EUVC #262: Winning with Non Dilutive Funding

0:00All right, everyone, welcome to today's roundtable on winning with non-diluted financing and revenue-based financing in particular. Today, we are privileged to have with us quite a cool panel. We've got Gilles de Malbosk, Chief Investment Officer at Harmony Family Office. He, of course, brings a wealth of knowledge about how an LP thinks about this asset class. Then we've got Bailey Mauro, Managing Director of HSBC Innovation Banking. He is going to give us the viewpoint of, of course, a large bank active in this space. Then we've got Himal Fraser-Rawal, general partner at White Star Capital. He is a GP with White Star, as I just said, and is running a hybrid fund strategy there.

0:47So that's going to be quite interesting. I think that's something that we've been missing in the European mentor ecosystem for quite a while. So very, very interested to hear more from him and hope you'll enjoy that as well. And then finally, we have Benjamin Reeder, founder and CEO of Levenu, who's bringing into the European ecosystem a completely new model or something that at least we haven't had enough of it in my perspective, which is revenue based financing. So, Benjamin, maybe let's start with you and I'll ask you to give us a good first overview of how you think about, you know, the state of revenue based financing and also, of course, the broader category of non-diluted financing in Europe.

1:29I think traditionally there were two main sources of alternative financing or non-equity financing. The first one being banks. Banks typically give non-diluting financing, most cases under the form of loans, either secured or unsecured. There's also alternative financing or non-diluting financing coming from governments. I think both those very big groups of entities are very well known for everyone to be the most innovative players in markets. Well, governments, I mean, grants are a way for any company to get additional funding, but it's a very tedious process. And in most cases, it's very, very specific for a very certain reason or for a very specific reason.

2:22banks do loans banks can do factoring factoring in my opinion has been one of the the very good things for growing companies to to get working capital in the big issue with factoring in today's world is that as clientele of any company is is globalizing a lot understanding the credit worthiness of the clients of the company getting financed is becoming way more difficult plus it doesn't fit the new the new types of business models now i think that brought us to a an innovation in terms of other sources of alternative financing i think we can start with venture debt which was focused on on those companies that probably had harder times getting financed through the traditional sources of alternative financing by specifically those people who were very focused on helping this type of company getting financed.

3:28In most cases, VCs had said, okay, guys, there is a piece of equity that we can do. We know where you're sitting at. We understand that you want to grow into a next valuation. We can provide the guys with venture debt. Now, the thing with venture debt is that it works. It's been used quite a lot, but it has a dilutive aspect to it. That is number one. And the second thing is that in a market where money becomes a lot more expensive than it was, in a market where VC funds have less dry powder or at least have less discretional ways of allocating their capital, that seems to be a source that dries up, which brings us to the more niche and more focused ways of alternative financing.

4:21And in my opinion, that is where the market is evolving to. The market is evolving to these very specific tailored products that really fit into the entire capital stack or the entire financing stack of companies. This is, of course, where you guys come in with Leavenue and revenue-based financing. So I saw Himal doing some notes when you talked about venture debt. So we'll get into that in just a second, but I wanted to just get you to outline how revenue-based financing is different and who serves well and who serves less well than me. Revenue-based financing started out as something for e-commerce companies.

5:03So basically based on all the, I think the big innovation here was a lot of the data going through or a lot of the financial data that you need in an underwriting process, especially for an e-commerce platform, sits on these digital platforms, right? So you can pull it in, you can do an analysis on it and you can make a very good assumption on what's going to happen on the short term. And it made a lot of sense for e-commerce companies as they needed capital to buy stock or as they needed capital to invest in marketing. So from a legal point of view, what they basically said is, look, let's take the revenues coming in, claim those as a collateral in the financing, and we'll go ahead and try and use that.

5:51So that's where it started. We shifted the industry, at least. we went to what we knew best which was software as a service companies as a starter and then the broader point of view recurring revenue based financing or recurring revenue based company sorry a business model that is everything subscription everything as a subscription is a business model that is expanding all over the world I mean every company suddenly has something as a subscription so it made a lot of sense for us to try and use that dynamic in terms of like evolving business models and try and grab a piece of cash flows that are linked to subscriptions to use as the underlying collateralization of financing and if you look at a lot of these startup scale-ups even bigger companies that have a recurring revenue model one of their biggest issues one of their biggest challenges is their customer acquisition cost it's in most cases capital that they need to deploy to convince clients to start using their services.

