Part I Interview with Lucas Timberlake, General Partner, Fintech Ventures Fund
Welcome everybody to another episode of Asset Backed, the podcast focused on specialty finance and Fintech lending among other topics. Today, my guest is a friend and also a general partner in an early stage venture fund, Luke Timberlake. Welcome to Asset Backed.
Lucas Timberlake:Thanks for having me.
Andres Sandate:On our show, Luke, we, you know, we we are always trying to cultivate relationships and bring on guests that are on the front lines of the specialty finance, the Fintech lending, and related areas. You know, credit has grown so much. So, but you guys come at it from a slightly different angle with Fintech Ventures, and I'd love to hear more about that. But before we jump in to your firm, tell us your backstory.
Lucas Timberlake:Great. So I started off right out of college doing on campus recruiting, and this was during the financial crisis, not to date myself, but I ended up at Merrill Lynch which had merged with Bank of America. So I had 2 different logins, my Merrill login, my BofA login. And I was doing project finance and infrastructure investment banking, primarily debt capital markets and advisory work for municipalities across the northeastern United States. And we were looking at everything from privatization of toll roads to debt to run the buses and subways through the MTA.
Lucas Timberlake:And even did some interesting tax exempt structures where we did one of the first commercial mortgage backed securities that was tax exempt for several office buildings in New York City. So I got my start there, cut my teeth for 3 years at Merrill Lynch. And as a result of that, actually, one of our former clients was doing infrastructure private equity looking at buying real estate and other sorts of assets from municipalities. And I ended up going over there to work on parking company acquisitions, and we looked at acquiring parking companies from municipalities and then putting in operating companies to run them. And a lot of what I was doing there was not only raising the equity as a fundless sponsor but actually going after project finance debt as well.
Lucas Timberlake:And one of the ways that we financed these parking companies that we ended up buying was using more traditional project finance structures because the leases for the parking companies, especially in Manhattan, had similar profiles to other sorts of real estate and infrastructure assets that you could get project financing from over 30 years with, you know, at the time 4 to 5% interest rates. So as opposed to going out and raise mezz financing, although we did some of that, we financed a lot of the transactions using project finance even those more operating company types of assets. That's actually what brought me down to Atlanta where we had several companies that I was working with and met my current partner on the fund who I ended up stepping back from the private equity world to join. Took about 6 months off, and we launched Fintech Ventures in 2016. And our thesis which comes from my partner's background founding a small community bank in Atlanta was that at the time there are certain areas of finance where banks and other large financial institutions cannot step in to serve for a variety of reasons.
Lucas Timberlake:Fixed costs are too high for these banks to service them, regulatory reasons prevent them, or they're simply just not interested in areas because the loan sizes etcetera are too small to move the needle. And this is the core focus of our fund to get to the thesis we're investing primarily in non bank lending and private credit focused companies whether that's the originators themselves, whether that's technology around the space, or whether it's companies that have some sort of use case within the private credit and alternative lending verticals. So I'll pause there. That's me in a nutshell.
Andres Sandate:Well, you you you sound like you come at venture capital with a a somewhat of a different background than some of the VC folks that I've met. You know, a lot of times they have been an analyst and maybe then worked their way up at a at a VC shop or a couple of different VC shops. You come at this with a a real credit skill set and a real fixed asset infrastructure, real asset, background. The first question that comes to mind is when when you made that transition, in, you know, in in this first, this first move into venture, like, how did you do that successfully? Because that that background and that training, I would imagine, has served you well given the credit lens, the underwriting lens, through which Fintech Ventures is is looking to invest.
Andres Sandate:But, initially, you're you're now focusing on the equity of these companies and, like, how big they can get. So maybe could you talk about that transition?
Lucas Timberlake:Sure. So the way I like to describe what we do, which, again, may be different than other venture capital firms, is that we take a private equity approach to early stage investing in alternative lending and private credit focused originators. So what that means is that even before these companies have originated their first loan, we're looking at the unit economics of what we think they could be, and we're also thinking about helping them raise credit if we don't provide it ourselves, which I'll get to to originate these loans from day 1. And that in my view, separates us from a lot of other venture capital firms that might be looking at lending businesses from terms that you've probably heard like ARR, you know, ACV, CAC.
Andres Sandate:You know,
Lucas Timberlake:that still factors in. But you can't really underwrite lending businesses even if they're, you know, have a technology angle or raising venture capital in the same lens as you would a software company. So we take a credit underwriting approach. We're still trying to, you know, generate venture backed returns, but we take a credit approach to every company that we look at. And that leads to us kind of passing on a lot of companies because we're looking from fundamentals from day 1 when there is no real data behind these companies to go off of.
Lucas Timberlake:And, you know, fortunately, because of the industries they operate in a lot of the unit economics for these businesses can be somewhat estimated going forward because, you you know, in most states, you can't have a consumer loan that's over 36% for certain sizes and durations. So you kind of know what the upper end of what the company can charge if they're originating consumer loans to prime consumers for instance. Or if you look at the cost of capital, it's somewhat fixed because it's a competitive market and you kind of know what people are going to borrow or I should say companies will borrow in order to lend out money to consumers. And then similarly you have a general idea what the customer acquisition costs will be at scale by looking at some of their publicly traded competitors. And the 8 old adage that I give in Fintech is especially for lending if someone has tried has if someone has not tried your idea it's the chances are it probably hasn't worked at this point for a variety of reasons because you can't make money doing it.
