Balance Sheet Businesses

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This week, we’re joined by Matthew Witheiler, principal at Flybridge Capital Partners, who will discuss the challenges of fulfilling lending demand.

By Matthew Witheiler, principal at Flybridge Capital Partners

One of the constants in life is need for capital. It’s one of the trends we follow closely here at Flybridge and one we’ve invested in numerous times in the past. Whether it’s consumers who need cash (ZestFinance) or businesses (BlueTarp), we’ve put our money where our mouth is when it comes to lending businesses.

The lending thesis really came into its own with the financial crisis. Consumer credit dried up and small business lending all but stopped. It wasn’t that consumers needed less money than before or that businesses were suddenly more efficient than in the past, it’s just that the traditional outlets (credit cards and banks) weren’t active. And while we’ve seen a recovery in the equity markets and signs are that credit card debt is rising again, access to capital is nowhere near as pervasive as it was pre-2008. Thus, businesses that facilitate access to capital remain well positioned in our opinion.

In our experience the challenge with lending businesses is not demand – as discussed above, there’s plenty of that. Instead it’s figuring out how to fulfill that demand. The dirty secret behind all lending businesses is that they need a balance sheet to lend against. In the venture capital-backed startup world, it’s highly unlikely that any of the equity money raised for the businesses goes out the door in the form of cash lent to its customers – the equity capital is intended to build the business and generate 10 times the returns or more, not debt-type returns. As a result lending businesses have to turn to partners to supply capital to lend against. The problem is that coming about this capital can be just as hard, if not harder, than coming about the equity capital an entrepreneur may raise; the dollar amounts are generally larger and the set of investors looking for assets in the category are more limited. Without lending capital to serve the product it’s hard to build equity value and without equity capital it’s hard to attract a lending partner. Quite the chicken and egg.

There are two ways that we encourage companies we meet with to solve this dilemma. The first way is to start small. With most lending products, data can be collected and loans tested on a small set of customers to prove business assumptions and demonstrate traction. With even a limited amount of lending capital on hand, directional data around acquisition costs, default rates and loan performance can be gathered; initial data can go a long way in convincing both debt and equity investors to participate. The second way is to lock down a debt facility, at least in paper form, before rising equity financing. The debt may be conditional on getting an equity partner to the table or meeting certain performance metrics and that’s fine – it at least shows that the business has the capability to make loans on day one.

In our experience the alternative is not nearly as attractive. It usually involves a small amount of equity capital raised followed by a brick wall as the business struggles to scale and grow past whatever initial capital access is available. From there it’s anyone’s guess how the business nails future equity and debt financing.

Balance sheet businesses are hard but, when done right, there are interesting pots of gold at the end. After all, almost everyone could use a little more money.