Flexible, Mission-Aligned Debt: The Great Equalizer
A growing topic among impact and traditional investors alike is the stark power imbalances that exist in asset management and, more specifically, venture capital. This is probably not the first time you’ve read or absorbed these data points: 98% of U.S. assets are managed by non-diverse teams. In private equity and venture capital, minority-led firms represent only 5.1% of firms and 4.5% of assets. For women, these numbers paint a starker picture, with women-led firms comprising just 7.2% of firms and 1.6% of assets. [1] Not surprisingly, these trends have had spillover effects. In 2023, women received about 2% of venture capital funding in the United States, and Black founders received just 0.48%. [2] Again, nothing new.
Specifically, if we want to have a conversation about power and capital, we have to talk about the dynamics in venture. One, in order to get money, you need to give away ownership. Two, in order to get money, you may need to give away control. If things aren’t going well, you may have to give up even more, through a down round or steep liquidation preferences. There is also an inevitable tension between proving scale and growth at all costs, and retaining a level of quality and impact that likely catapulted this idea in the first place. Oftentimes this means being pressured to make business decisions that run counter to impact, such as paying your employees or contractors less, or moving upmarket and away from lower income consumers to grow margins.
Beyond venture, the power dynamics in the credit markets are not much better. I have been in the private credit space for 15 years and am still appalled at the stories I hear from current and prospective borrowers. For example, we’ve heard of lenders denying credit to education organizations with $50M+ in revenue because they “don’t get school receivables,” despite this being an $18+ billion a year market. On the flip side, in a post-SVB world we’ve also seen lenders offer terms that are too good to be true…so long as the borrower moves all their cash to their institution. For any company that held cash at Silicon Valley Bank in March 2023, they know this is a risk not worth taking.
- Low thresholds for loan-to-cost or loan-to-value, which result in capital gaps that need to be filled;
- Floating interest rates, which create business uncertainty;
- Incredibly high collateral requirements, such as being asked to set aside cash in an amount equal to the loan amount;
- Steep prepayment penalties, sometimes as high as one-third of the loan amount; and
- Personal guarantees, which put the personal wealth of key principals at risk (provided they have sufficient assets in the first place, which is an exception and not the rule).
What is the solution to these pain points?
Flexible, mission-aligned debt. What does this mean? Being flexible does not mean being lax or wishy-washy. Rather, it emphasizes utilizing the full suite of features embedded in a loan product to design terms that meet the needs of borrowers and the impact they wish to achieve, while maintaining discipline and rigor to support repayment in a range of scenarios.
What does this look like in practice?
It means sizing the loan to be appropriate for the organization and current and future program needs. This might mean limiting total debt to manage a borrower’s overall debt burden and cost of capital, or considering larger commitments that can grow alongside organizational needs. It also means funding in tranches, which releases loan proceeds to an organization or project over time. This is both good for the borrower, as it keeps interest costs manageable, and good for us as a lender, as it allows us to manage our exposure based on the financial and impact performance of the deal. We also include funding conditions, which are financial or programmatic milestones that must be met to disburse additional funds to the borrower. Finally, we can be flexible on term and repayment schedules. We can allow for quick repayments where project cash flows are more immediate, or more patient terms where borrowers would benefit from more time. We can include interest-only periods to allow borrowers time to ramp up, while still offering sufficient time to fully amortize the loan thereafter to avoid bullet repayments which are bad for the business and stressful for founders.
Beyond customized terms, flexible debt offers other advantages as well. As a source of non-dilutive capital for for-profit companies, it allows founders to retain more ownership in their vision. It also reduces the need to demonstrate “hockey-stick growth” as the growth needed to repay debt is far more reasonable than what is needed to excite equity investors. For nonprofit organizations, flexible debt can enable long-term business planning when philanthropic funds are absent or slow to materialize, or if government contracts or other payors are slow to pay.
At Maycomb, we believe in the power of flexible, mission-aligned debt and have many proof points to show that it is possible to do multiple things at once. We can solve pain points for our borrowers by providing capital that meets their needs and is a breath of fresh air compared to other options. We can customize debt products for borrowers while simultaneously scaling our model. And we can satisfy the needs of our investors who are interested in both financial returns and impact. If, in the process, we can also help to alter the power dynamics between capital providers and the users of that capital, we’ve done our job.
[1] Source: Knight Diversity of Asset Managers Research Series: Industry (2021) https://knightfoundation.org/reports/knight-diversity-of-asset-managers-research-series-industry/
[2] Sources: Pitchbook, Crunchbase: https://pitchbook.com/blog/female-founders-and-investors-to-know; https://news.crunchbase.com/diversity/venture-funding-black-founded-st tups-2023-data/