Lucas Timberlake:So in my view there are no new lending products. There's only real new customer experience changes and maybe shifts in certain business models that have occurred and, you know, been the status quo. But it's very difficult to just go out and do new products given the regulations and kind of the competitive nature of financial services.
Andres Sandate:Yeah. I mean, it's such a gigantic and quite fluid market that ideas get replicated or it might not be true innovation if what I'm hearing you say is it's it's a version of, x that's applied perhaps to a new part of the economy. Quite interesting. So at Fintech Ventures, you mentioned, your team, your partner came from having launched a community bank. We have a lot of banks in the US, and banks are not historically known for their innovation.
Andres Sandate:We know that in the the the the banking ecosystem, we have our gigantic, you know, sort of too big to fail banks. That's not the vast majority, though, in terms of number. The vast majority of the banks are smaller banks, local community banks. Can you talk a little bit about why Fintech in general over the last, call it, 10 years, it feels has continued to capture market share from, banks as it relates to lending and some of the more specialized lending, businesses? Because like you said, making a loan and doing lending has been around for a long time.
Andres Sandate:Are these fintechs able to do it quicker, better, more profitably because they don't have branches? Like, I just would love to hear, like, what's the banking setup and how's that affording opportunity for innovation?
Lucas Timberlake:It's an interesting question, and I would say it's also evolved in the last 8, 9 years since we started. So as I mentioned, we started investing in non bank lending companies that are filling gaps that community banks or larger financial institutions can't fill for a variety of reasons. So an example of that is doing lending for someone to buy a home, fix it, and flip it. You can't go to a bank typically for that because it's a non conforming mortgage. Or a small business loan under 250,000 typically for a bank it's not really worth the time to underwrite that loan.
Lucas Timberlake:And so people are willing to go out to financial technology companies or even companies that are, you know, deemed to be specially financed companies with low or no tech still originating these loans in spreadsheets which is another area of opportunity for fintech, people are going to these types of lenders because it's easier for them to get a loan. Even if they pay for that same loan, you know, sometimes 30 to 50% more in terms of interest, they're willing to do that because banks have been deemed to move too slowly or, you know, don't even have the ability to underwrite or service this customer that needs a small business loan of 200 $50,000 or a bridge loan to buy and flip a home for another $500,000 So that's kind of been one area that fintech has stepped in and that's been really proliferated from the financial crisis in 2008 and some of the capital reserve requirements without getting too much into it that have made it difficult for banks to operate in some of these spaces that I just mentioned. But fast forward and part of our evolving thesis, I would say really at least what we noticed in 2020 due to the pandemic, etcetera, a lot of community banks and credit unions, and and we really think that community banks of around 250,000 to 2,000,000,000 where there's several 1,000 of those, those are kind of sweet spots for fintechs to target.
Lucas Timberlake:There we've seen a fair amount of innovation and these banks and stakeholders embracing lending technology to help them modernize their operations to compete with Fintechs. And that's really happened, you know, since the pandemic, at least from what we've seen. And we started to look at companies there that are helping community banks and credit unions either buy loans that have been originated by a fintech or helping them originate products that they're able to do legally, but didn't have the ability to do so because they lacked the technology or personnel to do. And so that's kind of what we've seen when it comes to the shift, let's call it, in the last 5 years within the community banking space as it relates to lending.
Andres Sandate:Yeah. 1 of the guests that I had on asset backed recently were a couple of founders, from a auto a consumer auto finance software startup called Karus, I believe, k a r u s. You can find the show on our asset backed website. But one of the things that they do is partner with banks, credit unions, and others that want to lend to underlying dealership groups, for example. And, you know, they provide, an AI powered, AI driven underwriting credit decisioning that doesn't replace the existing underwriting.
Andres Sandate:It sits on top of it, and so you get the you get sort of the force force multiplier, pardon me, on top of the data that they already have being the the originator. And so I think that that's that's an interesting dynamic that you see within Fintech. They're not all lending businesses, but they do, like you said, power lending. When you look at Fintechs, through this lens of of what Fintech Ventures finds most interesting. Are you looking for SaaS businesses as well as originators, or could it be 1 or the other just depending on a variety of different factors?
Lucas Timberlake:So I would say that's also evolved over time. But in my view, the greatest area of improvement within Fintech or financial services as it relates to lending, I should say, comes down to improvements in customer service. It's not innovations in the products as I mentioned, although you will see new products out there. But the learning curve for these new products can be quite steep. And, you know, one example I give to people is that, you know, home equity lines have been around forever.
Lucas Timberlake:But, you know, within the last 10 years, fintechs have introduced home equity investments where you don't pay interest but you get someone to buy a portion of your home. But at least from what we've seen having looked at 20 plus of these platforms is that the customer education component of that is never factored into the CAC or friction. And it's actually quite difficult to explain a new financial product to someone without people on the phone or boots on the ground or something that's, you know, just not incrementally scalable. So that's kind of one thing that I like to to point out is that for us fintech is innovation in the customer service. Maybe the back end processing, but it's not necessarily in the new products at least from what we've seen.
