Waves of B2B Alternative Lending and What’s Next

Originally published February 22, 2022

A lot has happened since my last blog post, Women of Color in Fintech including me moving back to NYC from London, starting my last semester at Columbia, and pouring every single free minute of my life into finding a job at a fintech venture fund.

I was out at a CBS Matters presentation (Columbia tradition where students share their life journey, check it out if you’re not familiar) and one of my favorite classmates asked me, “when is the next Michelle Unplugged coming out?” and then I realized 1) people actually read my blog (which made me really happy) and 2) it’s been a minute since I last posted -__-. I promise haven’t been idly sitting around. Most of my brainpower has gone to 48-hour investment case memo turnarounds and working on a Forbes piece doing a comparative analysis between the US and UK’s fintech ecosystem system (more to come here).

So here I am writing on a space that I am deeply interested in and excited to invest in. I’ll dive into the B2B alternative lending market opportunity, a historical overview and what went wrong, trends I’m seeing in the market, and my bets for the future.

When I was first learning about lending and access to capital, it didn’t make sense to me why banks and traditional financial institutions (FI) would lend to some but not others even when they both had profitable businesses. As I dug deeper, I learned it was because banks and FIs are afraid of what they don’t know and don’t fully understand how to underwrite business models outside of the traditional lending models like brick-and-mortar businesses and mortgage loans.

However, the intersection of emergent fintech infrastructure, market demand, and regulatory arbitrage have created optimal conditions for innovation within the alternative lending space to allow for the unlocking of capital for customers not serviced by traditional banking and lending institutions. With a market that is forecasted to grow globally to $401.7B in the next three years with the US as the second biggest region, the alternative lending space is positioned to further leverage the increased transparency that APIs have brought to consumer fintech companies and their deep understanding of non-traditional business models to continue to provide value to their customers.

THE QUESTION THAT KEEPS COMING TO MIND IS — WHEN ASSESSING CUSTOMER CREDITWORTHINESS, ARE THERE STRATEGIES OR KEYS THAT MORE READILY UNLOCK CAPITAL THAN OTHERS?

WAVES OF ALTERNATIVE LENDING

FIRST WAVE: ONLINE BUSINESS LENDING

The first wave of alternative lending was led by OnDeck Capital and Kabbage who provided online business lending (OBL) for small businesses. Founded respectively in 2006 and 2009, they were lauded as the online lending solution for small business owners to access capital and grow their business. However, they eventually both failed miserably selling OnDeck for $90M (2020) when at the time of its IPO was valued at $1.5B and Kabbage was acquired by American Express for $850M (2020) and was previously valued at $1.2B.

There are 4 reasons I’ve identified that OnDeck and Kabbage took the slippery slope from glory to doom.

1. Relied on debt markets as a source of liquidity: This was challenging because COVID made it difficult to value and sell their loans. During the first part of the pandemic, OBL volume increased significantly forcing OnDeck and Kabbage to cut costs and assume more debt to maintain operations and originate loans.
2. Dependent on payment collection as the main source of revenue generation: Early on in the pandemic when the world was still in shambles, there was high loan forbearance and delinquency from customers that negatively impacted revenue and dried out their cash flow.
3. Revenue dependent on new loan issuance: In early March of 2020 loan issuance dried up and while government support in the form of PPP loans provided temporary relief, it wasn’t enough for OnDeck and Kabbage to bounce back due to pre-existing leverage. It is interesting to note that Kabbage was able to pivot during the pandemic to handling PPP SBA loans which helped alleviate loan origination challenges.
4. Point solution: Both businesses only offered online business lending as their solo solution and didn’t have a diverse product offering of embedded financial products. This impacted their ability to diversify revenue streams and increase stickiness for their clients. Pre-pandemic, OnDeck had plans to apply for a bank charter to diversify its offerings but this never came to fruition

SECOND WAVE: LENDING BASED ON BUSINESS MODEL

The second wave of alternative lending has been led by companies like Capchase and Pipe that are using alternative data from traditional lenders like recurring revenue to upfront cash flow to B2B SaaS companies for the purpose of paying for short term expenses to grow their business instead of giving away equity to access capital. A clear understanding of their customer’s B2B SaaS business model coupled with a focus on different inputs enables Capchase and Pipe to unlock capital for an unserved market.

Capchase and Pipe are two similar companies that are increasing access to capital for their customers in two completely different ways. Capchase underwrites the cash advance by taking the debt on their balance sheet and controls the decision-making process and transaction. Pipe on the other hand is a marketplace for businesses to connect with institutional partners to access capital and third-party capital providers underwrite the loan. I love the Pipe business model because it doesn’t raise debt to provide their customers capital, spreads risks among external partners, and if there are issues with the business, they can quickly isolate and remove the bad actors instead of repeating the case of Greensill Capital.

Both these companies see their customer’s cash from recurring revenue very similarly to a fixed asset that provides stable, predictable cash flows available in the future. Traditional lending institutions are not knowledgeable on how to price the risk associated with these new business models and don’t believe the market is large enough to warrant inspection — a huge, missed opportunity.

THIRD WAVE: VERTICALIZED LENDING SOLUTIONS

The third wave is focused on a verticalized approach to lending and using industry-specific knowledge to unlock funds. Two of the companies that I found impressive that are having success with an industry-specific approach are Nophin and Vero Technologies.

Nophin is a seed-stage revenue-generating company I met over the summer that is a neobank for residential landlords that provides Nophin Advance, a solution to quickly access their customer’s full lease income upfront. The current solution on the market is a home equity line of credit (HELOC) that is a lengthy process and is extremely costly, carrying a 2–5% closing cost plus a variable interest rate. By understanding the residential rental vertical, Nophin is providing an efficient solution to access capital and helping solve their clients’ rent management and accounting needs.

Another company that is providing a verticalized approach to alternative lending is Vero Technologies (Series A) which provides inventory financing for auto dealerships by customizing the underwriting process. Currently, traditional lenders are not able to offer floor plan financing because of its complexity, and they fail to adequately analyze the opportunity, leaving it to specialized-antiqued auto financing companies. Through Vero’s deep industry knowledge, they are able to accurately underwrite auto dealerships and leverage technology to streamline accessing capital for their customers.

A paradigm shift is occurring, and this shift is being reflected in innovative practices and approaches. Today’s keys to unlocking capital appear to reside in an approach that opens the playing field to customers by looking at new data points instead of a traditional, generalized, one size fits all strategy.

I’m thinking of doing a company breakdown on Pipe, digging into its business model, looking into its financial performance, and speaking with its founders and investors. Let me know if you would find it useful!