Every fintech founder knows they have to raise equity. Often overlooked is the true fuel of a lending business: debt. The wrong debt deal can cost millions of dollars, compromise profitability, and thwart growth. On today's episode, Shawn receives a primer on debt deals from Rich Davis, co-chair of the asset-based lending practice at Paul Hastings, and Mike Armstrong, co-founder of Ensemblex. They discuss deal terms to watch out for, deal sizes and different providers, and the state of the market. Lenders and non-lenders alike will also benefit from Paul and Mike's perspective on leadership (stop telling people what to do), tenacity (you mostly survive suffering), and managing business relationships (speak up when it gets sour.)
Find Rich, Mike, and Ensemblex on LinkedIn.
Hosted by: Shawn Budde
Guests: Rich Davis and Mike Armstrong
Produced by: Meagan LeBlanc
Theme Music by: Brad Frank
Shawn
Hello, this is Shawn Budde of Ensemblex and this is The Ensemblex Exchange Podcast. Today I'm talking with Rich Davis of Paul Hastings and our own Mike Armstrong about the environment for structured credit and how it has changed over the last decade. Rich Davis is a partner at Paul Hastings and co-chair of the firm's asset-based lending practice. With his team, he specializes in specialty lending with a heavy emphasis in recent years on representing fintech originators and lenders to fintech originators, in bankruptcy remote warehouse facilities, corporate loans and forward flow and similar leverage transactions. Over the last four years, his team has handled about 50 of those types of deals a year, representing approximately 125 separate specialty finance companies in varying asset classes with maturity ranging from those just starting out, say Series A, to venture-backed, fintechs and public companies. Welcome, Rich.
Rich
Thank you. Great to be here.
Shawn
And Mike Armstrong is my co-founder at Ensemblex. Mike and I first worked together 25 years ago at Capital One and then again at ZestAI. Mike went to Duke for his BA and began his career as a U.S. Army Ranger. Mike has spent the last two years actively involved with the credit card business that we helped to launch, and that included leading the effort to secure debt facilities. Welcome, Mike.
Mike
Thanks, Shawn.
Shawn
So interestingly, you both spent some time in the Army. Mike as a Ranger. What was your role, Rich?
Rich
I started as an artilleryman, as an enlisted national guardsman, because I wanted to go to basic training, but then as an officer, I was in military intelligence. So Mike's going to win the push-up contest, undoubtedly, on this podcast.
Mike
You wanted to go to basic training?
Rich
I did. It was great. It was fantastic. You get paid to exercise. As much food as you want, it’s great.
Mike
I guess that's one spin on it.
Shawn
Yeah, so I'm curious, is there an interesting experience you had in the Army? And let's make sure that we keep that a PG kind of experience.
Rich
Well, Mike, you go first.
Mike
No, I want to hear yours.
Rich
Well, I had many interesting experiences in the Army. I ended up as an officer, I was a military intelligence officer and ended up leading a team of counterintelligence agents doing strategic counterintelligence for the Army, which is an odd role because it was in the domestic United States and with no law enforcement powers, but the responsibility to try to ferret out spies within the you know, Department of Defense and the Department of the Army. So I have a lot of interesting stories, many of them I can't talk about even many, many years later. The thing that probably happened for me that was the most interesting is one, the Army taught me that suffering is okay and mostly you survive it. Second, I was in the Army and the Army has a lot of meetings and it's very bureaucratic and I got bored and one day and on a whim decided to apply to graduate school and applied to a few, took the tests because the Army paid for them and decided whichever one I got into first, I would go to at night. And that happened to be law school. So I went to law school at night while I was in the Army. And then through some quirk of fate, here I am 25 years later, maybe 30 years later, almost now. So that for me, the Army was very formative in the sense that it both, you know, taught me a lot of really interesting lessons and gave me very interesting experiences, especially doing counterintelligence, but also then set me up for the future career of being a lawyer.
Shawn
Does that suggest that you could have just as easily been a doctor?