Lucas Timberlake:So we're looking for industries right now that are actually what people could call niche industries that are not as large as your average, let's say, prime consumer lending, which could be 1,000,000,000,000 of dollars in outstanding receivables, but are actually smaller and have been overlooked because they're not exciting enough. And I'll give an example of a company, for instance, that we think is interesting and invested in that fits this. The company is doing floor plan finance for used auto and power sports and agricultural dealers. And they're offering this financing because still you're calling up the auction as a used car dealer and as a used car yeah. At a used car dealership and you still have to clear the financing via the phone.
Lucas Timberlake:And there have been no web innovations because a lot of fintech entrepreneurs have overlooked it because it's just not an exciting enough space for some. But it's a pretty large market about 40,000,000,000. There's 2 to 3 players, you know, 1 is publicly traded, somewhat fragmented as all the components in place. And the innovations in technology that you can make seem small for the rest of us that are used to these, but are quite large and and can create high customer attention pretty quickly because they're, you know, such game changers for the operator for the business themselves. So to give you an example of that it's it's simply linking your bank accounts because you have several different ones that you use to fund the purchase of used autos into one tab that shows you in real time every single inflow and outflow of cash so you don't have to open 6 different windows to check your bank accounts manually and see when the money is hitting to clear so you can go out and buy new autos or tractors, you name it.
Lucas Timberlake:And those little improvements are actually quite game changing too. But to go even further and dive down into that example, this company has also developed a SAS product that is separate from their lending business that is focusing on financial institutions to give them the ability to issue inventory loans to their customers because it is a pretty cumbersome process to be have to look after the collateral and make sure all the covenants are hit and, you know, all the titles are cleared, etc. And so this is giving community banks and credit unions the ability to offer inventory financing to their customers. And so they have this what I call a dual threat model and that's what's most interesting to us as well as kind of diversified lending products that have a SaaS business and a balance sheet business and are not over reliant on 1 or the other.
Andres Sandate:Yeah. 1 of the one of the I guess the Outsiders perspectives of Venture as an asset class and I'd love to ask you about the environment the last couple of years is that it's such a long dated asset class. Right? And that the fund lives are 10 to 12 years. And, you know, the hit rate historically I mean, if you the data, the top decile of venture firms, you know, vastly outperform the other 90%.
Andres Sandate:You know, maybe you take the top 25%, and the pitch book data says, you know, that they they generate, I think I saw this week, 25% on average annual returns. I think the top decile is is is even higher than 30 plus percent annualized. But when you look at the bottom 50%, right, of of VC firms, you know, the numbers start to really diverge. My question is, with such a long dated asset class, how do how does a venture firm when looking at Fintech? Again, the lending part of this has not innovated dramatically over the last, you know, 100 of years.
Andres Sandate:Ways in which you service the customer, engage the customer, maybe even originate the customer, have evolved dramatically, with technology. And and so with the backdrop of a fund life that's 10 to 12 years in a gigantic industry, how how does your firm approach identifying innovation and or if it's not innovation that you're looking for, management teams or ownership teams that have a competitive advantage to service the customer base differently or better? Like, what what are those characteristics that comprise if it isn't innovation in the in the lending per se, but it's the, you know, the service aspect or other features, like, what are what are the hallmarks of those teams?
Lucas Timberlake:I would say the first thing is that even being within Fintech, we found it best to specialize. And so even though we've invested in WealthTech and the companies are doing well or in insurance, which we still like more and more over the last couple years, we've continued to double down on our focus on alternative lending and private credit focused companies. And as a result, you start to build somewhat of a brand where you get sent a lot of the deals within the space and you can kind of understand via pattern recognition which is really the ultimate advantage that you have what will work and what may not work. But you know at the end of the day the general rule of thumb is that you know, you'll do 10 deals and, you know, 2 to 3 of them will give you outside returns of 3 to, you know, 5 x plus, and then the rest may give you 0 to 1 times your money back. So even with perfect information, you're still not gonna be correct after 10 years.
Lucas Timberlake:And to your point, you probably don't know until 7 to 10 years into your investment whether it will go out go wrong or not. And, you know, I tell people that, you know, if you stack rank all of our companies from a certain point of time, it looks like, you know, a mangled spaghetti mess by the end of it in terms of, you know, highs and lows and being outperforming versus coming back. It it really depends, and a lot of it too, whether it's in Fintech or other industries, is dependent on luck and and headwinds and tailwinds. So a lot of it comes down to that. And it's sticking to a thesis, but also having the ability to evolve that thesis as necessary.
Lucas Timberlake:And for us, like I said, we were looking at companies that were competing or filling niches that community banks and credit unions couldn't serve, and now we've come full circle to investing in companies that are enabling these institutions to offer products to their customers that they couldn't normalize normally offer because the fixed costs of doing them manually without technology were too high. So a lot of it just comes back to, you know, having a thesis, but but also being able to to tinker and adjust on that thesis.
Andres Sandate:Yeah. I I'd love to run a little bit deeper on the idea of, founders and, you know, preparing their, preparing their firm, whether it's for an equity raise and or if they're an originator, and and doing, you know, some type of specialized lending as a as a part of their business or their business. Like, the debt capital markets compared to the equity capital markets, there's just a lot less price discovery. There's a lot less information out there when it comes to the debt capital markets, but yet you all it sounds like what if I heard you correctly, Luke, you all have seen enough of these models that you can kinda look at a business and see if they've baked in enough cost for educating customers and acquiring customers and serving customers as one one variable. Question is, have the founders over the last few years that you're seeing their businesses in specialized lending and and and private credit credit related, Fintechs, have they gotten better at preparing the things like their loan tape and their their their models, their risk models, their origination strategies, have they gotten better?
