Big Boys Going after Consumer Lending
Earlier this week, I shared my thoughts on consumer lending heating up. It’s a large and growing market that’s big enough for multiple winners and hasn’t kept up with changing consumer behavior. The market opportunity could move the needle for any company, even a juggernaut like Apple.
Today it was reported that Apple is partnering with Affirm to offer a buy-now-pay-later option for Apple devices purchase in Canada. This is yet another big announcement in the consumer lending space within a short time. Apple and Square are making big bets on it. (Affirm was already in the space.)
I figured consumer lending would be strategically important and change quickly, and it appears to be changing even faster than I thought. Change is generally good—I’m a fan of it. Especially when it helps solve pain points for consumers in a better way. I can’t wait to see how this space is revolutionized by these new entrants.
Consumer Lending Is Heating Up
Last month I shared my thoughts on how I could see Apple as the go-to consumer bank in the future. Since then, it’s been reported that Apple has partnered with Goldman Sachs to offer a buy-now-pay-later option for products purchased via Apple Pay on Apple devices. Today it was reported that Square is acquiring an Australian pay-later company for $29 billion. This announcement caught me off guard and got me thinking.
Consumer lending is a large and growing market. It plays a key role in the overall economy, so it’s big enough to move the needle for a huge company like Apple. And the market is large enough for there to be multiple winners. It’s not on the cutting edge—it hasn’t kept up with other changes in consumer behavior. Considering these and other factors, the moves by Apple and Square make perfect sense. I suspect they won’t be alone—we’ll see more companies entering this space.
I think consumer lending is about to change rapidly. I’m excited to see new entrants in the space and can’t wait to see what direction this goes in.
Preparing Financially for Entrepreneurship
An aspiring founder asked what I did financially to prepare for entrepreneurship and what I recommend. I started my company over a decade ago. I wasn’t far removed from college, and the world was a different place in general (inflation is real). Here are a few things I thought about that others may find helpful:
- Reduce fixed expenses – Your personal cash flow (i.e., salary) will likely decrease during your early years as a start-up founder. Reducing your fixed expenses (recurring fixed monthly payments) will give you more flexibility. You want to be able to focus on the company. But you don’t want to reduce them to the point where life is miserable, either.
- Reduce debt – Eliminating or reducing unnecessary debt is easier said than done. But if you’re fortunate enough to be in a position to do it, it will help diminish financial stress and lower debt repayments or remove them from your fix expenses altogether.
- Increase savings – Start-ups are hard and unpredictable. It’s not unheard-of for founders to take small salaries, go without a salary, or inject personal capital into the company when times are tough. Savings are a financial cushion that helps you weather the early years. If you can, increase your savings before you start your company.
- Get buy-in from loved ones – If others are affected by your entrepreneurial decision (e.g., family or a significant other), being on the same page is important. Discuss how entrepreneurship will affect the household (including finances). It’s important for everyone to have an idea of what the journey will look like and buy in.
- Consider a Roth IRA – If you’re eligible, consider opening a Roth IRA (you can fund it later). This is a great retirement vehicle in the traditional sense and also an interesting tool that founders can strategically use to invest or hold alternative investments (e.g., private company shares).
- Eat in – We eat three meals a day. Eating out is expensive, so eating in can improve your personal cash flow quite a bit.
These are just a few things that aspiring founders can consider doing before they start their company. Everyone’s situation is different, so some of these won’t be feasible for everyone. Still, they’re good things to be aware of and think about. Building a business is hard. Minimizing stress in other areas in your life can help a lot.
Bootstrap or Raise? Why Not Both?
Had a great conversation with a founder who’s taking a hybrid approach to capitalizing his company. He raised a small amount of initial capital and used it to build the early version of his product. He’s been acquiring customers and fine-tuning the product based on feedback, in search of a product–market fit. Instead of raising more capital, he has his customers sign one-year agreements and pay for the entire year up front. The company is cash-flow positive and can stay afloat without raising again as long as it continues to acquire customers. The founder is thinking about raising a large round to accelerate growth once the business achieves product–market fit.
This founder’s capitalization strategy is interesting, and it’s working well for him. He raised capital to get off the ground but began bootstrapping the company after the investor capital was spent and the product launched. Customer revenue is the cheapest and best source of funding for a company. The challenge is getting enough of it to fund investments in future growth, which this founder is doing with annual up-front customer payments.
I like this founder’s approach, and I’m looking forward to watching his journey. I’m sure he and his team will find more creative ways to build a big business!