Rich
No, absolutely not. Yeah, I'm not smart enough to do that. I'm amazed that I'm a lawyer, right? To be honest, I still wake up and wonder what happened, but don't tell anybody that. I just try to sound confident when I talk.
Shawn
Okay, it'll be our secret. And Mike?
Mike
I served in a peacetime Army from 1994 to 1998. So did a whole bunch of training, leading troops. We blew a bunch of stuff up. First time I fired an M1A1 Abrams tank, I thought the whole world had exploded. Yeah, no, there's a whole bunch of people that have served our country in really faraway places with different campaigns. Certainly since I got out in 1998. My experience, we were the nation's high alert force. It was a brigade task force. Our unit was part of it. I get a call on Thursday at about 6 PM. A couple of Iraqi generals had defected to Jordan. They triggered the high alert. We were called to deploy. All our bags were packed, ready to go. Within 60 hours, we were in Kuwait. And mind you, it takes about 27 hours to get to Kuwait from Fort Hood, Texas. So, they made me the commander of the plane, which at the time I thought sucked because I didn't want any more responsibilities, but the commander of the plane got to determine the seat assignment. And so we flew out in a chartered 747, Boeing 747, and I sat in the Captain Kirk seat in the nose, the first class seat with some of my buddies. And we put all the senior officers up top in the bubble and had a pretty good ride out to Kuwait.
Shawn
Very nice. All right, well, to transition a little bit, I'm curious, what lessons do you take from the Army that you think still apply to what you're doing today? Mike?
Mike
Yeah, I think look, the two lessons I learned, I learned from my father. My father was a career Army officer. You know, some families talk about sports at the dinner table. Some families talk about politics, some families, I'm sure talk about business, my family talked about leadership. And my father taught me two leadership lessons, one, always set the example, always. And the second was, if you take care of the people who work for you, you don't have to worry about taking care of yourself. They'll do a much better job of that for you. And so when I went into the Army, I didn't quite know what to expect, but I was delighted to learn that it was an environment where I could do just that. You know, I think a lot of folks look at the military and they think that, you know, it's about just telling people what to do. And for me, that wasn't the leadership I served under and that certainly wasn't my leadership. I think what we did a really good job of was training our people to be able to handle specific situations and missions. I think that's really important in the Army. I've certainly taken that into my civilian career. Competence matters, right? But the other is, I hate to tell people what to do. What I want to share is a vision and I want to share what we call in the Army, commander's intent. And with really talented people that have the support that they need to do a job well, they'll take that and they'll run with it and they'll amaze you with their ingenuity and creativity, in the military marching towards the objective, and in the civilian world accomplishing the intended business results.
Shawn
That's great. Thank you, Rich?
Rich
The Army and the officer corps and the non-commissioned officer corps is very leadership focused. And so it's, it is interesting. I think you get a lot of grounding in general leadership theory and practice. It's always been interesting to me and maybe more in hindsight than it was at the time. Because you wouldn't think in an organization where people are required to follow orders that training leaders, how to get people to follow those orders is that important. But, if you think of the scenario, luckily I was never in it and hope none of our soldiers ever are, but you know, you have to charge up the hill with your troops behind you against a fortified machine gun nest where they're firing at you. There's a lot of leadership that goes into getting those people to follow you. And so I very much second what Mike said that leadership in general and the notions of leadership and how you apply that in different circumstances was 100% the most of what I learned. There were some very specific lessons that I learned also, and they're maybe more fragmented, but they still come back today during certain times of my life. For instance, a 50-mile road march, right, where you haven't slept for a couple of days and everybody, you know, depending on what school you're in with the Army, the goal of the instructors is to try to get you to quit. The easiest way to see who is willing to do the work and to stay in and get, you know, have the fortitude to do what needs to be done is to, you know, you're on a 50 mile road march, you haven't slept, you've got 60 pounds on your back and a, you know, a lot of blisters, and they drive a truck by that has warm food that you can smell and you haven't ate either. And they say, just get in. All you gotta do is get in. And I really wanted to get in. I still think about that today over and over. I'd have a bunch of times, Mike, you probably did too. I would really love to get in that truck. That sounded great. And then you'd like twist your ankle or hurt your knee. And they'd say, good, get in the truck. It's fine. And I never got in. And so there are a lot of times today where we do a lot of very difficult deals. We don't get a lot of sleep sometimes. And I just think to myself, this is better than that, right? I didn't get in the truck then, so I'm not gonna get in the truck now. Those lessons very much still apply that I learned back that many years ago.