Andres Sandate:Or do we still, you know, do we still see a lot of founders that are just coming to market, like, underprepared? Not unprepared, but but underprepared relative to what what the stakes are.
Lucas Timberlake:It's an interesting question because I I would say that, you know, up until the last couple years there is a lot more debt capital out there at the earlier stage up for grabs. And models that work in a zero interest rate environment were getting funded, but currently are underwater or will not get funded. So I wouldn't necessarily opine on whether the founders are better or worse prepared. I think the the answer I would give is they need to be better prepared because just like the venture markets, the private credit markets, especially at the early stage, are much more competitive to get first tranches of financing. And a lot of it comes from, like I mentioned, being able to understand your business in the grand scheme of other peers at scale that may not be using tech or may not be similar, but you can kind of understand what the general cost of acquisition will be, default rates, etcetera, will be by looking at some of the peers.
Lucas Timberlake:And the biggest mistake I see is when I ask even pre revenue founders what the unit economics will be about 30% of the time they say I have no idea because I'm pre revenue. And I say listen, within this space that's not really an excuse because you can kind of back into it or look at enough public data to be able to understand, you know, how your product might perform. So that's kind of one of the aspects of it. I mean, the second is just thinking that their model will be better than the existing status quo. And that's not necessarily true when it comes to lending either.
Lucas Timberlake:You may have a lower cost of acquisition because you're using an embedded model, But at least from the 100 of lending deals that I've seen, you're probably not gonna be any better off when it comes to default rates than, you know, your lower tech brick and mortar peer. And if you kind of net all this out at the end of the day, the unit economics on a per loan basis are about the same. So that's kind of one example that I give to people is that having naive optimism within lending and private credit focused startups can actually be a negative factor because you have to remember your stewards of debt capital, which is way different than venture capital and it's a way different risk profile. And I look for founders that can have both the grand vision of scaling the company so the equity makes money, but also remembering that they're stewards of debt capital. And if they default on their facility by making bad loans or not having the ability to manage risk that the company goes away because the creditors are the first one to seize, you know, whatever is left as well.
Lucas Timberlake:So I look for people that can have this kind of balanced sense of optimism and, you know, founder drive with the institutional wherewithal to manage potentially 100 of 1,000,000, if not billions of institutional grade credit. And that's actually much harder to find than one might think because it takes 2 different hats that you kind of have to wear, you know, one on one side and one on the other at almost all times.
Andres Sandate:Yeah. I mean, you're you're talking about a founder who has, if you will, the ability to, you know, build and recruit a team, the technology, the vision to, you know, enter new markets or, for example, go international, enter these strategic partnerships, but at the same time, like, has to have a credit hat and has to have the ability to understand risk and understand the macro environment, etcetera. And that that is a rare combination. I would agree. I wanna ask you I I spoke to a founder recently and kinda give you a setup.
Andres Sandate:I won't name the name. They're going after the let's call it the working capital market. You know, that's a gigantic market. Small businesses need working capital. Access to capital for small businesses is is the lifeblood.
Andres Sandate:Right? And in this case, this is in the this is in the, you know, call it the trade business, the the construction services, businesses. And what was interesting about the conversation is they they very, very early. Right? They have customers.
Andres Sandate:These are small businesses, and they have decided to partner with a lender. So, like you said, that embedded lending kind of playbook, rather than building out their own internal models, their own underwriting, processes, their own origination processes, if you will, they they I would say they do have a little bit of the origination, but but the underwriting and the loan tape and a lot of those things, you know, they don't have because they're effectively renting the capital.
Lucas Timberlake:Yeah.
Andres Sandate:When you see those types of models and they're going after a market where, okay, maybe the customer experience is not very good. The existing lender probably doesn't offer a dashboard to the small business with all kinds of bells and whistles. They probably don't have great customer service. They probably don't understand that particular industry very well, but they do have a balance sheet. And you see a couple of entrepreneurs that are going and attacking that in this way, like, without a loan facility and without a balance sheet.
Andres Sandate:Can that work? And and I'm curious what what kinds of things you look for in that case, where they're sort of originating, but they're using kinda third party embedded financing model to do so.
Lucas Timberlake:So to clarify, are they are they brokering the loans? Are they doing a forward flow? Or how
Andres Sandate:it's not really forward flow or yeah. Yeah. It's it's not really forward flow or brokering. They they have relationships with this particular industry. And so when folks come to their website and apply, they're effectively kicked over to a 3rd party, you know, system to fill out paperwork, apply for the capital, and then they get a credit decision from that partner within a day to 2 days.
Andres Sandate:But the the founder said, you know, sometimes we get phone calls from the founder because they're saying, hey. I was supposed to get a decision in 24 hours. It's now been 3 days, and it turns out that it's just a wonky or underwrite. And sometimes they have to turn down the the the the business. You know?
Andres Sandate:And so, yeah, it's not so much forward flow as it's like they've they've got an end to a specific industry, and they're able to, like, kick over that credit file, if you will, to somebody else who's making the final credit decision.
