no restrictions on the use of the grants.

Interest expenses mainly represent interest paid on issuance of promissory notes. Loss on convertible promissory notes represents the beneficiary conversion feature upon conversion of the convertible promissory note to preferred shares. The balance is a result of the difference between the carrying value of the debt component of the promissory notes (carried at amortized cost) and the fair value of the debt component of the promissory notes, as the bifurcated conversion option derivative liability is marked to market through the date of conversion.

Changes in financial position

As of December 31, 2016, our cash and cash equivalents balance was US$19.0 million, representing a decrease of US$6.1 million from US$25.1 million as of December 31, 2015. During the year ended December 31, 2016, we received net proceeds of US$24.0 million from completed private placements of preferred shares and promissory notes, which was offset by negative cash flows from operations of US$26.7 million, primarily due to the increase in general and administrative expenses, including the increase in research and development expenses, as well as the payments of customer acquisition incentives.

Taxation

Cayman Islands

We are registered in the Cayman Islands. Under the current law of the Cayman Islands, we are not subject to income or capital gains tax in the Cayman Islands. In addition, our payment of dividends to our shareholders, if any, is not subject to withholding tax in the Cayman Islands.

British Virgin Islands

Our wholly owned subsidiary, CRF China Limited, was incorporated in the British Virgin Islands. Under the applicable laws of the British Virgin Islands, CRF China Limited was not subject to income or capital gains taxes. In addition, payment of dividends to the shareholders of CRF China Limited was not subject to withholding tax in the British Virgin Islands.

 

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USA

China Risk Finance LLC (before the Reorganization) and our subsidiaries China Capital Finance LLC and HML China LLC, which were established in the United States, are fiscally transparent for U.S. federal income tax and state income tax purposes and therefore not subject to tax. On August 18, 2015, China Risk Finance LLC was converted from a Delaware limited liability company to a Cayman Islands exempted company by way of continuation.

Hong Kong

Our subsidiary, CRF China Holding Co., Ltd., which was incorporated in Hong Kong in February 2015, is subject to the uniform tax rate of 16.5%. Under the Hong Kong tax laws, it is exempted from the Hong Kong income tax on its foreign-derived income and there are no withholding taxes in Hong Kong on the remittance of dividends. No provision for Hong Kong tax has been made in our consolidated financial statements for the year ended December 31, 2014, as our Hong Kong subsidiary was not yet formed then.

PRC

Our PRC subsidiaries are companies incorporated under PRC law and, as such, are subject to PRC enterprise income tax on their taxable income in accordance with the relevant PRC income tax laws. Pursuant to the EIT Law and its implementation rules, both of which became effective on January 1, 2008, foreign-invested enterprises and domestic companies are subject to enterprise income tax at a uniform rate of 25%. All of our PRC subsidiaries are subject to the income tax rate of 25% for the periods presented in the consolidated financial statements included elsewhere in this prospectus.

Under the EIT Law, an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a resident enterprise and will be subject to the enterprise income tax at the rate of 25% on its global income. The implementation rules define the term “de facto management bodies” as establishments that carry out substantial and overall management and control over the manufacturing and business operations, personnel, accounting and properties of an enterprise. See “Risk Factors—Risks Related to Doing Business in China—Under the PRC Enterprise Income Tax Law, we may be classified as a PRC “resident enterprise,” which could result in unfavorable tax consequences to us and our ADS holders and shareholders and have a material adverse effect on our results of operations and the value of your investment.”

Effective January 1, 2012, the PRC Ministry of Finance and the State Administration of Taxation launched a Business Tax to Value-Added Tax Transformation Pilot Program, or the VAT Pilot Program, which imposes VAT in lieu of business tax for certain “modern service industries” in certain regions and eventually expanded to nation-wide application in 2013. According to the implementation circulars released by the Ministry of Finance and the State Administration of Taxation on the VAT Pilot Program, the “modern service industries” include research, development and technology services, information technology services, cultural innovation services, logistics support, lease of corporeal properties, attestation and consulting services. The Measures for the Implementation of the Pilot Scheme on Levying Value-added Tax in Place of Business Tax, or the VAT Measures, became effective on May 1, 2016. According to the VAT Measures, entities and individuals engaging in the sale of services, intangible assets or fixed assets within the territory of the PRC are required to pay VAT instead of business tax. Under this transition, the tax base for additional tax changes from the base amount under the business tax to the base amount under VAT. All of our PRC subsidiaries were subject to the VAT Pilot Program as of December 31, 2016, majority of which were subject to a rate of 6%, in lieu of business tax. With the adoption of the VAT Measures, our revenues are subject to VAT payable on goods sold or taxable services provided by a general VAT taxpayer for a taxable period is the net balance of the output VAT for the period after crediting the input VAT for the period. Hence, the amount of VAT payable does not result directly from output VAT generated from goods sold or taxable services provided. Therefore, we have adopted the net presentation of VAT.

 

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Pursuant to applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. We may be subject to adverse tax consequences and our consolidated results of operations may be adversely affected if the PRC tax authorities determine that the contractual arrangements among our PRC subsidiaries and their shareholders are not on an arm’s length basis and therefore constitute favorable transfer pricing.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements as of and for the years ended December 31, 2014, 2015 and 2016, which have been prepared in accordance with U.S. GAAP. Our management is required to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated financial statements and accompanying notes.

The application of our accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of our consolidated financial statements, and actual results could differ materially from these estimates. For further information on our significant accounting policies, see note 2 to our consolidated financial statements included elsewhere in this prospectus. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Revenue is recognized when each of the following criteria are met:

 

  1)   Persuasive evidence of an arrangement exists;

 

  2)   Services have been rendered;

 

  3)   Pricing is fixed or determinable; and

 

  4)   Collectability is reasonably assured.

Marketplace lending services—Consumption loans

We launched the offering of consumption loans in the fourth quarter of 2014. Our services for these loans consist of:

 

  a)   matching marketplace investors to potential qualified borrowers and facilitating the execution of loan agreements between the parties (referred to as “loan matching”); and

 

  b)   providing repayment processing services for the marketplace investors over the loan term, including following up on late repayments (referred to as “loan repayment”).

Pursuant to the agreements entered into by marketplace investors in consumption loans on our platform, some consumption loan investors authorize us to enter into loan contracts with borrowers on their behalf, thus legally empowering us to act on their behalf. For these consumption loans entered into under our subsidiary’s name, although the loan contract is entered into under the name of our subsidiary rather than the consumption loan investor, the debtor-creditor relationship is established between the borrower and the consumption loan investor, not between the borrower and us or our subsidiary. The consumption loan investor, being the originator of the loan, is entitled to all the rights and obligations of a lender under the loan contract, including the legal right to collect funds directly from the borrower in the case of default, and bears the ultimate credit risk. We are not legally entitled to the economic benefits of the loan. The borrower is obligated to fully repay the principal and interests to the marketplace investor. Our creditors are not entitled to claim against the loans facilitated on our platform in the case of our bankruptcy under PRC laws and regulations.

Under the agreements entered into by consumption loan investors on our platform, we are obligated to recommend borrowers to these investors using our predictive selection technology. We are also obligated to enter

 

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into loan contracts with these borrowers on the consumption loan investors’ behalves, transfer the consumption loan investors’ funds to the borrowers at loan inception and facilitate the principal and interest payments by the borrowers. Accordingly, we have the right to charge consumption loan investors service fees for loan repayment services provided.

In light of the above, we determined that we are not the legal lender and legal borrower in the loan origination and repayment process. Accordingly, we do not record loans receivable and payable arising from the loans between the marketplace investors and the borrowers. We have determined that the consumption loan transactions contain the following two elements: loan matching and loan repayment. Although we provide a loan matching service at loan inception and a repayment service when the repayment is due, the collection of both service fees is contingent upon actual repayments from the borrowers. Accordingly, we recognize service fees relating to the consumption loans upon repayment by the borrowers.

Marketplace lending services—Lifestyle loans

We generate transaction and service fees by providing marketplace lending services to the users of our lending marketplace for lifestyle loans. Our services consist of:

 

  a)   matching marketplace investors to potential qualified borrowers and facilitating the execution of loan agreements between the parties (referred to as “loan matching”);

 

  b)   providing repayment processing services for the marketplace investors over the loan term, including following up on late repayments (referred to as “loan repayment”); and

 

  c)   the Safeguard Program.

According to the lifestyle loan agreements entered into by borrowers and marketplace investors on our platform, both the borrower and marketplace investor confirm that they enter into a debtor-creditor relationship directly with each other. The lifestyle loan investor is entitled to determine whether to fund the borrower’s loan at its own discretion. The lifestyle loan investor bears the ultimate credit risk and has the legal right to collect funds directly from the borrower if the borrower defaults. The lifestyle loan borrower is obligated to fully repay the principal and interest to the lifestyle loan investor. Our creditors are not entitled to claim against the loans facilitated through our platform in the case of our bankruptcy under PRC laws and regulations.

We are obligated to recommend borrowers to a lifestyle loan investor; provide a credit review report on the potential borrower to the lifestyle loan investor (which makes its own investment decision unless it grants us that authority); and assist the lifestyle loan investor to fund its escrow account, transfer funds to the borrower’s account and facilitate the repayment of principal and interest by the borrower. We are obligated to compensate lifestyle loan investors that are owed overdue interest and principle payments of a defaulting borrower with funds from the Safeguard Program (to the extent that investors have opted into the Safeguard Program), but our liability is limited to the funds available in the Safeguard Program. The remaining credit losses are borne by the lifestyle loan investors. Accordingly, we have the right to charge lifestyle loan investors an account management service fee for loan repayment and management of the Safeguard Program.

In light of the above, we determined that we are not the legal lender or borrower in the loan origination and repayment process. Accordingly, we do not record loans receivable and payable arising from the loan between the marketplace investor and the borrower. We have determined that the marketplace lending transactions contain the following multiple elements: loan matching; loan repayment and management of the Safeguard Program. We determined that both marketplace investors and borrowers are our customers. We receive payments from borrowers at loan inception and from marketplace investors over the term of the loan. In the case of loans for which investors have opted into the Safeguard Program, a portion of the amount received on such loans from both the investors and borrowers is allocated to the Safeguard Program in accordance with ASC Topic 460, Guarantees at fair value, including a margin. The remaining amount from marketplace investors is allocated to

 

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loan matching and loan repayment services using best estimated selling price, as neither vendor specific objective evidence or third-party evidence of selling price is available. However, as the revenue for both of these services is recognized upon repayments, there would be no impact to timing or the amount of revenue recognized if the amounts were allocated. Accordingly, the use of any best estimated selling price for these two services is not necessary.

Transaction revenue is recognized for loan matching from borrowers at loan inception. Revenue earned from investors for loan matching and loan repayment services is recognized over the term of the loan as cash is received. Revenue from management of the Safeguard Program is recognized ratably over the term of the loan.