7:02And then they start getting paid on a monthly basis. And a lot of business models, it takes three, four, sometimes even five months before that initial marketing investment to get a client on board is paid back. And that is a very difficult thing to finance. Now, if you go out and you can tell an investor to front you the next 12 months, because from a statistical point of view, you can prove that most clients stay longer than those five months or longer than those 12 months. And then suddenly, whenever you have a new client, you basically get a year of money up front that you can then reinvest as working capital in your business.

7:48And I think that's the entire idea where Levin U has built the route. Gilles, if I could bring you in here, because when we spoke the other day, I think you had the perspective of the capital provider in mind, right? So maybe you could share that with us, because I think that's relevant to bring in. And I think there are definitely some, let's call it strengths of revenue-based financing over others, where you sit on the capital stack and everything. So maybe you could dive into that. And then after that, I want to contrast RBF to what I know that Bailey and Hamel works a lot with, which is VentureDev.

8:22Yeah, I'm going to talk from an investor point of view, because I don't know all the technicalities as Benjamin does. But I love RBF as an investor. I've been investing for our clients in all sorts of alternative investment vehicles, the really weird ones sometimes, you know, niche ones. So when I came across RBF, I thought, hey, I've got to invest our clients' money in that strategy. But the problem is I had to go onto the platform every month. And I can't really do that for several clients to collect the coupon and reinvest it. So I was looking for an investment fund. And the problem is there is none.

9:11So before going into that, could you could you just explain to me why you as an MFO looked at this strategy and said, this is convincing to me, this makes sense? OK, you know, it's just the same reason why we invested in in it's got nothing to do with it. But but actually, yes, a private equity fund which finances accountants. And why did we invest in such a fund? Because it's easy to guess where turnover is going to be in a year or even three years time, because revenue turnover is very stable in this sector. And same thing with RBF. If I have enough visibility on the companies I'm considering, which is the case with platforms like Levenue, because they allow investors to see what's the revenues been for the last 12 months, what's the churn rate, what's all sort of KPIs.

10:16and historically investors have never had any as much visibility as they have with those platforms so i i like the fact that i know everything that's going on in the company whatever the storytelling of the ceo is because i have the the raw data because leavenue is connected to all the apis of the company of the bank of the accountant etc so it's very reconforting for investors. And I like the fact, just as with the accountants, I like the fact that I can guess pretty well what the turnover is going to be within 12 months. So for this key thing, the fact that risk is absolutely minimized because yes, every time I assess a strategy, I I only work on risk, really.

11:11And then performance takes care of itself. But risk is really low in that strategy. That's why I really like it. Could I bring you in, Hamal? Because last time we spoke, we spoke a bit about risk as well. And I know that you love the venture debt strategy because you're seeing that you get a good risk reward ratio there. So could you touch on both risk, but also how you see venture debt and RBF playing together? Is RBF, what from the RBF toolbox do you use versus not? If you look back over history in Europe and how funding has evolved, in 2010, you had two venture debt players. That's perhaps three.

11:58That's probably about it. And over the course of the last 14, 15 years, you start to see more and more different types of alternative finance come into the market, including venture debt, but others, basically basic financing and other forms as well. Having said that, the market is still dominated by equity. I think it's something like 5 % to 10 % of the capital mix of companies raising capital is really alternative or venture debt. Having said that, we sort of look at risk-reward. In Europe in particular, the types of companies that have taken revenue-based financing to date have typically been very, very small.

12:36So earlier stage businesses at sort of seed series A, who have started to win their sort of earlier stage contracts, typically in the software space or some sort of recurring space, have opted to take a little bit of revenue-based financing rather than equity at an early stage to prevent dilution. Now, as the companies have matured and sort of grown up a little bit, they've raised more equity and they've started to look at different types of funding sources, including venture debt, including growth capital, including hybrid capital. And it starts to become more sort of tailored to them as businesses start to become bigger, because the types of financing you start to, or the structures you're starting to put into these businesses, start to work with a specific need of finance.

13:18It's not just, look, I need some capital to extend my runway. Let's sort of sell down 30 % to 40 % of my revenue. We need something for specific purposes, and that's why we'll try and fund these things with pieces of venture debt or close capital or whatever have you. So when it comes to risk-reward, it sort of depends. And I know it's the sort of cop-out answer, but it's not meant to be. I think it depends upon the company. It depends upon the stage. It depends upon what they're trying to finance and also depends upon how much they're trying to finance. Because I guess one of the leaders in what perhaps Benjamin has done in the world has been Pipe.

