Congratulations! After weeks (or months) of negotiating, you’ve finally closed on your facility. If you’ve drawn on a line from your venture debt facility, money has been wired to your business banking account. Or if you’ve raised a warehouse, you can now fund and originate loans that will be repaid by a financing partner.
What happens now?
Throughout this series, we have provided many resources to prepare you for this stage of your business journey. We’d like to wrap up by focusing on how to manage debt post-closing.
Given that lender-negotiated key terms impact origination parameters and limit certain business operations, what tools and which best practices should you leverage to ensure you stay compliant while managing your business efficiently against those covenants? With the combination of diligence solutions (e.g., third-party calculation agents and paying agents) and demands set by lenders, how should you best manage your facility to meet these ongoing requirements?
For this article, we interviewed multiple lenders to glean their guidance and insights. We also sought the advice of several software providers who work with fintech borrowers to get their best approaches to managing one or more debt facilities.
Armed with these considerations and guidance around invaluable tools — many often not mentioned as part of the debt raise process — you’ll hopefully stay on top of all your contractually required reporting, tracking, and much more.
Credit Agreement and Funding Mechanics
The credit agreement, that lengthy document dedicated to formalizing your credit arrangement with the lender, outlines many of the key terms and ratios necessary for compliance. Reporting, in line with the terms of the agreement, will be necessary once the arrangement has been finalized.
For asset-backed debt, at a bare minimum, lenders will likely ask for monthly reporting packages consisting of loan tape metrics, consolidated (sometimes audited) financial statements, and accounts payable and receivable within 30 days of month’s end. Certain data points can put a company in default, so it’s absolutely critical that companies make sure they are compliant at all times, stay within their concentration limits, and calculate their borrowing base accurately. Similarly for venture debt, monthly financials will be shared as part of reporting requirements.
Certain workflows, such as calculations and borrowing base reporting, will need to be set upfront to assist with the maintenance of ongoing funding requests. Depending on the underlying asset class and sophistication of the borrower, there may be additional requirements specified by the lender.
We encourage fintech companies to work with lenders on their requirements and to have open discussions on what needs to be reported. Some fintech companies may even begin to set up automated tools before the facility is put in place. This should alleviate some of the stress post-closing and set companies up for immediate success.
Next, let’s review some of the relevant concepts from negotiating your first facility that relate to funding mechanics.
Eligibility criteria are the requirements that need to be met in order to originate an asset within the facility. Examples can include things like minimum FICO scores for consumer loans or minimum time-in-business or debt-service coverage ratios (DSCR) for small businesses. Note you can still originate “ineligible” assets, but you’ll need to use your own capital to fund them.
Criteria to originate an asset within the facility may also include concentration limits — which cap the percentage of portfolio concentration in any given geography, industry, risk bucket, etc. — or set min/max bounds on the interest rate for products you originate as well as overall gross yields expected in the portfolio.
The eligibility criteria will help define and outline the credit box (i.e., acceptable funding parameters and risk metrics) by using upfront, non-performance driven data such as revenue, time in business, and minimum FICO. Separately, there are performance criteria you will need to monitor and track against over time.
Using a small business borrower as one example: an end customer will go through a front-end loan application to make sure it complies with all the relevant criteria and fits within the credit box. If the application is approved, then the loan amount (minus an origination fee) would be funded to the customer. The loan would then be originated and recorded on the borrower’s balance sheet before being “sold off” to the lender.
Historically, originating a loan involves completing a number of tedious tasks including: organizing the data, assigning a loan ID, uploading all required documentation dictated in eligibility criteria, and working with a third party who acts as a diligence agent to validate the assets and perform an independent review. If no disqualifying criteria exist, the loans are pooled together, in batch, over the course of a week (or longer) and sent off to the lender. The lender would then wire money back through a separate bank account.
In some cases, a company will retain loans for 2 to 7 days to season them and establish itself as the lender of record, for regulatory purposes. Once these loans are seasoned, they are sold to the SPV / warehouse vehicle. However, since the SPV / warehouse vehicle is often consolidated to the company’s financials, the company must continue to report these assets on its books for financial statement purposes.
Having a tool to automate all the granular tasks involved in funding can save companies both time and money (i.e., equity tied up in a loan) — more on this below.
Servicing, Verification, and Reporting
Lenders we spoke to highlighted 3 key workflows pertaining to facility management: servicing, verification, and front-end analytics and reporting. Certain software and services providers have the ability to do all 3; other times the roles are divided.
Loan servicers are responsible for collections, where they auto debit gross principal and interest payments from a bank account and wire them to the lender. Lenders take gross principal and interest payments from the loan tape provided by the servicer, transpose that loan file into a master Excel sheet, and analyze portfolio performance from the repayment history. The portfolio performance is then compared to the parameters outlined in the credit agreement to ensure no covenants (i.e. max delinquency / default rates) were tripped. Companies often use a third-party servicer or in cases where they service the loans themselves, lenders typically require a back-up servicer who can step in and manage the portfolio if the company goes out of business.
For verification, lenders must approve assets in order to classify eligibility. Making sure that assets fit all the criteria can be manual and done in batch, or they can be done continuously.
Another key part of managing a facility is having a dashboard for front-end analytics reporting. Workflow tools (such as Setpoint, Vaas, and Finley) offer solutions for detailed loan information-enabling companies to track and stay compliant within their agreement terms.