Shawn
Beautiful. Okay, so let's talk about why debt matters. So one of the things I like to say is that if you're in the lending business, then you're also in the borrowing business. And I think a lot of people understand that they're gonna have to go raise equity, but they don't really understand that they're gonna have to go raise debt. And that can be about as hard, maybe even harder in many cases as the equity side. So, Mike, maybe you can kind of just lead us off, like, why is that strategically important for a fintech?
Mike
Sure, so just for some baseline knowledge setting, so when a lender makes loans, whether it's a credit card transaction or an actual installment loan where the whole loan is funded to a customer's account, they don't want to fund that loan with their equity. Equity is really expensive. It's ownership in the company. It's your most expensive form of capital, of course.
And so look, they look for more attractive, less expensive and sort of higher capacity, meaning bigger dollar sums of funding of capital to fund those loans. And the avenue that's opened up for early fintechs is to engage in the capital markets on the debt funding side. And so that's the why.
Now for a while, there was so much equity sloshing around fintechs, say from, I don't know, 2017 to 2000 through 2021 for sure. There are a lot of fintechs who didn't need to raise debt equity at first because they were able to raise so much money in their initial rounds that they actually funded the loan portfolio with their equity. But very soon, if successful, their growth would require them to find a different capital source other than equity, and that's why they would look to the capital debt market. So look, it's, I think, analogous to an airline. An airline can't run without fuel, and the fuel for a lender is debt capital, for sure.
Shawn
Yeah. And so just to make sure folks understand some of the kind of key terms here there's obviously interest rate. People think a lot about interest rate. But to your point on equity, you want to conserve as much equity as possible. And so the other term that people think about is advance rate, you know, and that's basically for every hundred dollars I lend out, how much of that do I get from my lender versus how much of that do I have to put in? And then I think the third thing is just covenants. Covenants are basically the terms under which the lender gets to come after you if you don't behave. We've found a lot of times the borrowers don't think much about the covenants. They're like, yeah, that all sounds good. So Rich, I'd love your thoughts on that. Is that consistent with what you see and what are some common mistakes that you see fintech founders make?
Rich
Yeah, and I might not even call them mistakes as much as I would call them circumstances that some founders find themselves in because they're not well grounded in the market and they maybe haven't been well advised. So, and the fintechs we work with are almost exclusively, I think, originators of some type of financial asset, right? So they're, as Mike was talking about, they're selling money. So it is a capital intensive business because the inventory you have and that you're selling is the dollars. The lenders in that market and they're by our measure and we're pretty close to the lender side of the market because we have so many clients that need capital from them, so we try to stay close to the lenders as well. In the fintech funding market in the US, there are about 40 lenders that are active, generally.
They go all the way from very large hedge funds, Fortress, Ares, those types of funds, credit funds, all the way to very small credit funds that instead of a $200 million debt deal, they're looking for a $10 million debt deal at a corresponding premium, right? High pricing. And then you also have, you know, a number of very active banks all the way from JP Morgan to Goldman Sachs who are looking for the same type of exposure. The banks are looking for something a little different than the credit funds are looking for. The credit funds are typically looking to create a pipeline of assets that they can lend against and earn from for a long period of time. For them, it's assets under management. That's how they get paid. And they're being paid by investors to deploy those funds. In the bank market, it's somewhat different. The bank market, especially the big bank market, is typically looking for originators that they believe will graduate to the capital markets. Because when they graduate to the capital markets, the banks can earn underwriting fees for the securitizations, for the IPOs. And so really they view that as an early stage, they can both deploy money profitably, put their balance sheet to work, but really then they can do what they love to do, which is earn fees from providing financial services to customers.