13:58Pipe has started in the US and has grown and grown and grown and grown, typically in software and recurring revenue businesses. And only recently have they started to go into the world where they're financing post-Series B companies and beyond. So it started very, very early. risk reward i think earlier stage company higher risk irrespective of what product you use late stage companies in theory should be less risk but again you've got to judge that subject to the company and the time i was on my way to pass it to you bailey but then i saw ben shaking his head and nodding a little bit here so i i think i need to bring ben in to give a rebuttal maybe yeah i don't need a rebuttal because in all honesty i'm i'm uh i'm agreeing with what amal is saying companies need a variabilized capital stack and they need to find the right ways of financing for the right thing they need to do and it's true i mean most of these earlier stage companies although just in between brackets i think what we see on our platform today is a way broader range and it really goes up to companies doing tens of millions, not say even hundreds of millions of euros in recurring revenue.

15:13But that's a different topic. They need to take the right type of financing. And for them, as a founder or as an entrepreneur, the only question that you have to ask yourself is what is my best cost of capital? And for anything equity, that's a very difficult calculation to me. What is the cost of capital of taking on a VC that will sit with me for the next seven years. You only say that when you're going to use that capital specifically for long-term investments that will really boost your valuation or whatever sits there. So that's the thing. And I think one of the issues right now is that an entrepreneur sits there, he wants to do stuff and he wants to allocate the capital that he gets in the best way possible, but he only has two options.

16:01So the capital, these seed and Siri A and even Siri B entrepreneurs raise through equity for which they get diluted, they use it for marketing, which is a purely working capital kind of expense, basically, that you can finance in a way better way. And then if you go to the other side of the table, I mean, you being a VC, not knowing, not having the money that you invest in a company of which you became a shareholder, go to marketing expenses is probably not the right way. You'd rather have those guys like work on actual IP because in the long run, that's where you're going to get the value out of.

16:41But if you go in as an investor and you have like the highest, you claim a piece of the top line of those companies that, yes, they're risky. Yes, they're probably still like most of the companies that get financed through our platform are either not yet profitable or just became profitable. So giving money to that type of company is definitely high risk. but if you can claim the highest level of their of their income statement and use that as a collateral for what you're doing the risk goes down and everyone is helped because you you give the entrepreneur a product a financing product that is tailored to what he needs it for and you give the investor something that yes he's giving he's he's financing risky companies but it's de-risked by the way it's designed.

17:35And I think if you ask me where we're going to stand 10 years from now, that's where we're going to be. There's going to be a whole suite of products, a whole suite of different financing products that tailor both the needs of the entrepreneurs. Why will they need this money? And on the other side, tailor the needs of the investors, thinking about, okay, how do we try and balance out risk-rewards? Could I ask you, Bailey, to take us through the business case from the founder's perspective as you see it. And I think if you start up where you're, you know, on your home turf, and then afterwards we can go to Himal and Ben and Gilles to kind of give us the perspectives of the other parts of the non-dilutive instruments.

18:15Sure. So when I was thinking about this from a founder's perspective, from a traditional funding view, I guess most founders have historically only had two options, right? I think you bootstrap. So you potentially use your own capital and you grow very slowly. it's very, very difficult. And, you know, I guess really a tough path to take, but probably that you might, you might come out with a better business model because you're very focused on bottom line, something that scales probably very efficiently and effectively, but it's just going to take a really long time. So that's probably the very traditional piece.

18:46I would argue that, you know, the counter argument to that is that now non-dilutive capital of some sort would really be able to help you grow faster and free up working capital. So exactly what Benjamin was talking about. You know exactly where you want to invest. You know exactly what the ROI is going to be. And non-delete of capital for someone who's bootstrapped is a great option. I think coming back to what Hamill said, the only option most other founders have is to look at equity. And so I was kind of thinking about, you know, what are some of the, I guess, less attractive parts of equity, you know, to be honest, and then how can non-delete of capital kind of counteract those?

19:20And I had a couple. But I think what I'll pick up on is what Benjamin was talking about, is that equity doesn't support working capital or specific investments when you have a clear ROI. It is generally to ensure the business creates more value to attract future funding at a higher valuation, period. And so I think non-dilutive capital, and Benjamin and I are going to agree completely on this, is amazing when you know if you put a dollar in or a pound in, you get two back, you shouldn't be using equity. Heads nodding here, we can agree on that. So I think that's a really interesting way to complement equity for debt and how to have a blended capital stack there.

