Thread by @fintechjunkie

1/24: Yesterday @QEDinvestors announced our investment in @GetCapchase and we couldn’t be more excited. The space is white hot with big rounds being announced recently by @pipe and @clearbanc (among others). Curious why so much capital is flowing into the space? A thread: 👇

2/24: What if I told you that I had a business that miraculously transforms sums of money intro greater sums of money? You put money in one end and more money comes out the other end. Amazing! This is a gross simplification of what healthy businesses do over and over and over.

3/24: Every Founder paints a picture of a problem their business can solve and their vision is accompanied by a spreadsheet that lays out how a very attractive money machine will be created as a result. The spreadsheet is full of assumptions and early-on only loosely grounded.

4/24: But there are classes of companies that can ground the economics of their businesses much faster and with much more certainty than others. And for a class of company, the money machine they can create produces amazing, durable and low-variance cash flows from day one.

5/24: The most common type of company that falls into this “amazing, durable and low-variance” cash flow category sells software. Well-run SaaS companies have fantastic margins due to near-zero COGS (cost of goods sold) and products that don’t require a lot of support.

6/24: One common characteristic of SaaS companies is that the revenue they generate is realized over an extended period of time. The best SaaS companies retain their customers for years. They strive for 90%+ annual contract retention rates and 120%+ revenue retention rates.

7/24: Paying for growth can be challenging. SaaS companies typically face significant losses while they’re growing because it’s not uncommon to invest a full year’s revenue (or more) to acquire customers who will stick with them for many years afterwards. Growth requires cash!

8/24: To solve this cash-crunch, SaaS Founders have historically raised equity (which is dilutive), venture debt (with scary covenants and expensive warrants) or asked their customers to pre-pay their contracts in return for significant discounts (15-30%).

9/24: New solutions have emerged that allow SaaS businesses to raise working/marketing capital based on the collateralization or sale of their low-variance, high-margin cashflows. Adding fuel to a cash-generating machine can be a smart and profitable decision!

10/24: When you double-click on these new solutions, they aren’t all the same. Some operate as two-sided marketplaces while others face-off directly as lenders to the SaaS companies. Product variance in large markets is a good thing because one-size doesn’t fit all.

11/24: But as an investor we can’t invest in “one of each”. We had to choose the model and team we thought had the most potential in the market. We did the work. We studied the space. We looked for analogues in other categories. And as a result we decided to back Capchase.

12/24: Capchase is a direct lender. They don’t run a 2-sided marketplace. They source and interact with their clients directly. Their model has quite a few structural advantages over a marketplace model and we think these differences will matter a lot to the SaaS community.

13/24: Benefit 1 - Speed

In a direct lending model, customers don't have to wait for the dynamics of a marketplace to get an answer. Applications (especially from repeat customers) are turned around quickly and the counterparty is always there and ready to wire funds.

14/24: Benefit 2 – Certainty

Working capital is a core component of how companies function, so building a relationship with your counterparty allows for certainty of funding even through the ups and downs of one’s industry, the economy or due to company specific issues.

15/24: Benefit 3 – Privacy

To most companies, asymmetry of information is critical. Companies want to keep details about their customers, their pricing and their profitability quiet. Sharing data in a searchable and transparent marketplace is required in order to find buyers.

16/24: Benefit 4 – Flexibility

Direct lenders can launch new products and geos quickly because they don’t require educating a whole marketplace of counterparties. Offers can be tailored based on companies’ needs and market feedback can rapidly translate into new products.

17/24: Benefit 5 – Diversity creates stability

A direct lender has significant control over the portfolio it funds and can rebalance systemically. Lenders on a marketplace have to actively win deals one contract at a time which can create lopsided portfolios.

18/24: Benefit 6 – The future can be valued

A direct lender can afford to put in the work with larger companies to forecast their future performance and lock down prudent growth plans. Marketplace models typically only fund contracts that exist in the present.

19/24: To be crystal clear, at-scale, winner-take-all marketplace models have amazing characteristics that investors and operators should be in awe of. When assembled the right way in the right industries they’re a thing of beauty to behold.

20/24: But our observation is that marketplace models have historically failed to dominate lending ecosystems. Not always…but pretty much always. Some marketplaces exist in the wild today that are still trying to find their sea legs. But many more have collapsed completely.

21/24: I’ve personally been a student, practitioner and investor in the lending space for almost 30 years (yikes!) and helped companies soft-pivot away from marketplace models and watched others completely melt down. I know they can work. I just haven’t figured out how.

22/24: So for anyone interested in doing a little independent research, there’s plenty in the public domain. Study the evolution of the consumer P2P lending ecosystem. Study the rocky road of The Receivables Exchange. Ask why all major “risk” assets are funded directly.

23/24: TL;DR: The SaaS space is gigantic and by no means are all SaaS companies “birds of a feather”. Multiple models in the market will only benefit the SaaS community and provide them with the capital they need and deserve to grow. The only question is how.

24/24: And I’d like to give a special shout-out to @nlevchin and @bling0 for spotting and funding Capchase before us. Capchase is special and you figured this out first!

And damn you Twitter for not having an edit function. I can’t believe I forgot @tonsing who also beat us to the punch. Glad to have luminaries paving the way for us....