And so very often with the banks, you'll see the banks at the point the company is mature enough to be in that market, you'll see the banks come in and say, I'll give you a $200 million loan, a warehouse loan, but I also want you to agree to mandate me as your lead arranger on your first securitization or maybe your first five securitizations. To get to the point of the question, sorry, I'm being long-winded. Because the deals tend to be complex. Most of these deals are structured as bankruptcy remote transactions, which requires a lot of structuring and a lot of legal costs. There is a tendency, because the lenders push this, for founders to become seduced with structure. It's cool to say to your friends at the bar after work that I just did a $100 million warehouse facility.
It's not cool when you have to write a check for a million dollars of legal fees to put that in place. And so what we always say to founders is let's look at the spectrum of what you could do. If you're sitting in a bar and somebody says, write your name on this napkin and write, I'll pay you back the $10 million you're gonna lend me. And they'll give you a check for $10 million. That's the best deal you wanna do. Do that deal first, right? You don't have to pay me anything to do that.
And then we move down the spectrum from a 10 page promissory note. That's pretty good too. It doesn't cost me much to look at that, even if you want me to. And all the way at the other end of the spectrum is the seduction with structuring where you pay the million dollars in legal fees and that's the bankruptcy remote warehouse. When you get into that world, which is what a lot of lenders in this market want, you really have to look at the time and effort and cost of putting that in place and making sure when you amortize that over the size of deal and the time you will have the deal in place and be able to use that capital to grow the business, that it makes sense to do it. And if it doesn't, you should keep looking for capital because, ideally you start with the IOU and the bar on a napkin and you use equity plus that kind of very easy capital, debt capital first, and then as you've grown it big enough where you can move past the most expensive and complex and smallest lenders in the warehouse funding market to the bigger ones, that's where you can start to see the return on investment from that type of heavily structured vehicle.
Shawn
Yeah, so just round numbers. If I start with 10 million, when do I graduate into the Fortress, Ares category? When do I graduate into the banks and when do I graduate into securitization?
Rich
Yeah, it's interesting. Well, Mike, do you want to take that one?
Mike
Yeah, I think that answer is it depends on the market conditions. We were starting a new installment loan business in 2015 and one of the large hedge funds gave us $150 million facility, right? They were going to charge us a really healthy mid-teens coupon and take a very healthy chunk of warrants. And warrants are sort of essentially options that allow that lender to participate in the equity if they so choose to exercise them. And so look, that was a huge facility. It was structured in some phases, but the upside for us was we had big ambitions to grow the business and we had found our lender. And it was tiered such that, the first level, I forget what it was, maybe say 20 million was priced at X and, you know, the pricing improved as the portfolio grew and performance was demonstrated. But it was very expensive. I mean, giving away warrants and equity is very expensive and the coupon wasn't cheap either. I think now, I don't think you can skip any steps. I think the graduation is you start with people want to see some level of performance before they even want to give you any kind of line. That's not absolute truth, but if you had some equity where you could book a few, two, $3 million and demonstrate that performance, that's going to give you a pretty good tailwind going into your first round of conversations with potential lenders.
If you don't have that, you don't have anything booked, then it's going to be determined by what's the strength of your idea. What's the strength of your reputation and what's the strength of how you show up in conversations with lenders and maybe some of the network of introductions and references that they have. And so that graduation would look like, you know, we started a credit card company. We launched it in Q3 of 2022. We found an initial credit facility.
It was a $30 million facility. We negotiated fantastic terms. This is a super prime credit card product. We got to 90% advance rate, which was, I think, market leading. Rich can correct me on that at the time. The pricing, we got them to cap prime plus a margin, and that was fantastic, because prime went up, I don't know what, seven or eight points after we signed the deal, or six points at least and so the thought there is we fill out that initial 30 million. We pay careful attention when we strike that deal of what would it take to refinance. And, you know, so I'd say from a lesson learned, a mistake that I see people out there, one, they don't know exactly what they're looking for. And two, in terms of what is their portfolio need? What's the size? What do they need now? What do need a year from now? And how are they going to graduate?