Customer acquisition incentives

In order to incentivize investors, we provide incentives to marketplace investors who commit to invest a certain amount of money to the consumption loan program for a defined period of time, which is calculated based on incentives for each first-time consumption loan multiplied by the total number of first-time borrowers for each period. Such cash incentives are accrued as they are earned by the marketplace investors and are accounted for as a reduction of revenue in accordance with ASC subtopic 605-50. When recording these incentives as a reduction in revenue results in negative revenue for a marketplace investor on a cumulative basis, the cumulative shortfall is re-characterized as an expense in accordance with ASC 605-50-45-9 given the inherent uncertainties with the consumption loan program which may not result in sufficient probable future revenue to us to recover such shortfall. During the years ended December 31, 2015 and 2016, we recorded cash incentives of US$7.1 million and US$9.0 million, respectively, of which US$3.5 million and US$8.3 million, respectively, was recorded as a reduction of revenue and US$3.6 million and US$0.7 million, respectively, was recognized as sales and marketing expenses. Gross billings on transaction and service fee is defined as transaction and service fee billed to customers, inclusive of related value added tax, before deduction of customer acquisition incentive.

 

     For the Year Ended
December 31,
 
     2014      2015      2016  
    

(in thousands)

 

Gross billings on transaction and service fee

        

— Consumption loans

            5,554        9,763  

— Lifestyle loans

     60,281        60,469        58,138  
  

 

 

    

 

 

    

 

 

 

Total

     60,281        66,023        67,901  
  

 

 

    

 

 

    

 

 

 

Customer acquisition incentive

        

— deducted from consumption loan revenue

            3,488        8,364  

— recognized in sales and marketing expenses

            3,588        673  
  

 

 

    

 

 

    

 

 

 

Total

            7,076        9,037  
  

 

 

    

 

 

    

 

 

 

Micro-lending loans

We grant micro-credit loans to borrowers through our subsidiary, Haidong. All income received on such micro-lending loans are recognized as interest income using the effective interest method over the loan period. Interest income is not recorded when reasonable doubt exists as to the full, timely collection of interest or principal. Interest income is included in other revenue in our consolidated statements of comprehensive loss.

Safeguard Program

We believe management’s judgment and assessment is required to determine how to account for the fair value of the assets and payables associated with our Safeguard Program. We maintain a Safeguard Program for the benefit of the borrowers and marketplace investors using our marketplace. Investors may choose whether or not they wish to opt into this program. In the event of borrowers’ failure to make repayments, these investors

 

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may be entitled to receive unpaid interest and principal under the terms of the Safeguard Program. In general, any unpaid interest shall be paid out of the available funds in the Safeguard Program to these investors when the borrower does not repay as scheduled, and any outstanding principal shall be paid to an investor if the loan remains delinquent for more than 180 days. There is no limit on the period of time during which an investor can receive payments for unpaid interest and principal from the Safeguard Program. The Safeguard Program contributions are generally not refunded even if there is no loan default.

At loan inception and upon subsequent loan repayments, a certain percentage of the amount is collected and segregated by us in a restricted cash account. For accounting purposes, at loan inception, we are required to record this Safeguard Program payable in accordance with ASC Topic 460, Guarantees. Accordingly, the payable is measured at its fair value. Default payments to marketplace investors can only be made from the Safeguard Program when there are sufficient funds available. Our obligation under the Safeguard Program to make payments is limited to the amount of the restricted cash at any point in time and we are not liable for any unpaid interest or principal at any point in time beyond such amount. In cases where an investor is paid for a borrower’s default, any future amount recovered from the borrower is to be contributed into the Safeguard Program.

Subsequent to the loan’s inception, the Safeguard Program payable is measured in a combination of two components: (i) ASC Topic 460 component; and (ii) ASC Topic 450 component. The liability recorded based on ASC Topic 460 is determined on a loan-by-loan basis and it is reduced when we are released from the underlying risk, meaning when the loan is repaid by the borrower or when the investor is compensated by the Safeguard Program in the event of a default. The liability is reversed only when we are released from the underlying risk and not ratably over the term. This component is a stand-ready obligation that is not subject to the probable threshold used to record a contingent obligation. The other component is a contingent liability determined using historical experience of borrower defaults, representing the obligation to make future payments under the Safeguard Program measured using the guidance in ASC Topic 450, Contingencies. Our obligation under the Safeguard Program to make payments at any point in time is limited to the amount of the restricted cash balance stated on the balance sheet.

A Safeguard Program asset is recognized at loan inception when the loan agreements specify the amount of future payments that will be contributed to the Safeguard Program. Generally, contracts entered into prior to November 2013 did not specify the amounts to be contributed to the Safeguard Program, so no asset was recorded. Contracts entered into after November 2013 generally did specify the amounts to be contributed to the Safeguard Program and, thus, a Safeguard Program asset was recorded.

The Safeguard Program asset is accounted for as a financial asset and is measured at fair value at inception. We consider the probable future cash collectible and take into account any expected prepayments and potential loan defaults in estimating its fair value. At each reporting date, we estimate the future cash flows and assess whether there is any indicator of impairment. If the carrying amounts of the Safeguard Program asset exceed the expected cash to be received, an impairment loss is recorded for the Safeguard Program asset not recoverable and is reported under revenue in our statements of comprehensive income.

At loan inception, we determine the Safeguard Program contributions for lifestyle loans made by investors that opt into the program based on the estimated default rate of the loans. In estimating the loss rate of the loans, the underlying risk profile and historical loss experience are taken into consideration. We gather information to assess each borrower’s risk profile and assign the borrower an application score, which is determined using our proprietary scoring technology. The borrowers are then grouped into different categories based on the application score assigned, and then for each score category we develop an estimated default rate based on actual historical default rates. We establish an ultimate loss rate estimation for each loan based on this method, taking into account any appropriate fine-tuning as we deem necessary. Using the estimated default rate, we are able to determine the fair value of the Safeguard Program liability at loan inception. We regularly review the borrower’s risk profile, actual loss rate of each score category and relevant economic factors to ensure that our estimations

 

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are kept up-to-date. Consequentially, the contribution percentages are updated regularly to ensure that the total Safeguard Program contributions, including both upfront and subsequent contributions, are based on the estimated fair value of the probability of losses of the loans covered by the Safeguard Program at each loan inception. Such contribution percentages vary depending on the estimated default rates of the loans covered by the Safeguard Program. Once the contribution percentages are determined at loan inception, no adjustment is made subsequently. Our average annualized contribution rate to the Safeguard Program was approximately 6-7% for each of the years ended December 31, 2014, 2015 and 2016. A majority of the Safeguard Program contributions are collected upfront from the borrowers and segregated in a designated account as restricted cash. Contributions from subsequent loan principal repayments, which are collected from investors at an annualized rate of approximately 1-2% of loan principal, are also deposited into a restricted cash account.

Investors who opt into the Safeguard Program bear their own financial risk and may suffer a loss if the restricted cash balance plus the subsequent cash receipts from Safeguard Program asset are exhausted. The Safeguard Program is payable on a first-loss basis. Payouts from the Safeguard Program are made to investors in the chronological order of default date until the restricted cash balance goes to zero, even though there may still be investors covered by the Safeguard Program. If the defaulted loans were originated on the same date, we make payout to investors according to the time of default in chronological order based on the payment schedule agreed for the defaulted loans. Taking into account the available funds in the Safeguard Program and all future Safeguard Program contributions from existing loans, as of December 31, 2014, 2015 and 2016, the maximum potential amount, as determined under ASC Topic 460, payable to the investors participating in the Safeguard Program in relation to the existing loans was estimated to be US$17.7 million, US$18.6 million and US$21.3 million, respectively. There is no limit on the period of time in which an investor can receive payments for unpaid interest and principal from the Safeguard Program.

In circumstances when a borrower chooses to make a full repayment prior to the maturity of a lifestyle loan, the borrower is contractually entitled to an early repayment credit, which is paid out of the Safeguard Program. Marketplace investors on our platform do not have the benefit of any similar provision and are never entitled to refunds from the subsequent contributions to the Safeguard Program. The amount of early repayment credits issued was US$922,000, US$591,000 and US$166,000 during the years ended December 31, 2014, 2015 and 2016, respectively. All of the movements related to the Safeguard Program balances are accounted for in the same financial line item in the income statements, which shall be presented separately and called “net change in movements of Safeguard Program” if it is material.

Allowance for loan losses

Our allowance for loan losses for our micro-credit lending business is determined at a level believed to be reasonable to absorb probable losses inherent in the portfolio as of each balance sheet date. The allowance is provided based on an assessment performed both on an individual-loan basis and collective basis. For individual loans that are past due for a certain period of time or where there is an observable indicator of impairment, a specific allowance is provided. All other loans not already included in the individual assessment are assessed collectively depending on factors such as delinquency rate, size, and other risk characteristics of the portfolio. We evaluate and adjust its allowance for loan losses on a quarterly basis or more often as necessary.

We write off the loans receivable and the related allowance when management determines that full repayment of a loan is not probable. The primary factor in making such determination is the potential recoverable amounts from the delinquent debtor.

The increase in allowance for loan losses in the year ended December 31, 2015 related to the consumption loans made by our micro-lending subsidiary, Haidong, for the purpose of testing the creditworthiness of certain first-time borrowers on our marketplace.

 

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Share-based compensation

We incur share-based compensation expenses in connection with our share awards and management’s judgment and assessments are necessary to determine how we account for share-based compensation. Share-based payment transactions with employees are measured based on the grant date fair value of the equity instrument issued and recognized as compensation expense net of a forfeiture rate on a straight-line basis, over the requisite service period, with a corresponding amount reflected in additional paid-in capital. The amount of accumulated compensation costs recognized at any date is at least equal to the portion of the grant date fair value of the vested awards at that date.

Share awards issued to non-employees are measured at fair value at the earlier of the commitment date or the date the services is completed and recognized over the period the service is provided.

The estimate forfeiture rate will be adjusted over the requisite service period to the extent that actual forfeiture rate differs, or is expected to differ, from such estimates. Changes in estimated forfeiture rate are recognized through a cumulative catch-up adjustment in the period of change.

Internal Control over Financial Reporting

In connection with the audit of our consolidated financial statements as of and for the three years ended December 31, 2014, 2015 and 2016, we and our independent registered public accounting firm identified two material weaknesses in our internal control over financial reporting. As defined in standards established by the PCAOB, a “material weakness” is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

The material weaknesses identified related to (i) a lack of accounting staff and resources with appropriate knowledge of U.S. GAAP and SEC reporting and compliance requirements; and (ii) a lack of sufficient documented financial closing policies and procedures, specifically those related to period-end expenses cut-off and accruals. Neither we nor our independent registered public accounting firm undertook a comprehensive assessment of our internal control under the Sarbanes-Oxley Act for purposes of identifying and reporting any weakness in our internal control over financial reporting. We and they are required to do so only after we become a public company. Had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional control deficiencies may have been identified.

To remediate our identified material weaknesses, we intend to adopt several measures to improve our internal control over financial reporting, including (i) hiring more qualified accounting personnel, including a financial controller, with relevant U.S. GAAP and SEC reporting experience and qualifications to strengthen the financial reporting function and setting up a financial and system control framework; (ii) implementing regular and continuous U.S. GAAP accounting and financial reporting training programs for our accounting and financial reporting personnel; (iii) setting up an internal audit function as well as engaging an external consulting firm to assist us with assessment of Sarbanes-Oxley compliance requirements and improvement of overall internal controls; and (iv) preparing comprehensive accounting policies, manuals and closing procedures to improve the quality and accuracy of our period-end financial closing process.