Company Equity: A Few Things to Know
Today I had independent conversations with two founders about founder equity versus investor equity. Founders usually set up only one company, so they often need to rely on other people’s advice. A few things I shared with these two founders:
- Common shares – Common shares are usually issued to founding team members who actively work in the business—ideally full-time if the business can pay salaries. It’s a good practice (and a requirement of many investors) that common shares issued to founders be on a vesting schedule.
- Preferred shares – Preferred shares are usually issued to an individual or organization that injects capital into the company but doesn’t actively work in the business. Preferred shares have a stronger claim to company assets than common shares do. Preferred shares issued to investors are usually not on a vesting schedule.
- Cap table – A cap table details who owns what amount and what type of shares, how much capital investors put into the company, and other details regarding capitalization of the company. Many founders do this in a spreadsheet because it seems easy enough, but small mistakes can be extremely costly down the road. Using—as early as possible—software like Carta or LTSE Equity (formerly known as Captable.io) is highly recommended.
Every company and investment has its own nuances and circumstances, so the info above isn’t set in stone. It’s just a high-level starting place for founders. Company equity and cap tables are important and something founders should pay close attention to. It’s worth spending the time to do research or ask others if you don’t understand something related to these topics.
Founders Who Need Liquidity Don’t Have to Exit
Today I read an article that detailed how individuals borrow against their assets. The piece goes into detail about how and why to use this strategy, but one section jumped out at me. It gave examples of founders and senior executives who’ve borrowed against their company stock to access cash while maintaining their ownership stakes. A few months ago, I shared my thoughts on founders derisking without selling the company. This article highlights another path for founders to consider.
Building a company often takes many years, during which founders take low salaries. It’s understandable that founders may need some liquidity as they transition through life stages while building their companies. Selling the entire company isn’t the only path available to them. The examples in the article include founders and CEOs at FedEx, Tesla, and Shift4Payments, all of which are publicly traded companies. Many founders won’t have the same options available to them as those folks do, but the examples are still food for thought.
Founders shouldn’t let concerns about liquidity limit their visions or how big they dream. If they want to swing for the fences, they should! They can rest assured that there will be opportunities to access capital along the way.
More Investors Will Be Buying Small E-Commerce Companies
Yesterday I predicted that we’ll see a record number of e-commerce businesses sold this year. I shared why I think the timing is opportune for many founders to sell. A friend pointed out that it takes two sides to complete a transaction and my post didn’t address the buy side. He’s right.
I believe significantly more buyers will be looking to acquire e-commerce businesses doing less than $10 million in annual revenue. Here are my reasons:
- The pandemic accelerated the shift to e-ecommerce, and this trend will continue. Buyers who want to participate in this trend but don’t want to spend time catching up and building something from scratch will be interested in buying a business.
- We’re in a low-interest-rate environment. Cash is earning nearly nothing, as are savings accounts and other risk-free investments, so people are looking for other investments to earn returns on their money.
- Many other asset classes have appreciated significantly in the last year and a half. We’re at peak prices historically for many asset classes, and some investors aren’t sure how much upside appreciation is left. Multiples on businesses have increased as well, but a small business in a large market that’s growing quickly has the potential to appreciate significantly.
- Finally, sophisticated investors are raising large sums of money to buy these businesses.
E-commerce businesses have historically been viewed as less sexy than other types of businesses and have received low multiples. I think that will change this year!
Payment Terms Matter
Many founders focus on sales, and rightfully so. If a company can’t get customers, it won’t be around long. So founders spend lots of time trying to get customers to agree to use their product or service. An equally important but less-discussed topic is payment terms. How customers pay can be just as important as what they pay. This is especially true for early-stage companies that don’t have an abundance of cash.
I’ve talked to a number of founders who readily share their sales metrics. As I learn more about the business, I like to get an understanding of how quickly they collect revenue and how payment terms are structured.
These is no one-size-fits-all approach to payment terms, but here are a few thoughts:
- Prepayment in full – If you can get customers to pay in full up front, you’ll have the best source of capital. You’ll be able to avoid paying interest on term loans or giving up equity to investors. If your product or service creates a ton of value for customers (they’re begging for your solution), see if any of them will bite. Make sure you (or your accountant) keep track of how much of your cash is from prepayments.
- Deposits – I think of deposits as partial prepayments. The customer’s putting some skin in the game. Deposits can be structured in various ways. It’s common for companies to require a deposit that’s a specified percentage of the total before doing any work. They’re not as good as full prepayments, but they can help companies avoid borrowing and identify problem customers early.