But they also don't understand the specific terms of, you know, around flexibility. If they want to refinance out, how much will it cost them? Are they locked into? Is there a non-call provision in the deal such that you can't bring in another lender for a particular point in time? So I think those are all things that founders and, you know, the people performing the capital markets role at fintech startups need to pay attention to. But in our case, look, we started with a 30 million facility. The vision was we'll get to 30 million and then we'll get a bank interested in us. And then that bank will give us a facility of up to, you know, a hundred, $200 million. And once you have, if you have a warehouse line where you can get up to $200 million, well, as soon as you have that bundle of 200 million, then you can access the securitization market as part of the capital markets. And you can securitize that portfolio. And as you graduate from each one of those steps from the initial facility of 30 million to the bank, to securitization, your pricing improves and your advance rates improves. And so it's not just graduating in the size of the facility, but the economic terms for the business also improve. And I'd say, you know, in the fintech capital markets, you know, frothy environment from 2018 to 2022, there are lenders that could skip steps. There were banks that would be interested depending upon the founder, depending upon the idea, they'd, they'd give an initial facility, they would structure it, I'm sure. But they give an initial facility these days, big banks, they don't want to waste their time on any lender that's not proven because they've been burned so often. It's a lot of work on their end too, to set up a facility and they're constrained by the same 24 hour day that the rest of us are on. They want to make sure they're spending their time on things they're actually going to pay out for them. So, you know, what I've seen in the market and heard is look, they really want you to have a 30, 40, more like $50 million portfolio before they really want to talk to you. And they want to see the capacity on the loan origination side that the portfolio can grow from there and that the economics, particularly the first unit economics, are you making money on each loan? Is that profitable? And then what's the overall viability of the company?
Shawn
So Rich, Mike touched on it a little bit, but I mentioned there's the coupon, there's the advance rate, there's the covenants. What are the other terms, in essence, it's weird to think, I guess it's kind of a prenup, right? It's weird to think about how I'm gonna get out of this debt deal before I've even gotten into it. But that's a term that I think a lot of people overlook. Like what is it that they have to watch out for?
Rich
Yeah, and it's in some ways from my perspective negotiating these deals, some of those terms are the hardest terms we negotiate. We've had a number of deals where we may be done with the documents after three months, but it'll take us another month just to finalize the negotiations around what a lot of people call the exclusivity requirements. And that tends to go hand in hand with right of first refusals, those types of provisions. So as Mike said, as the platform matures, your funding costs will naturally go down. That's the virtuous cycle, assuming the business performs well. So the lender in the first deal, let's say it's a mid-sized credit fund in today's market, a mid-teens coupon probably, that lender knows that within six months using their capital, you're going to outgrow them and you're going to kick them to the curb unless they keep you from doing it in their documents. And so, and the lenders know this. And so their intention, because as Mike said, it is from their perspective, these are hard, there's a lot of analytics that go into putting these in place and there's a lot of work and they can only do so many deals a year. And so they're going to want a certain amount of time with assets under management where they can earn on those assets before you kick them out.
So the lenders tend to focus, there's three things that really are hard to negotiate besides the economics. One is what is the tenor of the deal? So from my perspective, if you're doing your first deal in fintech, most of the time, the perfect, for most types of companies, the perfect tenor is about an 18 month to two year deal. That gives you enough time to earn back all the fees you paid and time you put in upfront to do it, but it's not so long, at about 18 months in my experience, you know, over kind of hundreds of companies like this, at about 18 months, you're at an inflection point where you can move to a different tier of lower cost capital provider. And so what the lenders will try to do is they will come in and say, well, I'll take all the risk with you in the early days, but I need a four year deal, right? And so, if we assume that I'm right or in the ballpark of right, that 18 months is about the time you hit that inflection point, you're giving them at a pretty high price, another two, two and a half years of more than you would otherwise have to pay if you give them that type of long tenor. So sometimes, you know, the way to negotiate that is to say, no, I only want two years. If the lender won't do that, the other way you can negotiate that is to say, I'll give you two years, but after two years, you're gonna have to drop the interest rate, because my business will have outgrown you. So you can try to reprice it upfront in the documents. So that's one thing.