Lucas Timberlake:So it's an interesting model, but the question would bear is whether it's more efficient than the status quo. And so we've seen a lot of companies that are trying to become more efficient loan brokers in the small business space for loans under 200 50,000 where, you know, your stove breaks and you wanna get your loan within 24 hours if you have a restaurant or else you're out of business.
Andres Sandate:Right.
Lucas Timberlake:And they're what these providers are competing with is, you know, shops of people that have a Salesforce and are just calling books of business and placing loans with the existing non bank finance providers, and it's not terribly efficient. And we've seen some that have tried to standardize credit boxes and underwriting and document management or even, you know, scraping bank statements with OCR. And the vast majority of these companies at least that we've looked at are no more efficient than the brokers themselves. And because they're investing so heavily in the tech, they're not as profitable either as the brokers themselves, which
Andres Sandate:because they're not capturing, like, interest margin. Right? They're not get they're getting, like, 1% origination maybe, but the economics might not be as attractive is what you're saying as the the brick and mortar specialty finance business.
Lucas Timberlake:So well, so I'm talking about the brokers that are brick and mortar brokers that have no balance sheet exposure and comparing them to a tech Yeah. Yeah. Broker. I mean, obviously, it would be great to to to have an interest margin, but what I'm saying is that
Andres Sandate:Yeah. The broker. Yeah.
Lucas Timberlake:Yeah. And they're no more efficient. There can be, you know depends on how you look at it, but 1 to 10% close rate of the loans that you get in as a broker, you know, typically, it can be 1 to 5, still a very large range percent. And, you know, typically, I've not seen any tech enabled provider that claims to save time and money be more efficient than that kind of status quo. And there, you know, there's no real value in the software or the bells and whistles that a company has built.
Lucas Timberlake:And obviously not implying this company because I haven't
Andres Sandate:met them.
Lucas Timberlake:But Sure. You know, just generally speaking, I I haven't really seen many tools that have tried and successfully changed this. And, you know, it's it's also another area within kinda more middle market finance of loans. Let's call them a 1,000,000 to 10,000,000, which has been one of the toughest markets to create from an efficiency standpoint. And we've seen a lot of providers try to match make community banks and expedite their underwriting process by giving them warm leads and I haven't seen any sorts of real successes quite yet in that area either.
Lucas Timberlake:And, you know, in my view, it's it's still something that's done, you know, via phone calls and via, you know, hand to hand comment that is not gonna be replaced by a chatbot or some sort of AI enabled tool or better document handling, you're still gonna have to chase people in email for their, you know, prior 2 years tax returns, etcetera. You know, some sort of chatbot or upload here is not gonna really move that forward. It might be easier to make the end process achievable, but you're still gonna have to chase someone somehow. And, you know, these business owners are running around. So the only way to do it is a phone call or text message.
Lucas Timberlake:No one's gonna do a little chatbot that you download. You know?
Andres Sandate:Yeah. Yeah. I had a I had a a founder of a I wouldn't call him a broker. It's not how he characterizes services, but he he's really helping connect. You know, I thought he was helping small and medium sized businesses going after that, you know, one to 10.
Andres Sandate:His sweet spot's really 7 to 12,000,000 up to 25, but as small as a1000000. And, you know, I sort of preface the question of you help them go find debt capital. And he said, well, it's really the reverse. Like, I help the debt capital kind of find, you know, sources of origination, if you will. Like, he he he has 250 relationships with various finance companies, nonbank lenders, some private credit funds, some asset managers, but it's a lot of, like you say, the these finance companies, right, that have capital and, you know, having that sort of you know, use the old term network, rolodex, whatever, you know, is extremely valuable to these founders, right, who may have a CFO, but, or a treasury department, but that person is not, you know, setting up transactions and closing deals and collecting term sheets for a living.
Andres Sandate:So they're only gonna see so much, you know, so much deal flow. I wanna ask you about the the embedded nature of financing. It seems like every SaaS company is trying to verticalize and create an embedded finance value proposition. Almost like do that, put AI on the end, and go to market. I'm I'm saying that tongue in cheek, but what from your perspective I mean, you see 100 and 100 of transactions and deals.
Andres Sandate:You get that pattern recognition. What what do you make of, you know, the verticalization of the SaaS model and and the embedded finance? Does it really come back down to, as, you know, a well known credit executive says, 2 things, assets and cash flows?
Lucas Timberlake:I mean, it it it should. And, you mean, not to pick on some of the larger companies, but, you know, a lot of them have created embedded finance options that have not gone terribly well, and now they're kind of walking back these programs and exiting them completely because they saw them as a way to make ancillary revenues. Most notably, Amazon announcing the other day that they're getting out of the space for financing their, you know, businesses on the platform that resell with them. And, you know, you look at a few others, and they're also kind of exiting the space. So I didn't know that, by
Andres Sandate:the way. That that that's interesting.
Lucas Timberlake:Yeah. Yeah. I'll I'll send the article Okay. And you can link it. But, you know, they're they're getting out of this space, and they would be the most logical provider.
Lucas Timberlake:Shopify has another big business, which I think is going better. But a lot of these providers are providing the working capital finance because they do have the data on the other. Sure.
Andres Sandate:Yeah.
