For companies whose products are financial assets, the need for capital to support these businesses is not just important, it is central to the core business. These companies must be able to source scalable, efficient and cost effective capital in order to deliver their products to market. In the earlier stages a company may be able to self fund their product(s) through equity capital, but as soon as leverage can be applied to the business, scale and profitability can be unlocked. Since the financial product itself is the core product of the company, and the ability to finance these assets is key to being able to appropriately serve customers, having a firm grasp on both the benefits and risks that can be found in the world of asset finance is extremely important. In this world, strategic thinking and planning will be key for any executive team to succeed.
In the same way as discussed with Working Capital, different structures and terms will be available to companies needing capital to finance assets. Different optimization goals will also be important for a company to think about during each phase of their lifecycle.
There is an entire world dedicated to the financing of financial assets. Specialized firms exist that only finance specific asset classes, or companies of certain size and scale. The profile of the asset being originated will dictate who a Company can work with and at what terms.
There are three key components to consider:
Depending on the maturity of the company and their asset origination operation, there are different stages in which the operation is nascent versus mature. Also, underwriting and servicing capabilities of the company are also determinants on which lender the startup can work with.
For example, given a fintech startup whose primary activity is loan origination, they need to have access to capital as early as seed to generate revenue. However, there is a chicken and egg problem since banks usually require at least a few months of loan origination data (i.e “loan tape) to issue capital. In rare cases where startups have an experienced team, backed by strong investors, and are able to demonstrate the creditworthiness of their customers; they can usually secure debt facilities equivalent to approximately 30% of equity raised. The proceeds will be used to prove the validity of their origination process before advancing further with equity financing or raising more debt capital.
In order to win favorable terms on the first debt facility, debt providers usually demand a projected origination volume should be at $20M+ within the first 12 months. Also, bank warehouse facility groups may require several months of data to underwrite the underlying assets because they are frequently more risk averse. For setting up an asset-backed facility, banks will probably require the most information, but they can frequently also issue a smaller amount of corporate financing, which can be used for origination in the early stages.
Lenders are aware that some company ventures are riskier than others. You might have to pay a higher interest rate than a company in a more profitable sector, even with a sizable down payment and excellent credit score.
Think about the distinctions between beginning a firm that offers senior services, a booming sector, and starting a video rental company (a dying industry). Again, it comes down to risk and return; given that the population of persons 65 and older is predicted to nearly triple to 1.5 billion by 2050, it is likely that an enterprise that caters to senior residents will be granted a loan with better terms than a video rental company.
Macro economics also play an important role in capital availability as well as lending terms and structure the borrower will receive. In an expansion market where interest rate is low, it is cheaper for companies to fund their assets with debt facilities given their credit score and business history are in good shape. Also, lower reserve requirement means more capital available to lend out to businesses.
The reverse happens when the global economy is facing uncertainties. In that environment where credit risk of the market is virtually higher, banks would enforce more stringent terms and structure to the borrowers while asset managers would allocate their capital to a less risky asset class like government bonds or commodities such as gold.
Lenders will be looking for answers in each category during their underwriting. The better a Company is prepared to speak to each of these topics, the more efficient the process will be and the better the terms should be. Preparation is rewarded by credit capital markets.
Our checklist for preparation prior to taking debt financing can be viewed here
Additionally, the structures used to finance these assets can be unique and significantly more complicated than working capital financing. We’ve seen many companies succeed and fail and we’re going to provide a step-by-step outline to hopefully help you better navigate this world so you yourself can succeed.
Any company will move through three categories through their life - thinking specifically about asset finance - these categories can be broken down into:
In general, as a company matures and moves through each of the previous categories, the following relationships will be established:
It is important to understand these relationships from the beginning so expectations are set appropriately. During the proof of asset phase the expectations for time to close and cost of capital should be clear so that as a founder or executive team member you can plan ahead and communicate to stakeholders a clear understanding of the process.
Here is a snapshot of what we believe are the key components and players for each stage of financing:
What we believe to be the ideal approach