The other two things go together. ROFR, right of first refusal and exclusivity. Same idea, the lender says, and this is very prevalent among the lenders, that let's say, just to pick an example, Fortress. Fortress is a lender that might start relatively early at a higher price, but because they're a very large credit fund, they have buckets of money they can pull from at lower cost. So they can grow with you all the way from early days, all the way to almost the point where you're in the bank market at a lower cost. So what a firm like that will say is, okay, I'll do your first deal, but over the next, either the term of the deal or over the next three years or whatever's negotiated, I want the right to match any other offer that you get from another lender so that you can't replace me without me having me having a say so. So in some ways, that's a very efficient mechanism for a borrower because if they match the other guy's prices, then you're in the same spot. The downside of that type of ROFR is that there comes a point in the company's life cycle where funding diversity becomes important. You're never gonna have it in the early days because you'll have one debt lender, you don't have enough origination volume to have more.
But at the point where you can have two, sometimes having two is a good choice. If they have a ROFR, it might be that you keep them in for another couple of years and you wait to get that diversification until you're four. But the reason you need the diversification is if one of those facilities blows up, having another one can save your business and you make sure they don't cross default to each other. The final point is exclusivity. The lender will say along the same lines, all of your eligible assets have to be put into my facility and financed with me until I am full or almost full. And the reason they do that is again, the minute you hit six months in, you'll just take your assets and finance them with their friend down the street who will do it at a much lower cost and a cost that they can't match with their ROFR. So they're trying to stop you and ensure that if the business is successful originating good assets, they're gonna get those assets in and they're gonna be financing them.
Those can become very tricky provisions because, let's put ourselves in the perspective of a venture capital funded fintech. When you're a venture capital funded fintech, you have to grow. It is imperative. That's what your equity, the equity dollars are there for. If you get too tied into a lender with ROFR and exclusivity and the lender says, I really love your business, but I'm only willing to fund products that meet this very narrow criteria your growth mandate from your equity might require you to be outside of that criteria. And so you have to be very careful not to be too locked into a lender and to their box because you may need to grow, you may have great opportunities to grow the business in a place where there is a risk profile that that lender does not like. And you can't give up your ability to do that, otherwise you'll never raise your next round of equity.
Shawn
Yeah, so there's one other term, Mike, that I became familiar with when we were doing this for the credit card business two years ago, the MOIC. Can you explain what that is and why someone should care about it?
Mike
Rich, what the acronym is it minimum on invested capital? Is that what it stands?
Rich
Yeah, Multiple on Invested Capital.
Mike
Yeah, so a MOIC was introduced to us in our term sheet. We didn't know what it was. So we asked people, including Rich, what is this? It's a term that the lender puts in so that if you do refinance them before the facility terms out, before it expires, that they get paid. Do I have that right, Rich?
Rich
Yep, that's exactly right. It'll be something like, if you prepay us before the end of the term, no, even if you prepay us at the end of the term, you guarantee that we will earn a multiple on our invested capital of say 1.4, right? So depending on your interest rate and depending on the term of the deal, you may meet that naturally depending on your originations, but you may not, in which case at the end of the deal, you have a big fee you have to pay or if you prepaid them early, you have a big fee you have to pay.
Mike
Yeah. 1.4, yikes, right? So if you just use that capital, right? No one's paying a 40% coupon. Or if they are, like, I hope that's a true statement. But we were in the kind of low to mid teens and what the MOIC looked like kind of matched, matched our coupon, which made sense to me because look, they need to get paid. And for a period of time, if I don't use the facility for the full length of term, for them to sort of get, you know, what they thought they were going to get out of the deal made sense. And look, from our timeline horizon, make sure you know what your business needs and then get the terms aligned around your business needs. And so we were signed up, you know, we thought we'd use this facility for about 18 months, but the MOIC was for a 12 month period. And I knew darn well that we would, whatever money, whatever money we drew in the facility, we were going to use for at least or about 12 months. So the sort of the real cost of the MOIC or the potential real cost of the MOIC was going to be pretty de minimis to us. But those are all things again, understand what you need, align the terms and then you know, do your best to manage the trade offs around the deal that you actually, you struck.
