Securing initial capital to fund loans is the critical first step toward scaling a specialty finance company. Here’s a look at how these firms navigate their initial financing stages:
Stage 1: Equity Capital
The journey often begins with founders raising a few million dollars in equity capital. This capital infusion primarily supports the development of a tech platform, operational framework, and the establishment of borrower acquisition channels. Importantly, a portion of these funds is sometimes earmarked to fund the initial origination of loans or advances, though we’ll see an alternative shortly.
Stage 2: Unsecured Promissory Notes
In addition to (or instead of) using equity capital, some firms opt to use unsecured promissory notes to fund the first cohorts of origination volume. While these notes typically have “high” interest rates, it is often seen as cheaper than giving up equity. These unsecured notes typically come with fixed rates, around 12% per annum and are typically funded by close “friends and family” of the firm or angel investors using boiler plate or lightly modified templates.
Stage 3: Small Institutional Credit Facility
As the firm proves it can originate its product and can begin to show off the beginning of a performance track record, it is now able to seek its first institutional credit facility. This stage is the earliest in which Pier typically gets involved. These facilities, usually around $10 million in size, require more sophisticated financing mechanisms to be put in place, such as the establishment of a bankruptcy remote SPV to manage and hold the loan portfolio. Successfully operating this $10 million facility shows the broader capital markets that the firm has the compliance environment and acumen to operate a facility at scale.
Stage 4: Scaling with Larger Credit Institutions
With a proven track record and a loan book exceeding $10 million, early-stage originators can attract larger credit institutions. These institutions offer credit facilities upwards of $50 million, characterized by longer terms and lower costs of capital compared to the earlier stages. This transition allows firms to scale operations and funding volumes significantly. Ambitious teams may be able to get a term sheet from one of these larger funds back in Stage 3. But, if a firm pursues this option too early, it could get caught unprepared for the long lock up, hefty equity warrant requirements, draw down fees, unused line fees, and significant legal fees.
Alternative Approaches: Internal Funds
While some originators may consider forming internal funds to finance their loan products, aiming for lower capital costs, this path is fraught with regulatory and compliance complexities. Navigating these hurdles demands considerable expertise and resources, often making it a risky option for early-stage firms.
Final Notes
The most common misstep I see is when a firm takes on too much complexity too early in its life and skips steps to fast track the process. While the temptation to do so is appealing when chasing growth, complexity has a cost and shortcuts rarely work in building a scalable and successful specialty finance company.
- Jillian
The music industry as a whole has grown 7.7% per year over the last decade and is expected to continue at 7.6% annually for the next 6 years.
Within the industry, recorded music has grown at 7.6% for the last decade, and is expected to grow at 8.1% for the next 6.
Within recorded music, total number of streams is projected to grow at 10%. Spotify's monthly active users grew 14% last quarter.
Country music is expected to be the largest music genre globally by 2030. Country music streaming grew 23.5% in 2023.
Revenue per stream has actually been shrinking. Streaming video on demand subscription pricing has grown at ~7.5% annually for a decade, while music has not. However, Spotify just announced it will be increasing pricing in a variety of its services. Also, Spotify's revenue per user grew 8% last quarter. Streaming revenue has upside potential.
The amount that an artist takes out of each stream is increasing as well. Every challenge and lawsuit we've seen recently has been in favor of artists. Spotify announced changes recently that will favor revenue sharing going away from the tiny artists and fraud (eg. no payment for <1k streams / 12 mo).
You know what gets me excited? Buying music royalty catalogs modeled to mid-teen unlevered yields, while assuming a 2% degradation rate annually.
Reach out if you want to learn more.
- Conor
