A look at revenue-based finance, with Pratik Sawal

It’s hard enough for consumers who earn precipitable salaries to manage unpredictable expenses, so imagine the situation for fast-growing e-commerce businesses that have unpredictable incomes and unpredictable expenses. To compensate for the perceived risk, big banks tend to take a very conservative view of repeatable earnings, hampering these businesses’ ability to fund their growth.

But what if loan obligations were tied to revenue instead of fixed every month? That’s a great question, and one answered by revenue-based finance. In today’s episode, Pratik Sawal teaches me about revenue-based finance and what it means to turn e-commerce data into growth-powering loans.

Pratik is on LinkedIn https://www.linkedin.com/in/pratiksawal/

You can find and follow me on LinkedIn (or connect) at: www.linkedin.com/comm/mynetwork/discovery-see-all?usecase=PEOPLE_FOLLOWS&followMember=brendanlegrange

Otherwise, my action-adventure novels are on Amazon, some versions even for free, and my work with ConfirmU and our gamified psychometric scores is at https://confirmu.com/ and on episode 24 of this very show https://www.howtolendmoneytostrangers.show/episodes/episode-24

If you have any feedback or questions, or if you would like to participate in the show, please feel free to reach out to me via the contact page on this site.

Regards, Brendan

The full written transcript, with timestamps, is below:

Pratik Sawal 0:00

Banks haven't innovated Small Business Finance in years, and there is no incentive for them to do that

Short term lending has been around for maybe centuries, right? What is new is identifying the customer segment, which you can really understand by just asking customers to connect their digital presence. Because if you connect with your Shopify API's, or Amazon API's or any of the e commerce tools' API's, you can actually get a very good understanding of what is selling, how much is selling, what is the seasonality, and then you connect your marketing ads you understand, like return on ad spend the amount of data your ecommerce entrepreneur can give you, an ecommerce founder can give you, is very different compared to what a restaurant can give you.

Brendan Le Grange 0:42

Dr. Francis Lau and I are busy building a three pronged credit training programme. Don't worry, I'll tell you all about it when it's ready, but for now, what's relevant is that it falls to me to introduce the concept of affordability checking. And for more than a decade. I've taught this in the same way that once you've priced the loan for risk, you calculate an applicant's repeatable monthly income and allow a certain percentage of that to be assigned as the maximum loan repayment. And then with the help of my beloved annuity curves, we can turn that into an upfront payout. If they're looking for that amount or less, we're all happy. If they're looking for more we have to down sell them.

It's simple and works very well for your typical salary earner. £1,000 a month for 60 consecutive months will settle a £50,000 pound debt, priced at about 8% APR. Is that affordable for an applicant that has on average £1,500 pounds of available income? Well, on one level, yes. In the long run, they will have enough money to cover their payments.

But there's usually another level we have to go through to be prudent, because averages are funny things. If an applicant has £1,550 available one month and £1,450 available another. That's £1,500 available, on average, nice and steady. If an applicant has £2,500 available one month and £500 available another, that's also £1500 pounds available on average.

Yeah. And while the former applicant will pass our checks easily, the last one won't. Because to be prudent, we'll ignore the higher earning months and cater to the worst case scenarios. Why? Well, because once the contract starts, there's a fixed monthly obligation - in the month in which they earn £500 , we can't assume they'll be able to afford the £1,000 repayments, even if the month before they were flush, because in that flush month, we didn't ask for more. But what if we did?

What if the obligation moved with those incomes?

Because the traditional lending model, as it is today, punishes volatile businesses. And there are a lot of very good, volatile or simply fast-growing businesses out there.

Welcome to How to Lend Money to Strangers with Brendan le Grange.

Pratik Sawal, after many, many delays, is an absolute pleasure to have you on the show.

Pratik Sawal 3:33

Really excited to be here.

Brendan Le Grange 3:34

Pratik, you're a mechanical engineer turned a banker, which is not an uncommon route into the industry, but saying that does injustice to your CV, which is really a who's who of the internet economy: ex-Amazon ex-Revolut, ex-Tide, ex-Wayflyer, and now an independent consultant. So talk to me about your early career and what put you on this path to where you are today.

Pratik Sawal 3:59

A lot of it is accidental, but I did my mechanical engineering only to realise that I didn't want to do that. So I moved to Bombay to work in a startup doing data analysis. My client at that time moved to Amazon to launch the Amazon business in India, so I was fortunate that he took me with him.