The process of designing and implementing an effective financial reporting system is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a financial reporting system that is adequate to satisfy our reporting obligations. See “Risk Factors—Risks Related to Our Business and Industry—If we fail to implement and maintain an effective system of internal controls or fail to remediate the material weaknesses in our internal control over financial reporting that have been identified, we may be unable to accurately report our results of operations or prevent fraud or fail to meet our reporting obligations, and investor confidence and the market price of our ADSs may be materially and adversely affected.”

 

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As a company with less than US$1.0 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, in the assessment of the emerging growth company’s internal control over financial reporting.

Results of Operations

The following table sets forth our consolidated results of operations for the periods indicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. Our historical results presented below are not necessarily indicative of the results of any future periods.

 

     For the Year Ended
December 31,
 
     2014     2015     2016  
     US$     US$     US$  
     (in thousands)  

Revenue

      

Transaction and service fees (net of customer acquisition incentives)

     60,281       62,535       55,891  

Other revenue

     1,027       946       1,092  
  

 

 

   

 

 

   

 

 

 
     61,308       63,481       56,983  
  

 

 

   

 

 

   

 

 

 

Provision for loan losses

     (580     (3,924      

Business related taxes and surcharges

     (2,960     (3,424     (1,122
  

 

 

   

 

 

   

 

 

 

Net revenue

     57,768       56,133       55,861  
  

 

 

   

 

 

   

 

 

 

Operating expense

      

Servicing expenses

     (7,465     (13,484     (13,889

Sales and marketing expenses

     (27,347     (34,182     (29,954

General and administrative expenses

     (23,739     (36,030     (45,372
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     (58,551     (83,696     (89,215

Other income (expense)

      

Other income (expense), net

     1,267       (2,456     (9
  

 

 

   

 

 

   

 

 

 

Profit (loss) before income tax expense

     484       (30,019     (33,363

Income tax expense

     (353     (7     (3
  

 

 

   

 

 

   

 

 

 

Net profit (loss)

     131       (30,026     (33,366

Accretion on Series A convertible redeemable preferred shares to redemption value

     (288     (288     (288

Accretion on Series B convertible redeemable preferred shares to redemption value

     (1,621     (1,621     (1,621

Accretion on Series C convertible redeemable preferred shares to redemption value

           (1,292  

 

(4,468

Deemed dividend to Series C convertible redeemable preferred shares at modification of Series C convertible redeemable preferred shares

                 (635

Allocation of net profit to participating preferred shareholders

                  
  

 

 

   

 

 

   

 

 

 

Net profit (loss) attributable to ordinary shareholders

     (1,778     (33,227     (40,378
  

 

 

   

 

 

   

 

 

 

Net profit (loss)

     131       (30,026     (33,366

Foreign currency translation adjustment, net of nil tax

     1       (533     (1,885
  

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

     132       (30,559     (35,251
  

 

 

   

 

 

   

 

 

 

 

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Year ended December 31, 2016 compared to year ended December 31, 2015

Revenue

Our gross billings on transaction and service fees are associated with the consumption loans and lifestyle loans facilitated on our marketplace.

Our gross billings from consumption loans were US$5.6 million and US$9.8 million for the years ended December 31, 2015 and 2016, respectively, which exceeded the respective customer acquisition incentive payments on an investor-by-investor basis, resulting in revenue from consumption loans of US$2.1 million and US$0.9 million in these respective periods. This difference between gross billings and revenue is due to our payment of customer acquisition incentives to investors who made investments in first-time consumption loan borrowers. Customer acquisition incentives are netted against gross billings on transaction and service fees earned from consumption loans in accordance with ASC 605.

As our average transaction fees for consumption loans were 1-2% of the principal amount in each of the years ended December 31, 2015 and 2016, our consumption loan volume growth from US$349.1 million in the year ended December 31, 2015 to US$611.5 million in the year ended December 31, 2016 has not yet translated into a significant increase in fees.

For the year ended December 31, 2015 and 2016, gross billings from lifestyle loans were US$60.5 million and US$58.1 million, respectively. The transaction and service fees for lifestyle loans were US$60.5 million and US$55.0 million for the year ended December 31, 2015 and 2016, respectively. Though the volume of lifestyle loans facilitated on our marketplace increased from US$391.6 million in the year ended December 31, 2015 to US$450.5 million in the year ended December 31, 2016, our gross billings for lifestyle loans did not increase proportionately, as the average transaction fees as a percentage of loan volume for lifestyle loans decreased from 15.4% in the year ended December 31, 2015 to 12.9% in the year ended December 31, 2016 as a result of improved borrower quality and change in loan product mix.

During the year ended December 31, 2015, we incurred loan losses in the amount of US$3.4 million in connection with the launch of our consumption loan business on a test basis wherein one of our subsidiaries, Haidong CRF Micro-credit Co., Ltd., acted as an investor for consumption loans. During the year ended December 31, 2016, the provision for loan losses decreased to US$0 as we did not participate in any consumption loans in 2016.

Our net revenue decreased by US$0.2 million from US$56.1 million in the year ended December 31, 2015 to US$55.9 million in the year ended December 31, 2016. This decrease was due to net revenue from consumption loans decreasing by US$1.2 million as a result of an increase in payment of customer acquisition incentives, partially offset by net revenue from lifestyle loans increasing by US$1.0 million.

Operating expenses

Our total operating expenses increased by 6.6%, or US$5.5 million, from US$83.7 million in the year ended December 31, 2015 to US$89.2 million in the year ended December 31, 2016, as set forth below.

Our servicing expenses increased by 3.0%, or US$0.4 million, from US$13.5 million in the year ended December 31, 2015 to US$13.9 million in the year ended December 31, 2016. This increase was primarily due to the increase in the number of servicing personnel. Our sales and marketing expenses decreased by 12.4%, or US$4.2 million, from US$34.2 million in the year ended December 31, 2015 to US$30.0 million in the year ended December 31, 2016. This decrease was due to the decrease in salary and rental expenses as we decreased the number of sales personnel and improved our operating efficiency for the lifestyle loan business as well as the decrease in sales and marketing expenses for the excess portion of customer acquisition incentives over gross billings from consumption loans. We achieved this by maintaining a stronger sales force and minimizing the use

 

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of contract employees and underperforming personnel. Our general and administrative expenses increased by 25.9%, or US$9.3 million, from US$36.0 million in the year ended December 31, 2015 to US$45.4 million in the year ended December 31, 2016. This increase was primarily due to the increase in information technology, data analytics and customer service personnel.

Net profit (loss)

As a result of the foregoing, we had net loss of US$30.0 million in the year ended December 31, 2015, while we also incurred a net loss of US$33.4 million in the year ended December 31, 2016.

Year ended December 31, 2015 compared to year ended December 31, 2014

Revenue

Our gross billings from consumption loans were US$0 and US$5.6 million for the years ended December 31, 2014 and 2015, respectively, while revenue for transaction and service fees (net of customer acquisition incentives) were US$0 in the year ended December 31, 2014 and US$2.1 million in the year ended December 31, 2015. This difference between gross billings and revenue is due to our payment of customer acquisition incentives to investors who made investments in first-time consumption loan borrowers. We only pay customer acquisition incentives to investors funding a loan to a borrower in that borrower’s first loan on our platform, and not to repeat consumption loan borrowers. Customer acquisition incentives are netted against the gross billings on transaction and service fees earned from consumption loans in accordance with ASC 605, up to the amount of cumulative revenue. For the year ended December 31, 2015, revenue from consumption loans was netted off to US$2.1 million.

As our average transaction fees for consumption loan were 1-2% of the principal amount in 2015, our consumption loan volume growth from US$1.5 million in 2014 to US$349.1 million has not yet translated into significant increases in fees. There was a significant increase in first-time consumption loan borrowers on our marketplace in 2015.

For the years ended December 31, 2014 and 2015, gross billings from lifestyle loans were US$60.3 million and US$60.5 million, respectively. The transaction and service fees for lifestyle loans were also US$60.3 million and US$60.5 million for the years ended December 31, 2014 and 2015, respectively. Though the volume of lifestyle loans facilitated on our marketplace increased from US$334.0 million in 2014 to US$391.6 million in 2015, our gross billings for lifestyle loans did not increase proportionately as the average transaction fees for lifestyle loans decreased from 18.1% in 2014 to 15.4% in 2015 as a result of change in loan product mix and improved borrower quality.

Our net revenue decreased by 2.8%, or US$1.6 million, from US$57.8 million in the year ended December 31, 2014 to US$56.1 million in the year ended December 31, 2015. This decrease was due to the US$3.3 million increase in provision for loan losses. The increase in loan losses from the year ended December 31, 2014 to the year ended December 31, 2015 primarily related to the US$3.4 million credit losses from loans issued by Haidong in connection with its participation as a marketplace investor on a test basis in our newly launched consumption loan business. Since the fourth quarter of 2015, Haidong has not acted as a marketplace investor for any consumption loans facilitated on our marketplace.

Operating expenses

Our total operating expenses increased by 42.9%, or US$25.1 million, from US$58.6 million in the year ended December 31, 2014 to US$83.7 million in the year ended December 31, 2015, as set forth below.

Our servicing expenses increased by 80.6%, or US$6.0 million, from US$7.5 million in the year ended December 31, 2014 to US$13.5 million in the year ended December 31, 2015. This increase was primarily due to

 

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the addition of 33 new data verification centers as well as the increase in the number of loan servicing personnel at our existing data verification centers.

Our sales and marketing expenses increased by 25.0%, or US$6.8 million, from US$27.3 million in the year ended December 31, 2014 to US$34.2 million in the year ended December 31, 2015. This increase was primarily due to the increase in our data verification centers from 70 as of December 31, 2014 to 103 as of December 31, 2015 as well as the increase in the customer acquisition incentive payments in relation to the new consumption loan business, which was offset in part by increased efficiency in sales and marketing and the increased average size of lifestyle loans from US$8,304 in the year ended December 31, 2014 to US$10,760 in the year ended December 31, 2015.

Our general and administrative expenses increased by 51.8%, or US$12.3 million, from US$23.7 million in the year ended December 31, 2014 to US$36.0 million in the year ended December 31, 2015. This increase was primarily due to the increase in research and development expenses relating to the issuance of consumption loans starting in the fourth quarter of 2014, as well as the increase in related corporate level operational functions such as product management, customer service, call centers and data analytics, as well as technology infrastructure.

Other income (expense), net

Our other income changed from US$1.3 million in the year ended December 31, 2014 to expenses of US$2.5 million in the year ended December 31, 2015. This change was primarily due to the loss on extinguishment of convertible promissory notes in the amount of US$2.2 million and related interest expense of US$1.2 million in the year ended December 31, 2015 in connection with the issuance of promissory notes.

