It is natural for early stage businesses to focus on presenting themselves to equity investors. For lending businesses, it is essential to also focus on how to appeal to debt investors – often they will be required to activate substantially more capital over the business’ journey.
As debt capital providers, we are constantly talking to emerging lending businesses as they seek to fund themselves as they grow to scale. Since we first launched our Asset Backed Financing strategy in 2019, we have seen time and time again how access to substantial pools of debt capital can be truly transformational for these non-bank lenders.
Here we discuss what we consider to be the essential characteristics to maximize the likelihood of attracting a debt capital provider that can help set an aspiring non-bank lender up for success.
Founders are often young and full of enthusiasm and great ideas, but lack industry expertise. This expertise is invaluable as it allows for your venture to benefit from lessons learnt with someone else’s capital. If you’re a founder, partnering with experienced operators significantly de-risks the venture for all stakeholders (debt and equity).
Fintech successes are awash with this dynamic. Think Anthony Eisen bringing his support to Nick Molnar at Afterpay or Peter Gray bringing his lending background to Larry Diamond at Zip. Critically, this can be imported through your cap table. If facing a choice between raising equity at a higher valuation from a purely financial investor, versus an experienced strategic partner who will be able to bring more than just capital to the table, this choice should be easy.
A clear funded path to profitability
Too often in recent years, founders have brought business plans to market that require growing a loan book to hundreds of millions before reaching profitability, which also requires significant future equity raises to make the future a possibility. This appeared suitable when a market of ever soaring valuations offered an equity put, however, the recent turn in equity markets reminds us that it never stays constant. The businesses that are well capitalized and deliver to a clearly articulated plan set themselves up for success, and give comfort to debt providers to allow them to provide their support.
A core focus on collections
In the lending business, there is an adage that it’s easy to lend money out – the hard part is getting it back. With a wave of innovative fintech businesses proliferating since the GFC, we’ve seen too many focus relentlessly in the first instance on origination, without placing enough emphasis on collections until it’s too late.
It is inevitable that any lending business that wants to successfully grow to scale has to undertake this pivot eventually. Leaving it too late can prove costly and not just in the obvious ways. If it isn’t at the core of a business model from inception, this pivot can be destructive and distracting, as its need is often discovered urgently. Taking the time to fix embedded problems reduces the ability to maintain traction with existing distribution channels, potentially threatening the good work done to date.
If done too late, given that historical errors will be embedded in your loan book, this can even be existential.
A distinguishing distribution model
We often say that in building a non-bank finance company, you need to solve for credit, solve for distribution and solve for cost of capital. In that order. Building a distribution model where you don’t have to give a large portion of the economics to channel partners who may adversely select you against your competitors is critical to building to scale. Finding a real problem to solve, more than just demand for capital, helps build a sustainable business that can be well compensated for the risk it is taking. Solving a problem for a channel who can drive distribution for your business helps scale effectively.
Buy-now-pay-later providers demonstrated this initially, although eventually competition eroded many of these benefits. More traditional vendor finance programs similarly empower a broad distribution network that you don’t have to pay for. Businesses that distinguish themselves with effective distribution platforms bolster themselves for a sustainable future.
Early stage lending businesses are unique in that they need to support themselves with substantially more debt than most start ups would require so early in their journey. The four points above are clear ways that you can identify yourself as suitable for taking on this responsibility. By no means do all the businesses we partner with tick all these boxes. But for those that do, it’s very easy for us to run hard at providing a compelling solution.