Shawn
Yeah. So we talked a little bit about this earlier, which is, you know, things were different 10 years ago. I remember working with a relatively early stage lender and they wanted to go get money from Ares, Fortress, those guys. So I'm like, I wouldn't even bother, like they're not going to talk to you until you have 50 million. And much to my surprise, they were able to get a term sheet, I think down in the 20-ish million range. So those were kind of, those were heady times. Where are we now, Rich? What has changed over the last decade? Maybe actually, let's go back 20 years. Where were we? How did we get to a point where a lot of those guys were kind of coming down market? And where are we now?
Rich
Twenty years ago, this market didn't even really exist. Specialty finance companies existed. If you think of CIT, before CIT was a bank, CIT was a massive, large specialty finance company that was invested in all sorts of areas, ultimately went into bankruptcy during the financial crisis and ended up acquiring or converted to a bank and the business survived.
Fintech, as I think of it, really emerged out of the 2008 financial crisis. And that's where you started to see, you know, at first it was limited, it was entrepreneurs with ideas looking at the failure of the financial system and saying there has to be a better way. In that environment, it was very hard to find a way to finance those businesses because you couldn't finance anything back then, right? The banks were...were in trouble. And I think we did our first deal, you would probably properly call fintech, early 2009, for a little company called OnDeck Capital had just started and they were formed by an entrepreneur looking at this mess of the financial system and saying there's got to be a better way. And at the time they had built some product features that were really extraordinary for the time using technology that nobody had used.
In retrospect, it's not so revolutionary. The market has really evolved since. But you've gone through multiple phases of fintech development, a washout or a slight washout, and then more fintech development. From my perspective, and this is perhaps very anecdotal from my perspective of a practicing lawyer in the market, but you kind of had the very early stages from 2008 to let's say 2012, to 2013, where you started to see some businesses come into the market saying there are things we can do with technology today and based on the mess in the financial system that couldn't have been done 10 years ago, let's find a way to do that. And that was the OnDecks and the Kabbages and those types of businesses in the small business space, for instance. And then you really started to see in 2013, 14, 15, you started to see the development of businesses like Prosper and Lending Club where they said, well, let's evolve. Let's think about how we can do that on the consumer side. And then in all of those evolutions where you kind of see a deployment of capital against innovative ideas, then you've had a series of many crises in the market. 2016, Lending Club had double pledged $20 million of loans. That one event shut down the forward flow market in fintechs for three years. And it was remarkable, right? Because at the time we were doing, I don't know, we were doing tens of millions of dollars of forward flow deals a year for, or a month for our client. We were doing them all over the place, but that event spooked the market so much that the lenders just stepped back and it didn't really come back until 2019. And so you've seen those cycles in the 2019 to 2021 period the money was flowing probably at an unhealthy pace. Now we're paying the price for that. You had a lot of equity funding go into the market that was then supported by debt capital that was funding companies that were probably looking instead of having a lot of real innovation or more copycat sort of derivative ideas of an idea in the US market that was really interesting five years ago. Now it's 10 derivatives removed and not nearly as interesting.
You know, in that market, the equity funding market in fintech, we're now kind of in this, I call it the morbidity stage a little bit. There's really not a lot of innovation in the market now. There are a lot of very distressed companies. Some great companies that are distressed, some companies that probably, you know, didn't deserve to survive, won't survive. Some that just had a bunch of cash will survive when they shouldn't have. But in my view, we're sort of in the beginning of the seventh inning, in that, and I look forward to the ninth inning, not because, you know, a lot of my friends are in those companies and we represent some of them, not because I want the system to kind of wash out those that don't need to survive, but the only way you get the refreshed capital to come in to fuel the innovation, like somewhere in the world at this moment, there is an entrepreneur saying, I'm looking at, just pick a fintech business. I'm looking at Brex and I can do it better than Brex, I just need the capital to do it. And that is the cycle that as soon as we get through this wash out phase in the next, hopefully few months or year that we're in, we can start to see that innovation start again.
