Market Update on High-Yield Tech Lending
In recent years, technology lending has become more and more prominent due to the changing needs of the tech startups emerging today.
Tech lending differs from other forms of private credit as it is more dependent on reliable revenue and whole company sale value and less dependent on accounts receivable, inventory held, or cash levels.
Before we dive into the newer model of tech lending, let’s look at where it began—with venture debt.
Venture Debt: The Pioneer of Tech Lending
Venture debt was first introduced by technology-focused banks like Silicon Valley Bank and Comerica to provide debt to companies that already had venture capital sponsors—usually from a large, brand-name VC.
The banks’ strategy was to court these promising startups and reap greater rewards in the event that they became large, successful companies down the line.
The Changing Face of Tech Startups
Through the late 1990s and early 2000s, software tools emerged that significantly lowered the barrier to entry for many tech founders.
As a result, the capital required to take a tech company from zero to $10M in revenue was reduced dramatically.
- Off-the-shelf software-as-a-service (SaaS) tools forestalled the need for on-premise software or dedicated development programs
- Infrastructure-as-a-service (SaaS) lowered the cost of hardware requirements
- The IT headcount required to manage hardware and business software reduced
Since then, a large number of technology companies can now grow and succeed without significant capital and certainly without venture capital. Atlassian, Qualtrics, and Shopify are some of the most successful bootstrapping startups.
In fact, greater than 95% of tech startups don’t get venture capital. Instead, they’re funded by founders, founders’ family and friends, and/or angel investors. Only management teams with aspirations of going public on the NASDAQ consider venture capital; companies with more modest goals of, for example, an eventual sale for $50 million, want to take another path.
The Evolution of Tech Lending
Since the mid to late 2000s, a number of tech lending companies have emerged. Depending on their business model, they offer investors varying rates of high-yield returns. These returns have typically been consistent and attractive through both up and down cycles.
Generally, returns to investors are driven by the target market of the tech lender, as defined by the average size of portfolio companies (in terms of revenue). Smaller portfolio companies are riskier and thus drive higher returns.
However, process automation has a role to play as well. Developments in financial technology (“fintech”) have allowed tech lenders to appropriately manage risk in the smaller end of the spectrum.
Returns to investors can be correlated with both portfolio company size and the degree of automation in the tech lender’s business model as follows:
The Role of Automation in Tech Lending
Just as the ‘everything-as-a-service’ era lowered the cost of doing business for technology startups, automation has lowered the cost of doing business for tech lenders.
Historically, the lower end of the lending market (in terms of annual revenue and loan size), has been underserved for a number of reasons including:
- A lack of profitability due to high administrative / back office costs
- Reliably assessing credit risk for smaller companies
Automation has removed these barriers for lenders. Through automated credit models and the efficient flow of data, the cost of underwriting and closing new deals, as well as managing existing deals, has reduced significantly.
As such, full automation of the lending process is a key goal of the ‘fintech’ market. Fintech has been under development in the consumer lending market for over a decade and now it has come to the tech lending market.
Best Risk-to-Reward: Companies with $2-10M ARR
Automation will continue to develop and the market will evolve. However, pursuing automation for the sake of it does not keep in mind the ultimate goal: returns to investors.
Based upon five years of investing in this market, TIMIA Capital believes that the best reward-to-risk ratio currently exists in the $2M to $10M annual recurring revenue market range. Through a hybrid approach of semi-automation combined with human oversight of investment committees and detailed due diligence, we find that, historically, the $2M to $10M ARR range provides the most stable return.
If you’re interested in learning more about high-yield tech lending by TIMIA Capital, visit our investor website.
Mike Walkinshaw, CEO
Mike joined TIMIA as the CEO in August 2015. He is experienced in revenue financing, venture debt and venture capital investing. Previous to TIMIA, he was the Co-Founder and Managing Partner of Fronterra Capital, as well as Managing Partner, CFO at Chrysalix Energy. Before working on the finance side, Mike worked in the technology manufacturing sector in product and program management, strategy and planning.
Mike has a Bachelor of Commerce from University of BC, and a formal CPA designation.