Lucas Timberlake:So it's it's possible, but the what's happening now is a lot of them are kind of walking back and not really getting as involved as they were in these areas. And when it comes to embedded finance more specifically, I I think it's gotten to be quite crowded of a space, and, you know, I I think we're gonna see somewhat of a shakeout when it comes to the players because there's just a lot of money poured in during zero interest rates, and now it's gotten incredibly more difficult to make money in the specific area. So I I think time will tell, but I I definitely am treading with caution when I'm looking at new embedded finance providers. And, you know, it should be interesting to to see. I I I think on the flip side, the area that I like is and it's gotten big enough because there are embedded finance players buying or borrowing money from large credit funds is the infrastructure space to help these embedded finance providers manage their institutional credit facilities from covenants to borrowing based calculations.
Lucas Timberlake:There's a lot of software there, and I think that is a pretty interesting area of technology and, you know, lending that we're looking at pretty heavily.
Andres Sandate:Yeah. Yeah. I had, I had a guy, Mike Schum, on from, Cascade. I'll put the link to that recording. And they, yeah, they came out of kind of this whole ecosystem.
Andres Sandate:They were actually doing, you know, I'm a call it microfinance, but they were doing finance, like, in emerging markets and and, and and really saw just a lack of standardization and software for the debt markets that existed on the equity markets. And, so, so they're building a company, like I said, Cascade, which provides a lot of this debt management software. And as debt flow through rates, private credit grows, I think there's a value proposition both for the originator, who has multiple credit facilities and multiple different financing arrangements or could. And also for, you know, even theoretically, like, the asset management side of the business that has lots of underlying, exposures, lots of underlying loans, and has obligations to its LPs and needs to kinda have a better understanding about what they own and be able to do the same type of attribution that you would sort of ask for from a from an equity shop, or a hedge fund back in the day. So so I think that you're right.
Andres Sandate:Like, that's an interesting area. I wanna ask you about capital, when it comes to private credit. There's been so much money raised in private credit over the last 5 years, And, you know, we saw and heard this, you know, dry powder argument. It still may exist with private equity and maybe to some extent venture. This all this capital and private credit, I was just up in New York a few weeks ago, and all these big gigantic publicly traded asset managers and more of them coming, you know, I think we saw CVC went public this week.
Andres Sandate:They all are adding, with the exception of a couple, like, more businesses. Their platforms are getting bigger. It seems like they're gobbling up majority of the capital, and it's increasingly coming from private wealth and retail. But income and credit and yield, those are, like, super hot areas, and I don't see that train slowing down. It may change a little bit when rates go, you know, from 7, 8% on an auto loan or mortgage, you know, down over the next few years, but we're not going back to 1 or 0.
Andres Sandate:I think everybody agrees. So my question is with all that credit that's there, and all all the capital that needs needs to be put to work and will, you know, will need to find a place, is the is the is the is the market in terms of what you guys are looking at at Fintech Ventures, is it as exciting as it's ever been, or is it requiring even bigger, set of binoculars to find these, you know, founders and find these businesses, to mat you know, I wanna say match up, but to to help realize the the capital opportunity that is out there.
Lucas Timberlake:So I'd say it's maybe shifting your binoculars to use that analysis
Andres Sandate:in
Lucas Timberlake:a different direction. Whereas, you know, you're looking at traditional originators that we started looking at 2016 to 19, there are still ones that are out there that will get funded. Then you have kind of the proliferation of embedded finance as well, which is just a real change the front end in terms of how you distribute these loans. That I would say is here to say as well. But with these kind of waves 1 and 2 of the Fintech alternative lending 1.0 and then embedded being 2.0 for lack of better numbers.
Lucas Timberlake:Yeah. Yeah. 3.0 in my view, and we're already seeing this, is the technology to serve as the infrastructure behind the scenes for the space. And whether that's plug and play embedded finance drop ins for people building applications where they wanna offer the financing directly, you know, we're seeing some of those, Or whether it's some of the platforms, including the one you mentioned, that are helping people manage their institutional grade credit facilities. I think those areas are all gonna change and continue to grow much larger.
Lucas Timberlake:And clearly, everyone's thinking about how can AI jump in here, but, you know, in my view, I don't see that occurring at least from the underwriting side, but maybe from the servicing side. But we're still kind of a long ways off, and I'm not sitting there looking for the next AI based consumer lending servicing startup yet.
Andres Sandate:Yeah. Yeah. Yeah. Yeah. Okay.
Andres Sandate:Last couple of questions. You know, you you you spend a lot of time on the road. You interact with lots of VCs, lots of founders, lots of folks in the debt markets, and just other practitioners who are helping the start up ecosystem and founders in various functions fractionally or on a consultative basis. Given the environment we're in, the the higher rate environment, and it just appears that we continue to to get data from the Fed that inflation is it's it's kinda sticky. Right?
Andres Sandate:We we saw numbers last week. You know? We're we're sitting here at April 30 today. We saw numbers come out last week that, that just continues to be sticky. There's there's really no other way to put it.
Andres Sandate:On the other hand, you know, you can look at lots of other data, wages, unemployment, earnings, and and be quite, you know, optimistic, I guess. But it just feels like there's a lot of uncertainty, and it feels like there's a lot of discomfort. The setup there being when you're traveling, talking, and attending all these events and conferences, are people real bullish, or are they bearish, or are they somewhere in the middle when it comes to Fintech and kind of these new models that you described, maybe asset light, but infrastructure building, good old fashioned lending, but maybe a different lens, different approach. What what are you what are you hearing in the, you know, at the coffee bar and, you know, in the, in in the hallways talking amongst these folks, when it comes to these new Fintech models.