19:53I think, you know, non-dilutive can also help in a couple other ways. It's less time consuming these days, right? We're hearing equity takes six to 12 months to raise. Most lenders can either get something very, very quickly if it's revenue based, right? Almost instantly or a little bit longer if you're a lender like us, maybe a couple of weeks up to a month to get funding, you know, much probably more time effective than going out to raise equity in this market. a couple other things you know equity comes with the board of directors not only with capital doesn't yes there is a warrant component but we don't sit on boards we don't have voting rights so you are getting a partner that is just on a long-term journey with you with kind of no say or voting in the matter which for an for a founder could be very attractive right your heads down trying to execute on a plan sometimes there's too many cooks in the kitchen so you know we can help with that because we you know we're kind of in the restaurant we're waiting for what's coming out or not necessarily making the sausage there.

20:48So maybe the last one I will just touch on really quickly is the impact to the cap table. So there's a wide span of non-dilutive, I'm putting it in quotes because venture debt is minimally dilutive. So we can touch on that really quickly. Typically venture debt lenders are taking less than 1 % of ownership in a business. So if you think a typical series A takes 15 to 20 % of your cap table and venture debt takes one, that's pretty compelling. So it isn't fully non-dilutive, but it's minimally dilutive. So if you're thinking about cap table management, that's an option. And then you've got, you know, once you kind of can attract working capital, those tend to swap out a warrant for a covenant.

21:25So now you truly are non-dilutive or you look at something like revenue base, which doesn't take a covenant. So I think there's lots of ways that non-dilutive capital can help ease some of the burden of equity, which has historically been the most traditional source of financing. But I do agree with sort of the sentiment in that the group here, which is blended capital stacks are probably the way forward. And we work a lot with VCs to make sure the equity is only used for value accrued investments and potentially moonshots to really push a company forward. And we try to chip away at day-to-day operations, whether that's leaning into supporting inventory or recurring revenue or marketing spend or equipment financing.

22:06We've got everything, but we can all probably agree on this call that's not the best use of very, very expensive equity. I just sort of pick up on a couple of things that you said, but I didn't look broadly agree. I think when we look at things like warrants and trading out a warrant for a covenant again, it all comes back to risk reward, right? It all comes back to, you know, I'm putting a warrant here at an early stage because fundamentally, I need to get paid more for the risk. And you would typically find that businesses that grow to a certain stage, once they're a bit more mature, they can actually service and keep to a covenant.

22:40because that having worked at a bank having worked in a fund where there were covenants and there were no covenants it's one of those things where at the bank i probably weighed for more covenants than anything else because most companies even mature companies could not stick to covenants and they are quite difficult to and can in my experience be pretty difficult and onerous on companies to to to weather so that's why a lot of funds and banks now have sort of resourced the the fact that they'll take warrants on things versus introduce a covenant. That said, again, we talk about blending the cap stack and so on and so forth.

23:18What we do with hybrid capital, which is a relatively newish landscape in Europe, but has been around in the US for many, many years, starting with a piece of credit, we walk into companies offer a loan, and we have the ability to assist that business in putting in a junior piece of capital thereafter, whether it be a convertible loan note to assist and turbocharge the growth of the company, so that they are actually being able to blend debt and equity instruments through one investor. And so this can be quite compelling, especially if you're thinking about risk-reward, because putting in a credit facility first and foremost allows this company to grow with less dilutive capital, should we say.

24:00And then thereafter, just before they're trying to raise equity around, if we have enough conviction and the company's performing and we have KPIs and all that sort of stuff and evidence to suggest that businesses are doing well, they can get a piece of very, very well-priced equity as well into these companies to charge growth. I think going away and simply sort of trying not to avoid equity is probably not the right way companies should be going because equity will be required irrespective in this market. What Himalov, of course, describes here is that they can do both. They have a hybrid in their model.

24:34You building with Lavenue or Platform, how do you typically see the financings come together? Does it come together as a mix where it's then partly Lavenue Capital that comes in? And then at the same time, first or whoever comes in as an equity investor in that same round? Or how's the dynamic working on your platform? It's a very good question. And I think it's very case dependent, right? You can have a bootstrapped entrepreneur that really understands his metrics and is more than happy with just revenue based financing to go and find the growth that he actually sees sitting there. Now, that's an exception.

