8 ABF learnings for FinTechs

Some key reflections for FinTech players thinking about their debt journey:

At Fence, we often talk to FinTechs who, after some consideration, have decided to embark on the asset-backed finance journey

These are often somewhat established companies that have gone through their initial equity financing stage and need additional fundraising / liquidity to grow their customer portfolio

These debt raisers tend to share a common pattern – they underestimated the time and effort required to raise and manage one of these facilities – and they are paying the price now

This is why we've taken the time to abstract some of our learnings when it comes to asset-backed finance. We'd love to discuss what some of the key pitfalls to avoid are, and what CFOs should be thinking about when navigating their debt journey

Why do companies decide to leverage asset-backed:

First, a quick intro for those less aware of the asset-based finance (ABF) world.

ABF is a type of funding source collateralized by a portfolio of assets. ABF differs from corporate debt which is collateralized by future corporate cashflows. As a result, lenders get to chose asset profiles that fit their investment criteria while protecting them against corporate default risk

ABF can have advantages over other sources of debt:

• Lower direct cost of capital

• Higher loan to value (the amount of funding per unit of collateral)

• Larger debt amounts

• Longer tenor

Why it can be challenging

Despite all its benefits, negotiating, structuring and managing ABF can get complicated, specially for first-time issuers

Some of the traditional challenges of ABF are:

• Negotiating: conducting a well-structured, data-driven negotiation process with 10+ lenders can take 3-5 months

• Structuring: structuring a deal can be expensive, with legal and advisory costs reaching €300k+

• Managing: handling operations, payments and monitoring tasks can require significant amount of time and resources

8 tips we see can help you negotiate, structure, and manage best-in-class ABF round

1.      Focus on building track record vs. sheer volume

Cost of capital in ABF is primarily driven by the performance of your assets. Lenders will examine your default rate by asset segment to the highest level of detail

• Originate high-quality assets as opposed to building a very large lending base before knowing what works

• If your assets have varying credit quality, think about setting up a segmented financing strategy for each (typically, blending assets of different profile into a single facility will result in worse overall conditions)

• Even once you have raised your first/s facilities, you should focus on overperforming since your track record will determine your future financing conditions

2.      Focus on structuring your data vs. speed of execution

Investors will ask for a “loan tape” or “data tape”, this is, your lending track record. Most companies who start their lending activities leverage pre-existing tools to manage this process in the search for “speed of execution”. As they scale, it often results in overly complex files with errors and unnecessary data that require significant re-work and explanation

• Adopt a tool / methodology that allows you to have a structured loan tape from the beginning

• Design a scalable lending framework: even if you are just lending to a few customers every month, think about building a structured loan tape file that scales as you grow your product. If required, use a loan management tool that helps you

3.     Be data-driven and build a story around your origination vs. waiting for lenders to come up with their own

• Use loan tape data coupled with your business perspective to develop a strong narrative around your asset origination strategy and why ABF makes sense

• Be proactive about selecting which assets you’d like to include in the transaction as opposed to waiting for lenders to find out

• Use visualization tools to find patterns in your data, and always anchor negotiation to data

4.     Prioritize partners who understand your business and actively want to invest in your asset class

• Selecting investment partners who believe in your assets and whose investment thesis is aligned with your business will give you power to negotiate not only lower cost of capital but overall better / more flexible terms  

• Some partners may be attractive for other reasons (e.g., branding) but if their strategy is not aligned to yours, you will end up paying for it (e.g., in structuring fees, reporting needs, refinancing needs…) 

5.     Consider total cost of capital vs. direct cost of capital

When selecting an investment partner, do not just choose based on interest rates. ABF transactions can have other terms that can be even more relevant for your particular case. Some examples include

• Facility size

• Advance rate

• Structuring costs

• Operational needs

• Reporting and monitoring needs

• Term

• Fee structure (e.g., commitment fees, servicing fees, origination fees)

• Providers involved 

6.     Take into account financial inefficiencies in the form of negative carry / cash drag

We find that most ABF borrowers can only access capital once or twice a month, and drawing funds is a daunting process (e.g., lengthy reports, several days wait, back and forth email, traditional banking transfer settlement)

This results in the borrower having to finance the equivalent to ~15 days of origination from their own balance sheet, which significantly increases indirect cost of debt, specially for short-term maturity assets

Selecting an investment partner who is flexible enough to deliver capital as you originate assets and / or managing your platform with a partner like Fence, who delivers capital instantly can be key to reduce your overall financing cost 

7.     Avoid performing recurrent manual non-value adding tasks yourself

When a company is starting their ABF process, it can be tempting to start doing all operations manually to learn from the process and automate them later. We’ve found lots of examples of companies who have built extremely cumbersome manual processes that consume lots of resources and that are extremely hard to implement

Instead, rely on a third party who can help you streamline the cost of operating your debt facility

8.     Think about your long-term financing strategy

It can be tempting to take the most attractive financing path in the short term, but it can lead you to sub-optimal outcomes over the long term

Think about which assets fit better for different financing strategies. E.g., whereas more common assets (e.g., student loans, auto loans) may be more suitable for securitization, other non-flow assets (e.g., unsecured consumer loans) may be more suitable for a warehousing facility

Avoid setting up structures today that will limit your ability to funnel your assets to the right funding strategies in the future

Consider that as you scale, you will have a multitude of financing options on the table that will likely have better / more targeted conditions, so avoid setups today that limit your ability to use different financing setups in the future

Overall, we think there is a lot of value to be extracted from ABF but it’s a complex, hard-to-navigate environment. We typically see the best results when borrowers surrond themselves by experienced partners who've been through the issues you will encounter in the future again and again. At Fence, we are here to jump on a quick call anytime you want to orient you in your ABF journey - see you around!