Lucas Timberlake:So it's been interesting. I mean, if you wanna dial into the conferences, there was a prominent Fintech conference that has started off with only being focused on lending, you know, lend it, which is a great conference. And then about 2, 3 years ago, the, you know, viewpoint was there was not enough demand to do a conference specifically focused around technology enabled lending specifically. So they rebranded to Nexus and offered different chains of or different tracks, I should say. Yep.
Lucas Timberlake:And as of the last year, I believe, the conference is no longer in business. And, you know, in my view, that is somewhat of an analogy for the space, meaning that, you know, there's not enough demand around the conference, but, you know, there's still enough there. So I would say it's the sign of maturity from an industry that really only started at the end of the financial crisis has hit somewhat of a critical mass. But right now we're in an interesting period that we've never experienced, which is rates, you know, at the highest level since the start of technology enabled lending. And you're definitely seeing a shakeout when it comes to certain originators.
Lucas Timberlake:You know, revenue based finance for technology companies is is under an incredible amount of pressure, for instance. And I think we're kind of in the middle innings of a considerable shakeout within the space. And this kind of occurred to go back in history around 2017 and 2018, we we kinda saw consolidation with a lot of consumer lending platforms that came up during the LendingClub and Prosper teenage years in terms of their life cycles go out of business. And then you actually saw a whole wave of companies after COVID, especially on the embedded finance side, start to crop up. And now I think we're gonna see just an eventual maturity of a lot of the sector occur because of the fact that, you know, it's hard to exit these businesses and rates The impact of rates is starting to trickle down.
Lucas Timberlake:Yeah.
Andres Sandate:I mean, there's a real right? There's a reality that's set in. I mean, I think not to take shots at at any any particular practitioners, it's it's just generally the case that there was a lot more venture that went into Fintech in, you know, 18, 19, 20, 21. And and the and it was the guys Ares, you know, the in the gaps pieces that they put out or their quarterly commentaries. I mean, that's, like, required listening in my in my estimation just because they're they're so astute and they get it, and they they understand all these underlying markets.
Andres Sandate:And I think in their q 4 or maybe it's q one probably, piece, they talked about, you know, a lot of the the the VC market, you know, funded a lot of these businesses as software businesses, put a good multiple on them. And now they're looking at them and saying these are actually lending businesses, and that's just a totally different business. Right? And and it'll be interesting to see how many of them, you know, get follow on financing or how how many of them get follow on equity when, you know, when those those businesses need to raise equity. Maybe they are raising equity.
Andres Sandate:I gotta think that there's like like you said, there's a reckoning. Last question I wanna ask you, and we'll have to do a 2 point o because because, there's so much that we didn't get to today on this first one, but I'd love to have you back on asset backed to talk about, you know, more more in the weeds. But I'd love to ask you, Luke, about, you know, founders who are preparing to you know, whether it's go go in front of VCs that are very Fintech focused and that are either software plays, and or these infrastructure plays, or they they have a more traditional lending business. And their take on it is that they think they can do it, potentially cheaper or they can service better, still a loan. But let's just say they've got some initial traction, and they've made some some loans or building a tape, and they are starting to go out to do that, maybe that seed or potentially like that pre series a bridge round.
Andres Sandate:What what are you wanting them to really step back and think about? You know, you you mentioned not not being so much head down that you don't understand unit economics and don't understand, you know, some some of the things you guys are continuing with. But what what do you what would be your message to founders? That'd be my last question for you today on on kinda 1.0 here.
Lucas Timberlake:Yeah. No. Definitely. I mean, this was great, and thanks for having me and definitely interested in in 2.0. I I wanted to quickly go back to something you mentioned in your last point regarding these companies being valued as software companies and something we're exploring, which I will articulate more as it comes out is is looking at a different security on the equity side completely to invest in these companies.
Lucas Timberlake:You know, whether it's similar to something like a redeemable preferred that banks have been using or something that works better for lending companies that are not going to be venture type SaaS outcomes, and if they are, they're gonna perform poorly in massive valuations have done so. So So that's kind of something that maybe we talk about in 2.0 and go further into the weeds because obviously we both enjoy this. But when it comes to to founders and and and loan tapes, I I'd say the the interesting part about where technology is currently for alternative lending is that it is relatively easy to get started originating loans. You can take an off the shelf loan origination system that won't cost you an arm and a leg. And then, you know, assuming you have the capital as collateral, you can go out and plug in.
Lucas Timberlake:It will be a high cost provider that basically can offer you lending as a service so you can start originating loans from day 1. So in my
Andres Sandate:view startup. That's the startup. That's the startup I just described effectively. Right? So now you're in business.
Andres Sandate:You go aft you go after your niche. You start getting some customers.
Lucas Timberlake:Yeah. But, you know, there, it's at least for a venture model, unfortunately, that's not good enough. You kinda have to think about your unique approach to your product and be able to articulate that and start building that even as you're originating loans. And so that's why I tell people that get started, you know, show that you have a loan tape because you need to generate that to get institutional credit to help scale. But also think about, you know, why your business model is unique and what sorts of nuances you have.