Income tax expenses

Our income tax expenses decreased by 98%, or US$346,000, from US$353,000 in the year ended December 31, 2014 to US$7,000 in the year ended December 31, 2015. This decrease was primarily due to the fact that we generated operating profit in 2014 but we incurred a loss in 2015.

Net profit (loss)

As a result of the foregoing, we had net profit of US$131,000 in the year ended December 31, 2014, while we incurred a net loss of US$30.0 million in the year ended December 31, 2015.

 

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Quarterly Results of Operations

The following table sets forth our unaudited consolidated quarterly results of operations for each of the eight quarters in the period from January 1, 2015 to December 31, 2016. You should read the following table in conjunction with our consolidated financial statements and the related notes included elsewhere in this prospectus. We have prepared this unaudited condensed consolidated quarterly financial data on the same basis as we have prepared our audited consolidated financial statements.

 

    For the Three Months Ended  
    March 31,
2015
    June 30,
2015
    September 30,
2015
    December 31,
2015
    March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
 
    US$     US$     US$     US$     US$     US$     US$     US$  
    (in thousands)  
    (unaudited)  

Net revenue

    8,598       14,747       14,133       18,655       13,117       13,926       16,796       12,022  

Total operating expenses

    (21,090     (21,114     (20,172     (21,320     (23,267     (19,433     (21,094     (25,421

Other income (expenses)

               

Other income (expense), net

    64       (781     (1,982     243       (66     (440     360       137  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit (loss) before income tax expenses

    (12,428     (7,148     (8,021     (2,422     (10,216     (5,947     (3,938    
(13,262

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross billings on transaction and service fees

    10,724       19,456       15,357       20,486       14,841       15,455       19,138       18,467  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table sets forth the total number of loans facilitated on our marketplace for each of the eight quarters in the period from January 1, 2015 to December 31, 2016.

 

    For the Three Months Ended  
    March 31,
2015
    June 30,
2015
    September 30,
2015
    December 31,
2015
    March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
 

Consumption loans

    633,412       1,401,576       1,331,575       1,227,031       1,148,884       1,117,779       1,179,567       2,521,555  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Lifestyle loans

    6,604       9,598       8,844       13,144       9,270       7,474       10,888       10,262  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table sets forth the loan volume on our marketplace for each of the eight quarters in the period from January 1, 2015 to December 31, 2016.

 

    For the Three Months Ended  
    March 31,
2015
    June 30,
2015
    September 30,
2015
    December 31,
2015
    March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
 
    US$     US$     US$     US$     US$     US$     US$     US$  
   

(in thousands)

 

Consumption loans

    46,717       103,848       99,408       99,146       105,980       120,038       147,863       237,610  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Lifestyle loans

    54,433       104,294       79,183       153,720       104,541       89,699       146,592       109,629  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liquidity and Capital Resources

To date, we have financed our operations primarily through cash flows from operations and the issuance of preferred shares and convertible notes in private placements. We may explore other ways to finance our operations in the future, including long-term credit facilities and offerings of debt or equity securities.

We incurred losses from operations of US$27.57 million and US$33.36 million for the years ended December 31, 2015 and 2016. As of December 31, 2016, we had mezzanine equity of US$116.22 million, and

 

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shareholders’ deficit of US$102.21 million. We had negative cash flows from operating activities for the years ended December 31, 2015 and 2016, the net cash used in operating activities was US$16.93 million and US$26.74 million for the years ended December 31, 2015 and 2016. As of December 31, 2016, we had cash and cash equivalents of US$18.98 million and other current assets of US$5.00 million. We regularly monitor our current and expected liquidity requirements to ensure that we maintain sufficient cash balances and accessible credit to meet our liquidity requirements in the short and long term.

Based on our cashflow projections from operating activities, existing cash and cash equivalents, and other current assets, we believe that we will be able to meet our payment obligations and other commitments for at least 12 months following this offering.

Substantially all of our future revenue is likely to continue to be denominated in RMB. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior SAFE approval as long as certain routine procedural requirements are fulfilled. Therefore, our PRC subsidiaries are allowed to pay dividends in foreign currencies to us without prior SAFE approval by following certain routine procedural requirements. However, current PRC regulations permit our PRC subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are required to set aside at least 10% of their after-tax profits after making up previous years’ accumulated losses each year, if any, to fund certain reserve funds until the total amount set aside reaches 50% of their registered capital. These reserves are not distributable as cash dividends. Furthermore, capital account transactions, which include foreign direct investment and loans, must be approved by and/or registered with SAFE and its local branches. See “Risk Factors—Risks Relating to Doing Business in China—PRC regulation of loans to, and direct investment in, PRC entities by offshore holding companies and governmental control of currency conversion may restrict or prevent us from using the proceeds of this offering to make loans to our PRC subsidiaries and their subsidiaries, or to make additional capital contributions to our PRC subsidiaries.”

The table below sets forth a summary of our cash flows for the periods indicated:

 

     For the Year Ended
December 31,
 
     2014     2015     2016  
     US$     US$     US$  
     (in thousands)  

Net cash provided by/(used in) operating activities

     (7,667     (16,934     (26,740

Net cash used in investing activities

     (2,087     (2,697     (3,087

Net cash provided by financing activities

     1,887       39,144       24,002  

Net increase/(decrease) in cash and cash equivalents

     (8,133     19,232       (6,062

Cash and cash equivalents-beginning of period

     13,946       5,813       25,045  

Cash and cash equivalents-end of period

     5,813       25,045       18,983  
  

 

 

   

 

 

   

 

 

 

Operating Activities

Net cash used in operating activities was US$26.7 million in the year ended December 31, 2016. This cash outflow was primarily due to a net loss of US$33.4 million. This impact was partially offset by non-cash items of US$2.7 million, an increase in accrued liabilities of US$0.8 million, and a decrease in investments held for trading of US$2.8 million.

Net cash used in operating activities was US$16.9 million in 2015. This cash outflow was primarily due to (i) a net loss of US$30.0 million, as adjusted by non-cash items, (ii) an increase in Safeguard Program assets and liabilities of US$1.0 million, as a result of the combined effects of contributions to and pay-outs from the

 

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Safeguard Program, and (iii) an increase in receivables, prepayments and other assets of US$4.3 million; partially offset by (i) a decrease in loans receivable of US$5.6 million in connection with the sale of micro-credit loans being provided by Haidong to independent third parties, (ii) an increase in accrued liabilities of US$3.1 million in connection with accrued employee salaries and tax payables, and (iii) a decrease in investments held for trading of US$1.1 million.

Net cash used in operating activities was US$7.7 million in 2014. This cash outflow was primarily due to (i) a net profit of US$131,000, as adjusted by non-cash items, (ii) an increase in Safeguard Program assets and liabilities of US$5.2 million as a result of the combined effects of contributions to and pay-outs from the Safeguard Program, and (iii) an increase in loans receivable of US$7.5 million as a result of more micro-credit loans being provided by Haidong; partially offset by an increase in accrued liabilities of US$2.8 million in connection with accrued employee salaries and tax payables.

Investing Activities

Net cash used in investing activities was US$3.1 million for the year ended December 31, 2016. This cash outflow was primarily due to the purchase of equipment and software.

Net cash used in investing activities was US$2.7 million in 2015, primarily due to purchase of property, equipment and software of US$2.7 million, including primarily vehicles, computer and electronic equipment and lease improvements.

Net cash used in investing activities was US$2.1 million in 2014, primarily due to the purchase of property, equipment and software of US$2.1 million including vehicles, office supplies, furniture and lease improvements in connection with our network expansion.

Financing Activities

Net cash provided by financing activities was US$24.0 million for the year ended December 31, 2016. This cash inflow was primarily due to the issuance of convertible preferred shares and promissory notes.

Net cash provided by financing activities was US$39.1 million in 2015, primarily due to (i) proceeds from issuance of convertible promissory notes of US$32.8 million to third-party investors, and (ii) proceeds from issuance of convertible redeemable preferred shares of US$11.9 million in connection with the offering of Series C Shares; partially offset by the redemption of convertible promissory notes of US$2.5 million.

Net cash provided by financing activities was US$1.9 million in 2014, primarily due to the combined effects of (i) proceeds from borrowings of US$3.1 million, including short-term loans in the aggregate principal amount of US$1.5 million from several directors in connection with a capital injection into one of our PRC subsidiaries and a loan of US$1.6 million by Haidong from a local bank in Qinghai Province in connection with Haidong’s micro-credit lending business; and (ii) the repayment of the loans from the directors in the amount of US$1.25 million. The remainder of the directors’ loans was repaid in February 2015.

Capital Expenditures

Our capital expenditures have primarily related to lease improvements and the purchase of office equipment. We did not incur significant capital expenditures in 2014, 2015 or 2016.

 

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Contractual Obligations

We have entered into non-cancellable operating leases covering various facilities. The table below sets forth our future minimum lease payments under these non-cancellable leases:

 

     Payments due by period  
     Total      2017      2018-
2019
     Thereafter  

Operating lease obligations (US$’000)

     7,632        4,869        2,632        131  
  

 

 

    

 

 

    

 

 

    

 

 

 

We recorded rental expenses of US$3.9 million, US$6.0 million and US$6.7 million in the consolidated statements of comprehensive income for the years ended December 31, 2014, 2015 and 2016, respectively.

As of December 31, 2014, December 31, 2015 and December 31, 2016, we did not have significant capital and other commitments, long-term obligations, or guarantees other than those relating to the Safeguard Program as disclosed elsewhere in this prospectus.

Borrowings

The table below sets forth our borrowings for the periods indicated:

 

     As of December 31,  
     2014      2015      2016  
     US$      US$      US$  
     (in thousands)  

Short-term bank borrowing

     1,634                

Loan due to a related party

     250                
  

 

 

    

 

 

    

 

 

 
     1,884                
  

 

 

    

 

 

    

 

 

 

In November 2014, our subsidiary, Haidong, entered into a loan agreement with a commercial bank for a principal amount of US$1.6 million in connection with its micro-credit lending business, which was guaranteed by our subsidiaries China Risk Finance LL (China) Co., Ltd and CRF Finance Lease Co., Ltd. This short-term bank loan was repaid in November 2015 and bears interest at 8.5% per annum. The agreement does not contain any restrictive loan covenant.

In May 2014, we borrowed short-term loans from three of our directors in the aggregate principal amount of US$1.5 million. We used the proceeds of these loans to capitalize one of our WFOEs in China when we were unable to obtain foreign currency in a timely manner. US$1.25 million was repaid in August 2014 along with US$42,500 in interest. The remaining balance of US$250,000 along with US$23,000 in interest was repaid in February 2015.

Contingent Liabilities

We did not have any contingent liabilities as of December 31, 2016.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements as of December 31, 2016.

Quantitative and Qualitative Disclosures about Market Risk

Foreign Exchange Risk

Our revenue and expenses are mostly denominated in RMB, and a significant portion of our financial assets are also denominated in RMB, whereas our reporting currency is the U.S. dollar. The RMB is not freely

 

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convertible into foreign currencies for capital account transactions. The value of the RMB against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions and China’s foreign exchange policies. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar, and the RMB appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the RMB and the U.S. dollar remained within a narrow band. Starting in June 2010, the PRC government allowed the RMB to appreciate slowly against the U.S. dollar. However, with the announcement by the PBOC to devalue the RMB in a move to support exports and boost the role of market pricing, the RMB has experienced significant depreciation against the U.S. dollar. For example, in August 2015, the PRC government allowed the RMB to depreciate by more than 4% against the U.S. dollar. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the RMB and the U.S. dollar in the future. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk.