25:14There's not that many that go that way, that route. Most of the companies on our platform have equity investors on board, have raised money through equity. we don't see that much venture debt because there's a there's a little bit of a of a of an of an overlaying like who who who can claim what at what point what we actually what we really believe in is is for if there's something that we try and do as much as we can towards the entrepreneurs trying to get finance through our platform is telling them guys we're just a very small portion within your capital stack you have to use us for this very specific reason and that's short-term working capital that's what we are good in and there's a whole lot of different players that can help you with the with the other pieces of of your capital stack so that is number one second of all i think 80 of the companies that get financing short platform because we we say no to a lot of companies coming on 80 of those who get financed come send through other types of financiers that is the i think in my opinion the the proof point that people do see us as just in addition to what they've done and it makes sense within within within it within a larger story and maybe to end my my answer on that question yeah it's really cool to have someone who can go into your equity and will also give you some venture debt and might even throw in another type of loan at the end of the things when everything is going well that's fine and i think from an investor's point of view it makes a lot of sense because it gives like it's a big toolbox that you can use and try and get as much as much yield out of an investment of a good relationship so that it makes sense from an investor's point of view from an entrepreneur's point of view, I mean, the cool thing about what we do is we are a marketplace, you will always get connected to the cheapest cost of capital, because there is there is a competitive auction that goes on on your financing.

27:21So from an entrepreneurial point of view, it's probably a less expensive part, like or a less expensive way of doing it. Now, on the other side, I mean, having a relationship with someone who can give you a whole different, an entire scope of different ways of financing is also a benefit because that means you only have one person to talk to and they can help you optimize as good as it is. So I think both models work, but where I see us sitting there is just like this little small niche for the short-term working capital, which is a big issue, by the way, it's a huge market, but it's a super small piece of the capital stack within these types of companies.

28:05We actually have this great saying in our bank when we talk about debt, which I think just maybe sums this up really nicely, is that we want to complement equity, not replace it. I think fundamentally that's where we go into every conversation because it is very often, especially in this environment, we get founders coming to us because they can't raise equity. And that's a very, very different risk profile than complementing a business that has already proven that it can raise equity and has shored up the balance sheet with liquidity to get through this period of time. So that's just really important.

28:35It seems like we're all agreeing on that concept that it's kind of just a short and sweet way to sort of say it. You're 100 % right. I think one of the big issues though, over the last couple of years, there was so much equity capital available that it became in a lot of entrepreneurial mindsets, it became the way to go. And people didn't think about it was basically so easy to raise so much money through equity that people didn't think about how do I diversify my capital stack? How do I choose the right financing for the right thing that I want to do with the money that I'm raising? And that is changing right now.

29:13So I think if there's something we should all do is go out there and tell entrepreneurs and people working in the finance departments of all these growing companies is exactly this. Guys, think about where you're getting it. I fully agree with that point as well. And I think the follow-on point to make is that equity markets, whether it be venture capital or private equity, have evolved tremendously over the last 20, 30 years. Unfortunately, venture debt has not. And that's why you have things like alternatives like RBF, you have hybrid capital, et cetera, where it's not the same thing over and over and over again, where they're trying to fit their square product into your round hole versus what an entrepreneur nowadays requires in Europe is something different, something that works with their cash flow or their revenue makeup, something that tailors a piece of funding that is different to equity to their business model for them to grow.

30:09And you have it in the US, and this is why a lot of the issues in Europe stem from creativity, but also having investors like Gilles and hands off for you to back alternatives like RBF and some of our investors who have backed hybrid capital who are willing to do something new and go into these products that will ultimately, I think, win in a long term. But it is something, Hamada, is changing really quickly. It is. The number of blue chip banks that I've seen in the last four weeks is just impressive. And they're all understanding this And they're all seeing that from their way of looking at things or the way they're connected to their end clients, the ones look, the companies looking for financing, there is just too much opacity within that process.

31:02So the reason why those guys are interested in what people like us are doing is because they see the need, but they're still they're thinking about, like, how are we going to get there and what's the best way for us to do it? Having people like Gilles who basically show them the light, telling them, guys, it's doable, this works, is indeed a heads up for Gilles and people like Gilles. One of our pioneering mission at EUVC is getting more capital to our ecosystem. And I think Benjamin just made a small commercial for you here. What do you say when you say to your clients and to your partners and so on, when you talk about RBF and debt financing to the more startup ecosystem?