- As you deliver – This is a good approach to aligning costs with revenue. It can be done in a variety of ways. The founder of a consultancy told me that he includes a payment schedule in agreements. He knows exactly how much he’ll be paid and when. This ensures that he’ll get regular revenue to help pay the teams doing the work and avoid cash crunches. It also motivates clients to keep projects on schedule. If they drag their feet, they risk fully paying for a project that hasn’t been delivered.
- After delivery – It’s common for a company to fully deliver its product or service and then request payment after the fact by sending an invoice to the customer. Large corporations love these types of arrangements and often ask for terms of ninety days or more. This means they’ll pay you three months or longer after you deliver and invoice them. This can put a huge strain on cash. If you’re a product company, you likely have to pay for inventory and pay your people before you deliver. If you’re a service company, you still have to pay people and other costs before you deliver. If you allow customers to pay after delivery, you need to assign someone in the company to monitor how much each customer owes and collect payments on time. Customers are already enjoying what you’ve delivered, so it isn’t uncommon for them to “forget” to pay or pay late if they know no one’s paying attention.
Cash is king, and founders should always know how much of it they have. Raising capital from outside parties is one way to make sure the company has ample cash, but strategically structuring payment terms is another approach that can be very effective.
Apple Might Be Your Next Bank
I recently replaced an Apple product. Having not kept up with their products for the last few years, I did some research. As I read their website and spoke with their customer service, I observed several things. The main one: Apple is edging into financial services.
- Trade-ins – People can dispose of an old device and receive a credit toward the cost of a new one. Reminds me of the car dealership business. I suspect this is handled by a third-party company behind the scenes, but it’s still a smart way to make products more affordable without using discounts or sales. The brand integrity is maintained. I’m pretty sure this reduces the average time between device upgrades.
- Financing – New purchases are eligible for 0% interest for a year if the customer signs up for Apple Card (more on this). This stretches the cost of a sizeable purchase into digestible monthly payments, making the products more accessible to more people. If you can afford the monthly payment, you can get a device now instead of having to wait until you have the cash for the full purchase price, and you don’t have to pay interest for a year. More importantly, this is an ingenious way to introduce consumers to the new Apple Card product.
- Apple Card – This is a credit card product, but done the Apple way. It offers a lot of things consumers value, such as cash back and no fees. The software and user experience appear to be very different than those of traditional credit cards. It integrates tightly with Apple devices and services that consumers already use every day. iPhones conditioned people to think of Apple as a company that helps them communicate. Apple Card will likely kick-start people into thinking of Apple as a company that can help them manage their money. If Apple builds a significant financial services business, this product will have paved the way.
- Apple Pay – This product is focused on making it easier for consumers to pay. It’s a mobile payment and digital wallet service. It’s been around since 2014, so it’s not new. It has gained traction. It positions Apple between consumers who love their devices and merchants who want to sell to those consumers. I noticed that Apple Card offers a 2% cash back on charges made via Apple Pay. Another great way to entice consumers to use multiple products.
Apple is a strong company whose hardware and software have heavily influenced our society since the release of the iPhone fourteen years ago. I suspect financial services (in addition to other unannounced businesses) will further solidify its role in consumers’ everyday lives. If it’s successful, I can see a day in the future when people will think of Apple as a place to go for help with managing their money.
Bootstrapping: Full-Time, but Not Really
I lived the bootstrap life with my company and learned a lot. It has pros and cons that founders should consider when deciding whether it’s the route they want to go. One of the things I regularly encounter is the full-time team taking no salary.
Building a company is hard. It takes a lot of time and effort. Naturally, you want your team to be focused. This usually means you want them to be working full time on your startup. This sounds great in theory, but it often doesn’t work in the real world. If the team is working full time with no salary (i.e., for equity or deferred cash compensation), they still must fund their lifestyle. They need cash. Some people are fortunate enough to have cash reserves, but most don’t want to burn through their savings. What usually happens is that your team starts doing things on the side for cash as they go longer without pay. As people start doing side things, they lose some focus. As they lose focus, things slow down a bit. As things slow down, people get frustrated. You see where this is going.
Bootstrapping is a good path in certain situations. I did it (albeit painfully) and built my company to over $10 million in revenue. I also personally went without pay and couldn’t afford to hire the people I needed for long periods of time. Founders should avoid asking people to work full time without a salary if that’s going to last for a while. It’s usually not sustainable, and talented people with options (including cash) may be less inclined to accept these types of offers.