Interest Rate Risk

Our exposure to interest rate risk partially relates to the interest income associated with micro-credit loans provided by Haidong. We generated interest income associated with micro-credit loans provided by Haidong in the amount of US$571,000, US$332,000 and US$175,000 in 2014, 2015 and 2016, respectively. In addition, we generated interest income on our interest-bearing bank deposits, in the amount of US$75,000, US$144,000 and US$29,000 in 2014, 2015 and 2016, respectively. Interest-earning instruments carry a degree of interest rate risk. We have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in market interest rates. However, our future interest income may fall short of expectations due to changes in market interest rates.

The fluctuation of interest rates may also affect the demand for our marketplace lending business. For example, a decrease in the interest rate may cause potential borrowers to seek loans from other channels and higher returns offered by comparable or substitute products may damper investor desire to invest in our marketplace. A high interest rate environment may discourage investors and borrowers from participating in our marketplace and may reduce the number of loans facilitated on our platform, which may adversely affect our business. However, we do not expect that the fluctuation of interest rates will have a material impact on our financial condition.

Recently Issued Accounting Standards

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), to clarify the principles of recognizing revenue and create common revenue recognition guidance between U.S. GAAP and International Financial Reporting Standards (“IFRS”). An entity has the option to apply the provisions of ASU 2014-09 either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying this standard recognized at the date of initial application. ASU 2014-09 is effective for fiscal years and interim periods within those years beginning after December 15, 2017, and early adoption is permitted but not earlier than the original effective date of December 15, 2016. The most significant aspect of our evaluation of Topic 606 relates to ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This implementation guidance discusses principal-versus-agent considerations and gross-versus-net revenue reporting, including specific indicators to assist in the determination of whether we control a specified good or service before it is transferred to the customer. We are still in the process of evaluation of the impact and through our evaluation, we believe that the accounting treatments under the new guidance are expected to be consistent with our current revenue recognition policies, and we do not expect the new standard to have a material impact on our consolidated financial statements. We will adopt Topic 606 during the first quarter of 2018. In addition, we are still evaluating the use of either the retrospective or modified retrospective transition method.

 

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In July 2014, the FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of ASU 2014-12 is not expected to have an impact on our consolidated financial statements.

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40)—Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 provides guidance regarding management’s responsibility to (i) evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and (ii) provide related footnote disclosures. ASU 2014-15 is effective for fiscal years and interim periods within those years beginning after December 15, 2016. We adopted ASU 2014-15 as of January 1, 2016. The adoption of ASU 2014-15 did not have a material impact on the Group’s consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance will impact the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified the need for a valuation allowance on deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities not under the fair value option is largely unchanged. The standard is effective for public business entities for annual periods (and interim periods within those annual periods) beginning after December 15, 2017. We are currently evaluating the method of adoption and the impact ASU 2016-01 will have on our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. A lessee should recognize in the balance sheet a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. ASU 2016-02 is effective for fiscal years and interim periods within those years beginning after December 15, 2018. Early adoption is permitted. We are currently evaluating the method of adoption and the impact ASU 2016-02 will have on our consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). This ASU affects entities that issue share-based payment awards to their employees. ASU 2016-09 is designed to simplify several aspects of accounting for share-based payment award transactions, including the income tax consequences, classification of awards as either equity or liabilities, classification on the statement of cash flows, and forfeiture rate calculations. ASU 2016-09 will become effective for annual and interim periods beginning after December 15, 2016, and early adoption is permitted in any interim or annual period. We adopted ASU 2016-09 as of January 1, 2016. The adoption of ASU 2016-09 did not have a material impact on our consolidated financial statements.

In June 2016, the FASB amended guidance related to impairment of financial instruments as part of ASU 2016-13 Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which will be effective January 1, 2020. The guidance replaces the incurred loss impairment methodology with an expected credit loss model for which a group recognizes an allowance based on the estimate of expected credit loss. We are currently evaluating the impact of this new guidance on our financial position, results of operations, EPS and cash flows.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 provides guidance for targeted changes with respect to

 

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how cash receipts and cash payments are classified in the statements of cash flows, with the objective of reducing diversity in practice. ASU 2016-15 is effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted. We are in the process of evaluating the impact of this accounting standard update on our consolidated statements of cash flows.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) (“ASU 2016-18”). This ASU affects all entities that have restricted cash or restricted cash equivalents and are required to present a statement of cash flows under Topic 230. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. This update will become effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019, and early adoption is permitted in any interim or annual period. We are currently evaluating the impact of this guidance on our consolidated financial statements.

 

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OUR INDUSTRY

We operate a leading platform in China’s marketplace lending industry, otherwise known as the “peer-to-peer” lending industry, which is a subset of China’s overall credit industry. Since no reliable third-party data is publicly available for the marketplace lending or consumer credit industries in China, we have engaged Oliver Wyman, a leading global management consulting firm, to prepare an industry report that analyzes these industries. All the information and data presented in this section has been derived from Oliver Wyman’s industry report unless otherwise noted. Oliver Wyman has advised us that the statistical and graphical information contained herein is drawn from its database and other sources. Although the following discussion describes historical growth and includes projections for expected future growth, such future growth may not occur at the rates that are projected or at all.

China’s consumer credit and marketplace lending industries have undergone significant changes in recent years and their robust growth is expected to continue. This section discusses the drivers influencing these changes and projections of future growth, market segments, key elements of competition and the various business models in China’s marketplace lending industry.

China’s Emerging Middle Class

China is the world’s second largest economy, and while its GDP growth was historically driven mainly by investment and exports, more recent growth has been driven by consumption, according to McKinsey & Company, or McKinsey. McKinsey expects that by 2022, more than 75% of China’s urban consumers, or 630 million urban people, will enter the middle class, with annual household income of between RMB60,000 (approximately US$8,650) and RMB229,000 (approximately US$33,000). Growth in China’s middle class, as illustrated in the chart below, is expected to stimulate China’s domestic consumption and provide a significant opportunity for the consumer finance industry.

Number of China’s Urban Households and Population by Annual Income Level

 

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Source: Adapted from Preparing For China’s Middle Class Challenge, McKinsey Insights China, March 2014, © McKinsey & Company. Reprinted with permission.

Development of China’s Consumer Credit Market

China’s consumer credit market in 2015 was RMB27 trillion (approximately US$3.9 trillion) with a CAGR of 19% per year since 2010, and accounted for 20% of China’s total credit market. Consumer finance, or

 

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consumption loans, consists of individual loans for consumption purposes, excluding secured loans as well as individual loans for business purposes. Today, consumer loans originated in China are primarily larger, secured loans for wealthy consumers. Unsecured consumer loans are an underserved segment and represented only RMB4.0 trillion (approximately US$575 billion) and 3% of the total credit market in 2015.

The low levels of net consumer debt and low individual credit penetration represent a significant opportunity for further expansion of the credit market to China’s middle class. There are several contributing factors to the low level of overall unsecured consumer lending penetration, including the general lack of credit data in China. According to the World Bank Global Findex Database in 2014, 16% of China’s adult population have credit cards as compared to 60% in the United States. According to the PBOC, as of the end of 2015, there were approximately 500 million individuals with quality employment records but no credit history. We refer to these individuals, who also regularly use mobile devices, as EMMAs (Emerging Middle-class, Mobile Active consumers).

The below chart illustrates China’s low level of consumer credit penetration as a percentage of GDP relative to other economies:

Consumption Credit Penetration as a Percentage of GDP by Country (Region)(1)

 

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(1) As of 2015 with regard to China, Hong Kong and the United States, as of 2014 with regard to Taiwan.

Source: Oliver Wyman report based on data provided by CEIC; Taiwan’s consumption credit penetration data is provided by Euromonitor International.

One of the fastest growing segments in the Chinese consumer finance market is non-bank consumption loans, which are expected to grow from RMB0.9 trillion (approximately US$130 billion) in 2015 to RMB4.4 trillion (approximately US$630 billion) by 2020, representing a CAGR of 29%. Consumption loans encompass pure credit-based consumer financing of smaller purchases as an alternative to credit cards, and exclude corporate loans, micro-small enterprise, or MSE, loans and individual operation loans. Individual operation loans are loans to small business owners for business purposes. Large consumption loans ranging between RMB100,000 (approximately US$14,400) and RMB500,000 (approximately US$72,000) are mainly provided in the form of credit card-based credit, while small consumption loans of less than RMB100,000 are dominated by licensed consumer finance companies and, more recently, marketplace lending companies.

 

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The chart below sets forth the outstanding consumption loan balance as of the end of the periods presented, segmented by those held by banks and those held by non-banks.

Total Consumer Credit Market by Type

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Source: Oliver Wyman report based on data provided by the PBOC and Euromonitor International.

China’s Marketplace Lending Market

China’s marketplace lending market is expected to grow at a CAGR of 61% from 2016 to 2020. Marketplace lending gained momentum as an alternative source of loans in China after 2009 due to the availability of capital coupled with the difficulty for small and medium-sized enterprises and private individuals to gain access to traditional sources of credit. Marketplace lending rapidly gained popularity among borrowers for providing quick credit and among investors for providing higher returns. Growth further accelerated with increasing government regulatory support. The following figure shows existing volume and projected growth in China’s marketplace lending market.

Lending Volume of China’s Marketplace Lending Market

 

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Source: Oliver Wyman report based on data provided by Wangdaizhijia.com.

China’s marketplace lending industry is comprised of four distinct segments: consumer finance loans, corporate loans, MSE operation loans, and individual operation loans. Each of the latter three segments is business-oriented with the loan proceeds used primarily for business purposes. Only consumer finance loans are

 

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purely for individual consumption purposes. The market in China for consumer finance loans, or consumption loans, is vastly underpenetrated, with such loans currently comprising only 4% of China’s marketplace lending loan volume.

Market Drivers for China’s Consumer Finance Marketplace Lending Market

Growing Consumer Market Underserved by Banks

Growth of China’s consumer finance market is expected to be largely driven by financially active consumers who currently do not have a credit history or access to bank-issued credit cards. Chinese consumer income grew at a CAGR of 11% from 2010 to 2014, which is faster than that of other major global economies and the overall GDP growth of China. At the same time, China’s household consumption and disposable income have increased due to the country’s evolving demographics, including the “western” lifestyle adopted by the younger generations, the rising middle class and continuing urbanization. The PRC government has made income growth a policy priority as consumption becomes increasingly essential to China’s economy. However, according to the PBOC, as of the end of 2015, there were approximately 500 million individuals with quality employment records but no credit history. These individuals have little, if any, access to credit from other sources.

