In recent years, it has become more and more apparent that our investing activity is impacted by what’s going on in the VC market. We’ve found that having two distinct deal types for the majority of our transactions has allowed us to stay active through all VC market environments since the inception of Pier. As a reminder, we 1) provide credit facilities to specialty finance originators who use our capital to make loans/advances/other contractual cash flows and 2) purchase portfolios of loans in the secondary market from stressed sellers.
I’ll share a bit about how the VC market is impacting us today. There is clearly a lack of funding from VCs for post Series A fintech originators who have battle scars from 2020 – 2022. Whether it was a significant drop in origination volume due to all the stimulus money, or performance issues as stimulus wore off, there is a cohort of fintech firms who aren’t going to make it. We continue to see these firms struggle for liquidity, sell off assets and even shut down entirely. When turbulence hits, we are there to bid on the company’s loan book. Last year, we participated in a few small deals. Several portfolios were too big for us, but we’re in the hunt on many of them and expect to win several more in 2024. In our view, the pain is far from over…which means deal flow should be plentiful in 2024.
On the flip side, we see equity capital flowing into fresh, early stage companies who don’t have any COVID era baggage. The loan originators are in need of credit facilities and we have a deep pipeline of deal flow here. With a new pile of equity capital, these loan originators are in a strong position to provide the first loss capital and financial covenants required for our credit facilities. We expect VC capital to continue to flow throughout 2024. We have doubled our efforts of building relationships with early stage fintech VCs and see a lot of deal flow from them.
If you’re one of our VC friends reading this, we’re grateful for you!
And lastly, I would be remiss to not acknowledge that we often work with loan originators who aren’t funded by traditional VC capital. Low burn (or no burn) and slower growth specialty finance firms are attractive to work with for obvious reasons. We try to diversify as much as possible – and it’s beneficial to face borrowers who have different sources of capitalization.
-Jillian
When we provide a credit facility to loan originators, our loan is backed by a portfolio of loans that they originate. In order to cleanly segregate those assets from the company itself, our borrower creates a new special purpose vehicle (SPV) that holds those loans outright. We then provide debt to that vehicle. This vehicle is the subsidiary, the main operating company is the parent.
An important feature of this structure is bankruptcy remoteness. The goal of this structure is to ensure our assets are protected from any creditors or claims on the parent in the event of bankruptcy. We don't want creditors of the parent coming after our assets (the loan portfolio). Generally speaking, bankruptcy means there are more liabilities than assets, so if our facility gets mixed up in that, we run the risk of not getting back the full amount we lent.
To ensure bankruptcy remoteness, the SPV needs to truly be distinct from the Parent. And as a subsidiary entity, the remoteness could be challenged in a bankruptcy court. In the end, it's a facts and circumstances decision to be made by the bankruptcy judge. While there is a large number of expensive solutions to help support bankruptcy remoteness, there are several less expensive tools that we employ. Here are a few of those tools that we have implemented or adjusted recently:
- Independent Director - We recently added an independent director to new deal SPV's, providing third party oversight that shows remoteness.
- Limited Parent Guarantee - We used to require a full guarantee by the parent but have been guided that anything more than 10% could threaten bankruptcy remoteness.
- Servicing Agreement - Clear segregation of duties and contractual obligations between entities helps clarify entities roles.
Optimizing these tools for cost and effectiveness is critical in our efforts to provide sub $15M credit facilities to outstanding loan originators.
- Conor