Lucas Timberlake:Like I said, in my view, it's mainly customer acquisition is really the only place you can innovate because other products are too hard to understand or may not even be, feasible under the current or any regulations. And trying to go and understand your unique insight to acquiring customers is probably your best bet when it comes to starting a lending company now. And this is why embedded finance providers have taken off is because they are significantly reducing the CAC and friction of acquiring someone that wants to borrow money. Because, you know, thinking that you're gonna reduce defaults by 50% using machine learning and AI, I would be very surprised to see anyone that can do that at scale. And so in my view, it's focusing on customer experience and better mousetraps for acquisition.
Lucas Timberlake:That's really the areas that I see direct originators still being able to innovate in. But, you know, again, I would would sit here and try to throw out ideas of where to look and just currently, I don't have many because a lot of it has been tried, and now it's about thinking about different ways of doing business or going, like I said, to smaller niche markets that are still large enough to build good businesses in, but may be overlooked because they're not exciting enough or not attractive enough to entrepreneurs. And so, you know, inventory finance for used auto dealers have another player in the debt collection space and is looking at financing around that. Another 10 to $15,000,000,000 industry looking at specific industries and doubling down would be my advice to start a lending company as opposed to just looking at consumer prime lending for every single consumer with an auto or something like that.
Andres Sandate:It it sounds like that that we'll just do a preview while we're here because it's a good it's a good opportunity for us to talk about the next show that Luke and and I are gonna do is we're gonna dive into, a 2 point o. And I think I think some areas that you hit on today, would would be great setup. I'd love to have you back on. One is unique origination. And and what does that truly look like?
Andres Sandate:And and when when a startup that is, looking for financing, whether it's equity or debt, is talking about our unique ability to originate our our differentiation, how we're gonna acquire customers, whatever you wanna call it. What does that what does that really mean? So I need to ask one good topic. I think a second one is, customer experience. You know?
Andres Sandate:You can go throw a whole bunch of venture money at bringing on a whole bunch of people to sit in a call center or whatever model. Maybe they're gonna sit at home. They're gonna do both. But but, you know, we've also seen the cost of doing that. You brought this up earlier, may not be any cheaper than the cost of doing that without a tech aspect to it.
Andres Sandate:Right? So let's talk about that as a second topic. Like, how do you do customer experience cheaper but better? I think that be interesting. And then I think a third area, which you just hit on, which are these niches, as somebody coined the term, you know, and I'll use it.
Andres Sandate:The riches are in the niches, of credit. Right? Yeah. So there's all these specialized areas of credit. You know?
Andres Sandate:I think PIMCO said that specialty finance is a you know, it's in the trillions, in terms of what it is. It's more than just consumer loans. It's mortgages. It's auto. It's all these other areas, you know, buying a refrigerator, you know, buying appliances, and more and more and more.
Andres Sandate:And so these are gigantic markets. They used to largely get financed, and from a takeout standpoint in the public ABS. Now we're seeing more private ABS. That market's in its infancy. So maybe a third area we could dive into is just these these more esoteric, nuanced areas of credit that potentially are, you know, maybe not right for innovation, but they because they they are still they are there, but, you know, they are open for business, let's say, from the standpoint of tech companies when it comes to what we just talked about, you know, a unique insight on origination, a unique way to service the customer, and deliver a better experience.
Andres Sandate:Anything else in our Yeah.
Lucas Timberlake:I mean, closing point be before part 2 would be that, you know, we say it's unique, but it's not really that unique. It might just be selling something else completely or packaging alone, obviously, if it's regulatory compliant to do so in a different manner. And so an example I'll give of an interesting model of a company that we have is they're selling an owner benefit package to single family landlords sold through the property managers of said properties, and that includes insurance against tenant default. And that's a very high product to a high friction product to sell on your own, but they're also layering in a lending component to get up to a year's worth of rent essentially default free from the property. But it is all sold via a SaaS subscription model that the property manager takes out to all of his property owners and does on an opt out basis.
Lucas Timberlake:So you basically are paying a monthly SaaS fee to get the rights to your future cash flows through this owner benefit package, and it's worked out incredibly well. And so in my view
Andres Sandate:Interesting. Yeah. Yeah. So a gigantic asset class. Yeah.
Lucas Timberlake:Yeah. Multifamily people to pay for the rights to their own lending is actually to their to to borrow getting people to pay for the right to borrow is actually an incredibly efficient manner of customer acquisition that a lot of people overlook because it sounds counterintuitive. But I'll leave it
Andres Sandate:there. Yeah. Well, that's 4 areas, folks, that are tuning in to the asset backed podcast that you can expect Luke Timberlake, general partner from Fintech Ventures, and I to break down on a future show who we might have to turn this into a recurring series, but, we will leave it there. We have many things, to talk about when it comes to specialized finance, specialty finance, private credit, Fintech lending, but this was a great start. I think we can offer the audience quite a bit, whether it's a founder or it's a it's a lender or it's it's other folks that are in this ecosystem.
Andres Sandate:So I look forward to having you back on a future show.
Lucas Timberlake:Likewise. I appreciate it, and talk to you soon.
Andres Sandate:Luke Timberlake, general partner with Fintech Ventures, focused in, the Fintech area, specialized lending, Fintech lending, offices in New York, as well as Atlanta. Thank you for joining me today on the Asset Back
Lucas Timberlake:podcast. Thanks for having me.
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