Regulatory Environment that Favors Leading Operators

China’s marketplace lending industry has historically been largely unregulated, creating a favorable regulatory backdrop for its fast growth. Recently, PRC regulatory bodies, including the CBRC and PBOC, have issued policies, guidelines and principles applicable to the marketplace lending industry. See “Regulation.” Our company has engaged extensively with key regulators to help shape best practices in China’s marketplace lending and credit industries. According to Reuters, the evolving policies, guidelines and principles have reduced the number of marketplace lending companies by eliminating those whose operations are not fully compliant. We believe these recent developments will benefit the compliant incumbent category leaders, including our company.

Proliferation of Internet, Mobile, Data and Channels

In 2014, there were 649 million Internet users and 520 million smartphone users in China, which represented 48% and 38% of the total Chinese population, respectively. Between 2011 and 2014, the number of Internet users grew at a CAGR of 7% while the number of smartphone users grew at a CAGR of 33%. The use of e-commerce and social media, first through the Internet and now through mobile devices, is growing rapidly in China. In 2014, e-commerce and social media reached over 300 million and 470 million people, respectively. The PRC government aims to deepen the integration of the Internet within the economic and social sectors through its “Internet Plus” policy to accelerate the offline to online shift of many traditional businesses. These e-commerce and social media channels potentially provide valuable data on millions of consumers.

Investors’ Strong Appetite for Financial Investment Products

By 2014, investment demand from retail and institutional investors had reached RMB31 trillion (approximately US$4.5 trillion) and RMB66 trillion (approximately US$9.5 trillion), respectively, and is forecasted to grow through 2020 at CAGRs of 20% and 13%, respectively. However, due to negative real returns on bank deposits and underperforming equity markets, many Chinese households and institutional investors have not realized their investment return expectations and are seeking investments with more attractive risk-adjusted yields. We believe that marketplace lending has evolved to connect these retail and institutional investors with borrowers whose loans can generate attractive returns that are less correlated with the general market.

Typical Online Investor Acquisition Models

Online investor acquisition models usually feature low minimum investment thresholds of approximately RMB5,000 (approximately US$720) and offer products with little differentiation, with an emphasis on volumes.

 

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The investment products on these platforms are differentiated in terms of minimum investment thresholds, maturities and returns, often in the form of wealth management products, and are targeted to mass investors. These products typically have low, fixed yields. Shorter and flexible maturities for investments are usually designed for mass investors as a replacement for deposits. Investment products with higher yields typically have longer maturities.

 

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BUSINESS

Our Business

We operate one of China’s largest consumer lending marketplaces in terms of total number of loans, having facilitated more than 10.7 million loans to more than 1.4 million borrowers at significantly lower borrowing costs than many of our competitors. We believe that higher quality borrowers are price-sensitive and correlated to lower borrowing costs. Our technology-driven marketplace facilitates loans between borrowers and sophisticated investors, providing borrowers accessible, affordable credit and offering investors attractive risk-adjusted returns. According to the People’s Bank of China, or the PBOC, as of the end of 2015, there were approximately 500 million individuals with quality employment records but no credit history. We refer to these individuals, who regularly use mobile devices, as EMMAs (Emerging Middle-class, Mobile Active consumers). We believe EMMAs constitute one of the largest untapped consumer credit market opportunities in the world.

Our technology enables EMMAs to access affordable and flexible digital credit through mobile devices. We generate recurring fee revenue from borrowers and investors, including transaction and service fees for loans facilitated on our marketplace. We do not bear credit risk for loans facilitated on our marketplace.

We acquire quality borrowers through multiple channels, including social networks, online travel agencies, e-commerce platforms and payment service providers. Applying our predictive selection technology, we efficiently select prime and near-prime EMMAs for our platform. In 2016, 89% of all loan volume originated on our platform consisted of prime and near-prime borrowers, whose creditworthiness is roughly comparable to FICO scores of between 660 and 720. Through our “low and grow” strategy, we initially offer smaller, shorter-term loans to these EMMAs and then use our proprietary decisioning technology to proactively offer them larger, longer-term loans as they demonstrate positive credit behavior, allowing us to retain high quality EMMAs with significant lifetime customer value.

The investors on our marketplace consist primarily of affluent, high net worth and family office investors seeking attractive returns at well-defined risk levels. We plan to further diversify our investor base, including more institutional investors. Investors are attracted to our marketplace because of the range of loan durations available on our platform, including short-term loans, our marketplace’s risk-adjusted investment returns, our track record, the intrinsic diversification on our platform and our corporate governance standards. In addition, we believe that our marketplace is one of the few marketplaces in China with full risk transfer to investors, which appeals to sophisticated investors that we believe provide a more stable source of lending capital.

We believe that Chinese banks do not extend credit to EMMAs due to the absence of credit data, the high costs of traditional data collection and the inability of banks to engage in variable pricing, which refers to the practice of charging different interest rates to different borrowers based on credit quality. This is illustrated by the fact that only 16% of China’s adult population had credit cards in 2014, according to the World Bank Global Findex Database. As a result, hundreds of millions of financially active and technologically savvy consumers in China lack access to affordable credit. According to Oliver Wyman, China’s total non-bank consumption loan market is expected to reach RMB 4.4 trillion (approximately US$630 billion) by 2020.

We have developed our proprietary technology over 16 years through our work with some of China’s largest banks, including Bank of China and China Construction Bank, to help them develop credit scoring models and risk management systems to issue over 100 million credit cards. This proprietary technology enables us to cost-effectively identify quality EMMAs to be potential borrowers on our platform and offer them affordable credit. Our predictive selection technology analyzes hundreds of variables based on each EMMA’s online footprint , and we use this to selectively target high quality EMMAs and offer them initial loans on our platform. After repayment of these initial loans, our automated decisioning technology determines on a loan-by-loan basis which borrowers qualify for larger loans, the loan amount, fees, interest rate and term, before the loans are recommended to investors on our marketplace. We use cumulative borrowing behavior data from over 10.7 million loans facilitated on our marketplace to continuously improve our algorithms and technology.

 

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We offer flexible products to serve the lifetime credit needs of EMMAs. Our consumption loans are loans with terms of between two weeks and three months, which have principal amounts generally in the range of RMB500 (approximately US$72) to RMB6,000 (approximately US$865). Consumption loans are initially approved using our predictive selection technology and subsequently based on historical repayment behavior on our platform using our automated decisioning technology. Our lifestyle loans are loans with terms of between three months and three years, which have principal amounts generally in the range of RMB6,000 (approximately US$865) to RMB100,000 (approximately US$14,400). Borrowers of loans with principal amounts greater than RMB6,000 (approximately US$865) are required to submit their data for verification at one of our data verification centers as part of our anti-fraud and risk management processes prior to loan approval.

Our platform’s technology advantage and data access have enabled us to become one of the most affordable and scalable consumer lending marketplaces in China. Our end-to-end automation allows us to match EMMAs with investors and execute transactions in an efficient and cost-effective manner. Our ability to access and analyze alternative sources of data on potential borrowers allows us to continuously develop, refine and validate the scoring capabilities of our predictive selection technology. Collectively, this results in lower borrowing costs for our borrowers.

The attractiveness of our marketplace to EMMAs is evidenced by the fact that, as of December 31, 2016, 67% of the borrowers on our marketplace were repeat borrowers. We have experienced a high rate of borrower retention on our marketplace consistently over time. Using the borrower cohort of first-time consumption loan borrowers from the fourth quarter of 2015, as set forth in the following graphs, during a twelve-month period on our platform, the average loan size per borrower increased from US$71 in the first month to US$148 in the twelfth month, and average cumulative loan volume per borrower increased ten times from approximately US$100 in the first month to approximately US$1,000 in the twelfth month.

 

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The growth of EMMAs’ lifetime customer value on our marketplace is just beginning. Our strategy is to serve EMMAs’ lifetime credit needs. We seek to facilitate more loans that are larger and have longer terms to higher quality borrowers and gradually lower borrowing costs to borrowers who have demonstrated favorable repayment behavior on our platform. We believe rewarding favorable repayment behavior will help us retain borrowers and that we will be able to generate increasing fee revenue from increased loan volumes from these higher quality borrowers.

 

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The following graph shows when our cumulative transaction and service fees from cumulative consumption loan volume exceed customer acquisition cost for consumption loans on an average per borrower basis.

 

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(1) Represents breakeven volume to recover customer acquisition costs, which is based on an average transaction and service fee of 1.6% for consumption loans for 2016, and customer acquisition cost for consumption loans on an average per borrower basis of US$17 for 2016. The customer acquisition cost for consumption loans on an average per borrower basis for 2015 was US$20 and the average transaction and service fee for consumption loans during 2015 was 1.5%.
(2) The amount of customer acquisition cost on an average per borrower basis is calculated by dividing the customer acquisition cost for consumption loans by the number of new consumption loan borrowers in the relevant period. The customer acquisition cost for consumption loans is the sum of (i) the customer acquisition incentive offered to investors of consumption loans for first-time consumption loan borrowers, and (ii) any expenses directly related to the acquisition of first-time consumption loan borrowers. In 2015, our customer acquisition cost for consumption loans also included provisions for loan losses from loans issued by our subsidiary, Haidong CRF Micro-credit Co., Ltd., or Haidong, in connection with its participation as a marketplace investor on a test basis in our newly launched consumption loan business. Since the fourth quarter of 2015, Haidong has not acted as a marketplace investor for any consumption loans facilitated on our marketplace.
(3) All figures presented using exchange rates as of December 31, 2016.
(4) The actual cumulative loan volume needed to generate the cumulative transaction and service fees to recover customer acquisition costs, or the breakeven volume, and the actual period needed to generate the cumulative transaction and service fees to recover such costs, or the breakeven time, may differ from the graph and vary from cohort to cohort.

The total cost of acquiring a new consumption loan borrower (including customer acquisition incentives) was US$17 for the year ended December 31, 2016. The average breakeven time required to recover the customer acquisition cost is becoming shorter in the more recent cohorts as compared to earlier cohorts due to repeat borrowing by high-quality borrowers of larger loans with longer terms. In addition, our continuous improvement of algorithms utilizing the credit behavior data of over 10.7 million loans facilitated on our platform has helped us shorten our breakeven time. We expect these quality borrowers to generate significant lifetime customer value on our marketplace through their repeat borrowing of loans with progressively larger amounts and longer terms.

 

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The chart below shows our cumulative number of borrowers as of the dates shown.

 

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(1) Represents the cumulative number of unique borrowers on our platform since inception as of each date presented.

In 2015, we acquired approximately 600,000 new borrowers, and in 2016, we acquired another approximately 718,000 new borrowers. As part of our business strategy, we continue to enhance our data analytics and predictive selection technology and focus on refining our models and validating key assumptions and unit economics, including repeat borrowing rates, cumulative borrowing per borrower by each cohort, borrower upgrade rate, risk quality, break-even period of customer acquisition incentives and gross billings. As of December 31, 2016, we exceeded 1.4 million cumulative borrowers on our platforms.