Shawn
That's great. Mike, why don't we switch gears just a little bit. I think, you know, last topic here is what do you need to do to get along with your debt provider? You know, they're obviously critical to you, but they've got a lot of risk as well. So how do you make sure that they're happy and you're happy?
Mike
Yeah, I think that's a great question. I think, look, there's a lot of numbers involved in the term sheet. There's a lot of numbers involved in the analytics, covenant reporting. What's also incredibly important is the relationship. You're doing business with these people. So I think that there needs to be a read on fit. Now, not everybody gets multiple term sheets, but if you do, you want to do business with someone that you, you feel good doing business with. What's their track record?
We recently had an experience where we had tremendous relationship. The person who was running the particular deal, they were very responsive, they were knowledgeable, they understood, they'd come back with answers to questions or, hey, I have a need, can you accommodate this? Or they'd come to me, I have a need, can you accommodate it? It was a real partnership.
And it was a partnership, certainly bounded to the loan agreement, but it was a partnership. And when he could help, he could say yes. He would say yes. When he couldn't, he would say, I can't say yes to that. Can we figure something else out? Like it was a real partnership. There are also some things mechanically we did. We invested heavily in the analytical environment and to reporting. They had a pretty steep requirement in their covenant. and in the loan docs that we initially pushed back on, but they wanted to see monthly cohorts, monthly tranches for all performance. And so rather than just reporting a portfolio aggregate or quarterly aggregate of originations, we had to organize and capture everything by months. Now, from an analytical perspective, that's great. That's how we probably look at it anyway. It just added a little bit more tax in terms of effort. But we were able to accommodate that and we got our analytical reporting incredibly tight.
So much so that we oftentimes, the person we had driving our recordings back to our lender, she was educating them on sort of the reporting that they had asked for and why it mattered and how we were perfectly compliant with it. So I think it was a really fantastic relationship, and to the extent you can get that, that's great. I've been involved with some deals before. In an earlier company, we had, Shawn and I were part of a startup in LA. We had a debt funder. They were just horrible there were terms in the term sheet that gave them some license to interpret it in a very harsh, Draconian way. And they had us over a barrel and they leveraged every ounce of that leverage. And it was awful. And I think to the extent that before you do a debt deal, if you have the opportunity, if you only get one term sheet and you believe in your business, like you got to take that term sheet.
But if you have a term sheet and, if you have multiple term sheets, I very much would ping your network. All of these lenders are known and I would do some reference checks or ask them for some reference checks. I think the relationship matters. But certainly doing the things you need to do on analytical reporting, covenant reporting, communication, timely, all the things you would do to manage a healthy business relationship, I think are also really important. And if and when the relationship goes sour, we called it out. We had an experience recently where the relationship went from like, if I were to grade it, like A - A plus to like D - D minus in a period of four months. This fund clearly was going through some distress. Our portfolio is probably the best looking person at their dance. At least that's what they told us. But something was going on and they wanted to make wholesale changes to our loan agreement that we weren't on board with in the full, you know, the accompanying full sort of, you know, onslaught of attorney time and attorney fees associated with that. So what we ended up doing there is we just called it out and said, Hey, like, don't know what's going on on your end, but this isn't going to work for us. And the term of our facility was expiring and we had another facility coming on board and we let the facility expire. And we said we’re sort of done.
Shawn
Yeah, I think that highlights, you know, what Rich said before, you really, when you're big enough, you really want to have two partners. Yes, I very clearly remember back in our prior business where they didn't fund us in arrears and we, you know, it was an existential crisis. Our investors stepped up and carried us through, but it was, it was not a fun time. I'll leave it there.
And with that, I want to thank you both for joining me today, so thank you, Rich. Thank you, Mike. You can follow Ensemblex, Mike Armstrong, and Rich Davis on LinkedIn. You can also visit us at Ensemblex.com, and you can find The Ensemblex Exchange Podcast on all major platforms. Thank you all for listening in today, and we look forward to seeing you soon.