Spent three years setting up India business, setting up is the wrong word, there was like a large team. And then three years in the UK business. Amazon is wonderful. I learned everything there, to be honest, I owe a lot to Amazon, all my thinking comes from them. But at the same time, in Europe, as a product manager, tt's slow, because obviously you're working with hundreds of millions of shipments at any given point of time. You can't experiment as well.

And Revolut at that time, was growing massively. So I had the good fortune of working there for two years, at Revolut business which is a B2B bank account for small businesses. After two years there, got burnt out because of COVID. I moved to Tide trying to launch a marketplace, spent a year trying to figure that out, then, when one of my ex colleagues from Revolut moved to Wayflyer, and he wanted someone to lead product, and he pushed me, basically.

Yeah, and Wayflyer is a leading name in the world of revenue based financing, but what is revenue based financing? And what sort of work were you doing there?

So, revenue based financing is not innovative in any way: it's a short term loan given to small business owners, so that they can buy inventory or spend on digital marketing. While revenue based financing has payback as a percentage of revenue a customers making.

So in a nutshell, the way it works is they can connect your Shopify platform/ Amazon platform/ point of sale terminal/ bank data by open banking, accounting data of either QuickBooks has API's and things like that. And then Wayflyer and other revenue based financing companies do a good analysis of understanding this particular business.

And then they give them a short term loan, and the collection is not fixed. So it's not a three months loan. And it's not even called a loan in most of the geographies, it's called a merchant cash advance because what you're buying is future receivables from a merchant.

Brendan Le Grange 6:07

I'd always assumed it was a case of you know, you've got terms of 60 days. And so basically just a very simple advance, but actually, you do need to understand how the business works and absorbing some of those unknown psych when the when the revenue is going to be generated.

Pratik Sawal 6:24

And it's it has got a real good product market fit, as it's called in the startup world. Because a lot of these, at least in the e-commerce segment, you have this three to four months working capital constraint, because ecommerce segment can actually grow massively over a very short period of time. But no banks will finance that, because banks want 18 months of data to give any loan, right?

They don't understand an e-commerce business which can go from £0 to £200 million in a matter of 12 months, they can't even give £10 million when their monthly revenues is £10 million. So hence, this alternative lenders have propped up and it's serving a very good market niche which big traditional banks can never.

Brendan Le Grange 7:00

Pratik, if I am an e-commerce provider, I've got my business up and running growing fast. Now I want to access finance, how do you, with your lending hat on, turn that revenue stream or that future possible revenue stream, into a loan? What sort of things are you thinking about to value that and put it in those sort of flexible loan terms?

Pratik Sawal 7:24

I think there are a couple of things to highlight. In the background, the way it works is we get from customers four types of data: (1) is their ecommerce data, which is Shopify Amazon; (2) is their banking data by open banking; (3) is their marketing data, which is how much money they are spending to gain the revenue; and (4) is their accounting data for large value transaction.

So using this for data points, we determine a forecast of what this person's revenue should be, and the profitability of business should be over the next 6 to 12 months period, and use that forecast to decide 'if we provide a particular offer to customer, what is the usual payback period to be expected'?

So although we are saying to customers that they have to pay only 10% or 20% of the sales as repayment, what is actually happening in back end is we are calculating what is this 20% revenue will lead to in terms of three months or six months or...

Brendan Le Grange 8:20

So you would do it the same way that a traditional lender might say I want £10,000 a month, you do that exercise, but then you think what is £10,000 a month in terms of the expected revenue? And does that make sense as a percentage, okay, it's traditional loan thinking made into a flexible way for businesses.

Pratik Sawal 8:41

It's a forecast so it can go wrong, so there's some kind of performance risk we are taking as a lender, but because we have such a rich source of data, we can actually take on that risk.

And it's a short term loan. So the riskiness of this endeavour reduces even further.

And especially for some of these digital businesses, you probably have significantly more data than even bank could have. They know all that data in extreme detail. And hence some of these, the default rate I've seen in the industry is ridiculous load as low as like 0.6% or 0.8% default rates.

Brendan Le Grange 9:14

Yeah, and I think that's a key part, as you say, you can really get into the strength of this business on data these days, so much is available to you. And then if you've got that business owner mindset,

Pratik Sawal 9:23

And the beautiful part is it's super customer friendly, because customers don't have to care that I have to pay a few £1,000 every month, they have to care about maximising their sales, which what they want to do.