As part of our disruptive innovation business model, we pay customer acquisition incentives to investors for each first-time consumption loan borrower on our marketplace and these are included in our customer acquisition costs. These incentive payments are significantly higher than the fees we generate from the first few loans by these borrowers. As borrowers pay off their initial loans and repeat borrow on our platform, we utilize our proprietary decisioning technology to proactively offer them larger, longer-term consumption loans based on positive credit histories, allowing us to retain high quality EMMAs with significant lifetime customer value, and, in turn, we are able to generate more gross billings to offset the customer acquisition incentives. Other than the customer acquisition costs that we pay in respect of first-time consumption loan borrowers, the costs to operate our consumption loan marketplace on a day-to-day basis are mainly general overhead costs. As we execute our “low and grow” strategy and offer larger, longer-term loans to borrowers that have demonstrated favorable repayment behavior on our platform, we believe that we will be able to generate increasing fee revenue from increased loan volumes from these higher quality borrowers to recover customer acquisition costs and generate profit for our consumption loan business.

 

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Predictive Selection Technology Model is Most Efficient in Customer Acquisition While Minimizing Application Fraud

 

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Source: China Rapid Finance records, which are consistent with Oliver Wyman research results.
(1) Derived from data for lifestyle loan borrower acquisition on our platform from 2015 to 2016.
(2) Derived from data for consumption loan borrower acquisition from the end of 2014 to the beginning of 2015 for testing purposes. We discontinued using this model when the predictive selection technology model began being applied.
(3) Derived from data for consumption loan borrower acquisition on our platform in 2016.

The above graph sets forth the average acquisition costs per borrower for direct sales, open application and our predictive selection technology models. Since 2011, we have acquired lifestyle loan borrowers through the direct sales model, which is labor intensive, costly and less efficient. In the beginning of 2014, we started to test acquiring borrowers through online channels using an open application model. The customer acquisition cost under the open application model was approximately US$80 to US$100 per borrower, as the cost per click in obtaining online borrowers combined with the low response rate resulted in relatively high acquisition costs. In addition, the fraud rate is high in the open application model. We discontinued using open application model since the end of 2015. Since November 2014, by cooperating with data partners to access the digital footprints of the EMMA population and applying our technology-driven big data algorithm, our average borrower acquisition cost for loans facilitated using our predictive selection technology model, including customer acquisition incentives that we pay to our investors, was approximately US$17 for 2016. Due to the relatively low acquisition cost, we are able to acquire quality and repeat borrowers on a large-scale basis. The key to our consumption loan borrower acquisition model is our predictive selection technology, which enables us to analyze non-traditional, unstructured data we receive from our data channel partners and accumulated borrowing behavior of past borrowers on our marketplace to identify and offer pre-approved loans to prime and near-prime EMMAs.

Market Opportunity and Our Marketplace

We believe EMMAs constitute one of the largest untapped consumer credit market opportunities in the world. According to Oliver Wyman, the demand for consumer credit by this segment of China’s population continues to grow rapidly and it is poised to become China’s principal engine of consumer spending over the next decade. According to Oliver Wyman, China’s total non-bank consumption loan market is expected to reach RMB4.4 trillion (approximately US$630 billion) by 2020.

China’s current banking system, however, is unable to address the borrowing needs of EMMAs, particularly those of salaried private sector employees and sole proprietors. According to the PBOC, as of the end of 2015, there were approximately 500 million individuals with quality employment records but no credit history. Because banks typically do not extend credit to EMMAs, the vast majority of China’s population is underserved by the current banking system and is seeking alternative affordable solutions. As a result, the PRC government has introduced new guidelines and regulations to help facilitate non-bank credit access to these underserved consumers at an acceptable price.

 

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To address this market opportunity, we have developed a marketplace that provides benefits to both borrowers and investors. Borrowers benefit from access to affordable, unsecured credit through digital channels; rapid and efficient credit scoring and decisioning; the ability to build a credit history; and transparent pricing and loan terms. Investors benefit from the range of loan durations available on our platform, including short-term loans, our marketplace’s risk-adjusted investment returns, our track record, the intrinsic diversification on our platform and our corporate governance standards.

Our Competitive Strengths

We have been able to establish a leadership position in China’s consumer lending industry because we are able to use our proprietary technology to efficiently identify and select prime and near-prime EMMAs for our platform, offer them smaller, shorter-term affordable loans and retain quality EMMAs on our platform by offering them larger, longer-term loans as they demonstrate positive credit behavior. We believe that the following strengths differentiate us from our competitors and provide us with advantages for realizing the potential of our substantial market opportunity:

 

    Leading online consumer lending marketplace in China. We operate one of China’s largest consumer lending marketplaces in terms of total number of loans with more than 10.7 million loans facilitated to more than 1.4 million borrowers since inception. We believe that we can maintain and extend our leadership position by continuing to attract and retain quality borrowers and investors to our marketplace with our predictive selection technology, which cost-effectively identifies prime and near-prime EMMAs for pre-approved affordable consumption loans on our marketplace, and the scalability of our “low and grow” strategy.

 

    Expansive customer reach to quality EMMAs through multiple channels and data sources. We have established partnerships with Internet companies and data channel partners, through which we are able to leverage a vast amount of consumer data regarding EMMAs’ online footprint, including social media, search, browsing and transactional activity, to which we can apply our predictive selection, credit scoring and automated decisioning technologies and algorithms. With the trust of our partners and the benefit of their data, we proactively identify and select prime and near-prime EMMAs for our platform and reduce our costs of acquiring borrowers. The data from our partners, in conjunction with cumulative borrowing data from over 10.7 million loans facilitated on our marketplace, is used to continuously improve our algorithms and technology.

 

    Predictive selection technology enabling large-scale, low-cost acquisition of quality EMMAs. Through more than a decade of creating credit solutions for financial institutions in China and over five years of “test and learn” experience in facilitating marketplace lending (See “History and Reorganization—Our Company”), we developed our proprietary predictive selection technology that successfully addresses the limitations of China’s consumer credit data. Our predictive selection technology analyzes non-traditional and unstructured data sources to accurately assess creditworthiness so we can identify and select prime and near-prime EMMAs for our platform. This technology allows us to reduce our average cost of acquiring borrowers such that we are able to offer affordable credit options to our potential borrowers. This creates a network effect whereby we are increasingly able to attract and retain more quality EMMAs to our marketplace.

 

   

Automated decisioning technology enabling us to proactively facilitate loans. Once we have used our predictive selection technology to preselect quality borrowers for our marketplace, we are able to execute our “low and grow” strategy by applying our proprietary automated decisioning technology to proactively offer them larger, longer-term loans as they demonstrate positive credit behavior, allowing us to retain high quality EMMAs with significant lifetime customer value. According to Oliver Wyman, there are only three major service providers of decisioning science technology in China — our company, FICO and Experian — and we are the only one of these companies that facilitates loans. Our automated decisioning technology enables us to assess the creditworthiness of potential borrowers, including those that have borrowed on our platform in the past, and automatically determine the

 

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principal amounts, fees, interest and terms of the loans to be offered to them on our platform such that the borrower has a higher likelihood of being able to fulfill his or her repayment obligations. Furthermore, our centralized and automated loan approval processes allow us to make immediate system-wide changes to the loan approval criteria applied throughout our operations. This intelligent, automated, machine learning technology improves the effectiveness of our algorithms by using cumulative borrowing data collected on our marketplace to better analyze credit behaviors and provides us with a strong competitive edge in risk management.

 

    “Low and Grow” strategy that provides scalability with high lifetime customer value and allows us to meet EMMAs’ evolving credit needs. We offer affordable credit to prime and near-prime EMMAs without the need for a prior credit history. Our marketplace uses our predictive selection technology to identify and select EMMAs based on their online footprint. We initially offer these quality EMMAs smaller, shorter-term loans. As they demonstrate creditworthiness on our platform, we use our decisioning technology to proactively offer them larger longer-term loans, allowing us to retain high quality EMMAs with significant lifetime customer value. As EMMAs become potential borrowers of loans with principal amounts greater than RMB6,000 (approximately US$865) on our marketplace, they are required to submit additional data for verification at our data verification centers as part of our anti-fraud and risk management processes. Our “low and grow” strategy results in highly scalable revenue on our platform with high lifetime customer value as we continue to meet EMMAs’ evolving credit needs.

 

    Diversified investor base with full risk transfer to sophisticated investors. Our marketplace provides an attractive investment opportunity for investors. We have built a diverse investor base consisting of affluent, high net worth and family office investors. By taking advantage of our proprietary predictive selection technology, variable pricing and automatic decisioning technology, investors funding loans on our marketplace are able to achieve attractive returns on smaller, short-term loans while diversifying their credit exposure to include EMMAs. Investors to first-time consumption loan borrowers on our platform benefit from the receipt of customer acquisition incentives. Average returns to investors on our marketplace are significantly higher than those achieved through other traditional investment channels in China. We pride ourselves on our compliance with regulatory requirements and adoption of industry best practices, including third-party audits, transparent disclosure of all fees, interest rates and risks and timely and accurate reporting of account balances and fund flows. In addition, we believe that our marketplace is one of the few marketplaces in China with full risk transfer to investors, which appeals more to sophisticated investors that we believe provide a more stable funding source.

 

    Recognized industry leaders on our management and advisory teams. We have a strong management team with a long history in consumer finance in both the United States and China. Our founder, chairman and chief executive officer, Dr. Zhengyu (Zane) Wang, is a leader in the credit analytics and decisioning science industries in both the U.S. and China. He has played a key role in setting industry standards for credit analytics and developing consumer credit infrastructure in China. From 2001 to 2010, Dr. Wang advised leading Chinese financial institutions, including Bank of China, China UnionPay, Industrial Bank of China and China Construction Bank, in the underwriting, scoring and issuance of more than 100 million credit cards and more than US$100 billion in credit card loans. Our advisors, Nigel Morris, co-founder of Capital One, and Phillip Riese, former president of the consumer card group of American Express, are recognized pioneers in the global consumer credit industry. Our management, board and advisory teams have significant experience in the credit industry spanning multiple areas of expertise, including loan origination, underwriting technology, fraud prevention, risk management and collections both internationally and in China. In addition, since our inception, we have adopted robust corporate governance policies and practices and engaged extensively with key regulators to help shape best practices in China’s marketplace lending and credit industries.

 

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Our Strategies

Leveraging our competitive strengths discussed above, we plan to implement the following key strategies to extend our leadership position in facilitating consumer loans to prime and near-prime EMMAs and achieve our mission of fulfilling their lifetime credit needs:

 

    Rapidly grow our borrower base using our predictive selection technology. We operate in one of the largest untapped consumer credit market in the world. With our proven predictive selection technology and large volume of reliable data on EMMA borrowers’ usage and credit characteristics, we plan to rapidly grow our borrower base with new quality EMMAs by efficiently selecting large numbers of low-risk borrowers and offering them pre-approved smaller, shorter-term loans, and further selecting from among them to offer subsequent larger, longer-term loans as part of our “low and grow” strategy.

