Future of Investing

Is debt financing the new big equity round in fintech?

  • fintech firms turning to straight debt to finance ops
  • Klarna's borrowing at around 4%
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Is debt financing the new big equity round in fintech?

After months of reading about hefty equity rounds, financing trends in fintech may be changing. Klarna, a leading European payments upstart, said on Monday that it had raised 300 million crowns (it’s based in Sweden). The firm is, after all, a major player in Europe, handling about 10 percent of all online transactions, according to Reuters. But, perhaps a sign of the changing tide in startup land, instead of a big splashy equity financing, this one was done as debt.

“Klarna is picking up speed in year-on-year revenue growth because of success of recent product launches and markets expansion,” said Jesper Wigardt, Klarna’s PR manager, in an email to Tradestreaming. “We issued the inaugural capital market loan in order to diversify funding sources and to strengthen the capital base to support continued accelerated global growth.”

Why use debt when you can use equity?

This was Klarna’s first time dipping into debt markets, but other top private technology firms have turned away from equity to finance their operations. Earlier in June, Airbnb announced it had raised $1 billion in debt financing. Though the hospitality marketplace still has $2 billion banked, it turned to straight debt financing to add to its coffers.

For fintech firms, using straight debt is generally a new phenomenon. Up and coming financial technology firms have a variety of financing options and straight debt may prove to be a smart financial move.

“If a company is growing rapidly, and has sufficient cash flow, debt can be a more cost effective financing tool than giving up large percentages of equity,” remarked Kyle Zasky, a partner in fintech merchant bank, SenaHill Partners.

Private fintech firms don’t normally turn to debt markets

Private technology firms are accustomed to using various forms of debt to scale up. The most common, convertible debt, enables a young, upwardly mobile firm to raise money quickly without having to quibble over early-stage valuations. Using convertible debt, which turns into equity at a later financing round, startups and their investors can kick the valuation can down the road to a later-stage investor to set after the company has matured somewhat.

Transportation-on-demand leader, Uber, used convertible debt earlier this year when it closed a $1.6 billion investment round. According to Bloomberg, Uber’s bond, which was sold to Goldman Sachs clients, is a six-year bond and converts into equity at a 20 percent to 30 percent discount to Uber’s valuation at the time of an initial public offering. Convertible debt typically pays a coupon but the intention for all involved is that the debt eventually converts into equity. Facebook raised billions of dollars in convertible debt shortly before its IPO. Big banks frequently use access to late-stage, pre-IPO convertible debt as a way to let favored clients into hot companies at preferential terms when the stock hits public markets.

Online lenders do use debt, but differently

Online lenders have also been using debt to capitalize their businesses. Firms like Affirm, Avant, and Payoff, all which provide online consumer loans and recently closed large investments, use debt facilities to replenish their inventory of cash to loan out to borrowers instead of lending out their own equity. But unlike convertible debt, which is dilutive, these types of fintech investment rounds don’t impact cap tables. Firms like Victory Park Capital, a Chicago-based alternative lender, and other big banks lead large debt rounds for the online lending industry.

“In fintech, there are certain business that lend themselves well to debt, such as lending businesses or companies that just need capital on their balance sheet for regulatory purposes,” said SenaHill’s Zasky.

Using straight debt to finance growing startups isn’t as common, though. Reuters reports that Klarna’s debt comes in the form of 10-year notes with a floating rate based on three-month Swedish interest rate plus 4.5 percent per year, or an initial coupon of about 4 percent.

Klarna claims it’s profitable and Swedish media has reported that the firm fetched a $2.25 billion valuation after Swedish insurer Skandia invested.

So far, Klarna is the first headliner to diversify its funding sources in this way. Time will tell if tapping the debt markets becomes more common and whether it makes its way over to domestic markets, too.

 

Photo credit: markus spiske via Visualhunt / CC BY

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