 

    Help EMMAs build their credit histories on our platform and meet their evolving lifetime credit needs through our “low and grow” strategy. Through our “low and grow” strategy, we are able to proactively offer quality EMMAs larger, longer-term loans as they demonstrate creditworthiness, which helps meet these borrowers’ evolving credit needs. Our proprietary automated decisioning technology is a key part of our “low and grow” strategy as it analyzes the creditworthiness of potential borrowers on our marketplace, including those that have already borrowed on our marketplace. Using this technology, we can recommend consumption and lifestyle loans with various terms, including loan amount, fees, interest rate and term, to meet EMMAs’ evolving credit needs as China’s economy continues to develop. While EMMAs build their credit histories on our platform, we benefit from their continued repeat borrowing. This results in highly scalable revenue and risk management.

 

    Continue to work with multiple channels and multiple data sources and further penetrate our total addressable market. We currently have multiple channels and data sources and are in active discussions with many additional potential data channel partners, including Internet platforms, e-commerce companies, online travel agencies, telecommunication service providers, and payment providers. These partnerships provide us with additional means by which we can acquire quality borrowers using our predictive selection technology. We also plan to deepen our relationships with, and acquire new, data partners, which provide us with valuable big data. We analyze non-traditional and unstructured data from these data sources to better refine our proprietary algorithms and technology so that we can better assess creditworthiness of potential borrowers.

 

    Further diversify our marketplace’s investor base. Investors on our marketplace currently consist primarily of affluent, high net worth and family office investors. We plan to further increase the number of sophisticated institutional investors on our marketplace to further diversify our investor base. We also seek to attract banks, trust funds and other forms of institutional investors to provide lending capital and thereby reduce borrowing costs.

 

    Invest in our technology platform. We are a technology-driven company, and we plan to continue to make significant investments in our proprietary technologies, algorithms and data sources to increase the speed and scale at which our marketplace can identify prime and near-prime EMMAs and facilitate loans. We plan to further develop and upgrade our mobile-based applications to provide more convenient, secure and rapid marketplace services. We also plan to continue to apply our “test and learn” operating philosophy and refine our predictive selection, credit scoring and automated decisioning technologies to adapt to new data sources. Our technology development center in Mountain View, California has allowed us to stay at the forefront of emerging trends in machine learning and credit analytics. We believe that these investments will enable us to connect an increasing number of borrowers and investors, continue to identify new potential borrowers, and maintain the security and integrity of our marketplace.

 

    Enhance the profile of our brand. We plan to invest further in the development of our brand. To date, we have engaged in only targeted marketing campaigns. We will increase our investment in both online and offline marketing and advertising channels to increase awareness of our brand.

 

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Our Services

Our marketplace provides prime and near-prime EMMAs with flexible loan products to serve their lifetime credit needs. We first offer these EMMAs smaller, shorter-term loans and then use our proprietary decisioning technology to proactively offer them larger, longer-term loans as they demonstrate positive credit behavior. The loans facilitated on our marketplace are categorized as either consumption loans or lifestyle loans. Our consumption loans are loans with terms of between two weeks and three months, which have principal amounts generally in the range of RMB500 (approximately US$72) to RMB6,000 (approximately US$865). Our lifestyle loans are loans with terms of between three months and three years, which have principal amounts generally in the range of RMB6,000 (approximately US$865) to RMB100,000 (approximately US$14,400).

Unlike traditional banks in China, which may only provide credit cards with interest rates capped at 18.25%, loans facilitated on our marketplace have interest rates of up to 24%, which is within the permitted range under PRC laws for non-bank lenders, thereby allowing us to more appropriately price risk. For consumption loans, annual investment return is calculated as total interest income received by the investors, plus customer acquisition incentives given to investors, less service fees paid to us by the investors, less credit losses from consumption loans borne by the investors, all divided by the investors’ weighted average balance of lending capital. Annual investment return for investors of consumption loans was 12.8% and 10.4% for the years ended December 31, 2015 and 2016, respectively. For lifestyle loans, annual investment return is calculated as total interest income received by the investors, less service fees paid to us by the investors, less subsequent contributions to the Safeguard Program borne by the investors, all divided by the investors’ weighted average balance of lending capital. In the years ended December 31, 2014, 2015 and 2016, average annual investment return for investors of lifestyle loans on our marketplace was 11.9%, 11.5% and 11.3%, respectively.

We generate recurring fee revenue from borrowers and investors, including transaction and service fees for loans facilitated on our marketplace. All borrowers of loans facilitated by our marketplace pay us fees on transactional basis and investors pay us service fees over the term of the loans. We do not bear credit risk for loans facilitated on our marketplace. For a further description of our transaction fees, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

As of December 31, 2016, 67% of the borrowers on our marketplace were repeat borrowers. Borrowers are only permitted to hold one outstanding loan at a time on our marketplace. Based on a survey of our borrowers, the principal uses of our consumption loans include shopping, entertainment, daily supplies and phone or Internet bills, and the principal uses of our lifestyle loans include large purchases, business expansion and home improvement. The maturities of loans facilitated on our marketplace range from one day to 36 months.

Loan Products

Consumption loans

Our consumption loans are loans with terms of between two weeks and three months, which have principal amounts generally in the range of RMB500 (approximately US$72) to RMB6,000 (approximately US$865). We use predictive selection technology to analyze non-traditional and unstructured data to proactively identify quality EMMAs to whom we offer consumption loans. Our predictive selection technology identifies qualified EMMAs for our consumption loans and our automated decisioning and credit scoring technologies determine whether a loan should be offered and the terms of the loan. Unlike the underwriting tool or process of a bank or traditional credit company, predictive selection technology does not gather the credit data of a loan applicant and determine whether a loan should be granted. As most of our target borrowers do not have credit history but are active on the Internet, we use predictive selection technology to screen out a targeted pool of individuals that are considered more likely to be potentially prime or near-prime borrowers based on non-credit data elements such as online activities, social groups and networks. Predictive selection technology is an algorithm technology that analyzes an individual’s non-financial and behavioral data and acts as a sorting mechanism rather than an underwriting tool. After consumption loan borrowers take out their initial loan, repay and re-borrow, they

 

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establish a credit and repayment record for themselves, which we track and monitor. We make use of these historical repayment records to further improve our credit decisioning technology as well as refine our assessment of credit limits and scoring categories of these borrowers. Borrowers who do not repay on a timely basis have such delinquency reflected in our database, causing them to be less likely to be eligible for future borrowings. Our decisioning technology analyzes historical repayment behavior of consumption loan borrowers to determine creditworthiness for subsequent loans on our platform.

Potential borrowers identified by our predictive selection technology can obtain consumption loans on our marketplace through our digital channels, which comprise our website, mobile application and our partners’ digital platforms. The lending relationship for that loan is fully mobile, with the borrower being able to check his or her balance and make repayments all from his or her mobile device. As borrowers on our platform develop a track record of timely loan repayment, their costs of borrowing decrease and they are able to access loans on more attractive terms than those offered by our competitors. Our marketplace has facilitated over 10.7 million loans through mobile devices since inception. The following diagram illustrates the ease by which a potential borrower can accept a consumption loan through a mobile device:

Loan Acceptance Process on CRF Mobile App

 

 

LOGO

Lifestyle loans

Our lifestyle loans are loans with terms of between three months and three years, which have principal amounts generally in the range of RMB6,000 (approximately US$865) to RMB100,000 (approximately US$14,400). Borrowers of loans with principal amounts greater than RMB6,000 (approximately US$865), prior to loans being approved, are required to submit their data for verification at one of our data verification centers prior to the loan being issued.

Our network of 107 data verification centers is spread over 94 cities across 23 provinces and three municipalities in China. We analyze the information collected by our data verification centers as well as

 

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borrower loan repayment behavior on our marketplace to qualify borrowers for lifestyle loans. Lifestyle loans require the potential borrower to provide basic personal information as well as the purpose of the loan. Borrowers authorize us to inspect and verify third-party data related to the borrower’s credit, including, but not limited to, the potential borrower’s credit records, bank transaction records, pay slips, domicile registration records and phone and utility records. We also have the capability to conduct on-site customer credit evaluation measures for our lifestyle loans through our data verification centers. Individuals whose applications for lifestyle loans are denied may apply again at a later date at our data verification centers, at which time all of their data will be re-verified.

For each loan application, we collect and verify hundreds of data inputs for analysis by our proprietary credit assessment technology. As we continue to refine the algorithms underpinning our proprietary credit assessment technology, we will be able to reduce the number of required data inputs and enhance our data verification for larger loans.

Micro-credit lending

Our subsidiary, Haidong, principally engages in micro-credit lending. These micro-loans are made outside of our marketplace. These micro-credit loans accounted for less than 1% of our total loans facilitated as of December 31, 2016. When we began the testing phase of our new consumption loans using our predictive selection technology in the fourth quarter of 2014, Haidong initially served as the principal investor for such loans. However, beginning July 1, 2015, Haidong no longer provides lending capital for these consumption loans and only assists in the facilitation of consumption loans.

We also plan, collectively with other third parties, to apply for the establishment of an online micro-credit company that would have the ability to lend directly to online micro-credit borrowers in China. However, the likelihood and timing of the approval for the establishment of such online micro-credit company is uncertain.

Borrowers

Our marketplace currently serves prime and near-prime EMMAs in seeking a flexible and affordable credit. One of our goals is to help quality EMMAs establish a credit history. Borrowers on our marketplace generally choose our platform because of the convenience and attractive interest rates. Our marketplace is accessible in all geographical areas of China by means of our online and mobile-based channels. Borrowers can make repayments through third-party payment companies, mobile devices or in-person at our data verification centers (in the case of lifestyle loans). The majority of borrowers on our marketplace typically are 18 to 29 years old with a college degree and live in large cities in China.

Borrowers, including existing borrowers on our marketplace, who apply for lifestyle loans must submit their data for verification at one of our 107 data verification centers in 94 cities across 23 provinces and three municipalities in China. As we continue to grow, we plan to open additional data verification centers throughout China. We believe these data verification centers provide us with the ability to effectively access underserved EMMAs.

Complementary to the anti-fraud mechanisms built into our proprietary predictive selection technology, our network of data verification centers also supports our platform’s fraud mitigation efforts. After a potential borrower applies for a lifestyle loan, our data verification center personnel conduct in-person field visits and detailed credit diligence to ensure the reliability of the information included in the application. To date, we have not experienced any significant instances of fraud as the credit diligence and data verification measures performed by our network of data verification centers generally are able to detect invalid information in borrower applications. An applicant is automatically rejected if invalid or fraudulent information is found in his or her application. We believe the fraud prevention functions and payment management service functions of our network of data verification centers strengthen the reliability of our marketplace.

 

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Investors

Our marketplace enables investors domiciled in China to invest in loans with varying principal amounts, fees and interest rates and terms. Investors are attracted to our marketplace because of the range of loan durations available on our platform, including short-term loans, our marketplace’s risk-adjusted investment returns, our track record, the intrinsic diversification on our platform and our corporate governance standards. For the years ended December 31, 2014, 2015 and 2016, average annual investment return for lifestyle loan investors on our marketplace was 11.9%, 11.5%, and 11.3%, respectively. Annual investment return for investors of consumption loans was 12.8% and 10.4% in the years ended December 31, 2015 and 2016. As of December 31, 2016, we had approximately 9,850 investors on our marketplace. The following