If they maximise their sales, that lender gets repaid faster, everyone's happy. And you just have to worry about that one fixed fee and not worry about the APR or IRR or fixed or variable, whatever. So you don't have to worry just one fixed fee.

So yeah, I think the lending is not new. The model is not new. I think in short term lending has been around for maybe centuries, right? What is new is identifying the customer segment which you can really understand by just asking customers to connect their digital presence, because most of these customers have such a high digital presence. Like, open banking is a small element of this underwriting, to be honest, it is an important element but a small element.

So I think what alternative lenders have identified beautifully is a niche segment.

I know players who are working on giving funds to ecommerce businesses or giving funds to SAAS businesses have given rise to point of sale devices. And there was a report I forgot which by Funding Circle or somewhere in UK, where they said that for the first time in 2022, alternative finance have actually overtaken traditional finance for small business lending.

Brendan Le Grange 10:40

Yeah, so we're talking about the sort of brands and businesses we're familiar with from sort of Instagram ads and such, it's either going to take off and be selling around the world in a couple of weeks, or they're going to be fading away. And a traditional bank looks at that and says, Well, I'm too scared about the ones that will fade away so yeah, I'm just gonna go a step step back.

Pratik Sawal 10:59

They don't understand it.

Yeah, especially traditional bank, they cannot understand niche customer segment ever, only 10 to 15% of their business customers will be ecommerce businesses. And hence, these alternative lenders will always fill the gap.

And one thing which beautiful work in RBF industry is the collection is not weekly, or monthly, or fortnightly, it's actually daily collection. So every day, we look at how much money a particular customer has made. If the repayment term is 10% of daily sales, we take the 10% of that as a direct debit, fill it out. So because of all these technologies blending, the API's being readily available, open banking, adoption increasing, and lastly, direct debits becoming more and more prominent, this ecosystem has worked really well. And what RBF industry has done is brought all these things together and gave a offering to customer which they never had.

Brendan Le Grange 11:48

I think it's a fantastic example of fitting the payment terms to the business.

Normally, when we think about a loan, every month, you need to pay me 1000 pounds, you're gonna do that for three years, and then the deal is over. But what you're saying is we understand this is a business that's much more volatile than traditional. So what we're doing is matching our ambitions to yours.

Pratik Sawal 12:10

The customer sees three numbers: that's the amount they will be getting, which is, let's say they are getting a million pounds; the fee they have to pay, let's call it 10%, so they have to be £100,000; and what percentage of daily sales the lender will be taking. And let's assume 15%. So from customer's perspective, they have to pay £1.1 million pounds to the lender at the rate of 15% of daily sales.

It can take three months, it can take six months, it can take 18 months. Yeah, so the repayment term is not fixed.

Why customers love it is because they just assume they have made 85% sale and the 15% will go to lender, they don't have to worry that I have to pay 100,000 a month, and I didn't make a sale this month. And what do I do now?

Brendan Le Grange 12:55

Both easy to see why it's great for the customer. But it also then highlights why you need a different sorts of lender, why you need somebody who can understand how long am I going to be waiting for sales to reach the target amount. So clearly does need either somebody different to your traditional banker or somebody who understands at least the data that comes from ecommerce. And I feel like that's probably a big gap for many lenders

Pratik Sawal 13:23

Completely.

And so two things to highlight there. Firstly, a normal underwriter will basically underwrite every business similarly, they look at data perfectly right. But they will need more data to make decisions. Yeah. And ecommerce sellers always have a working capital constraint. They'll buy inventory from let's say, China, pay 50%, two months later, you will get your goods, you have to pay another 50%, then you have to spend another 20% on ads, digital ads, that's a lag of three, four months. And that's where these niche players play beautifully. Because you're you're getting that capital for three, four months, you can do all these things without worrying. And as you start selling you keep repeat that capital.

Brendan Le Grange 14:03

Yeah, as I said, I think it really showcases both what makes us really exciting and what makes it daunting for people new to the space and on that you have struck out as something of a revenue based finance expert for hire.

So tell me about the work you're doing at the moment.

Pratik Sawal 14:19

That's a very interesting way to put it: revenue based finance expert for hire.

I'm actually more more than expert for hire, I'm actually doing freelance work. So I think I've picked up a skill of this industry, working with multiple clients and multiple geographies. I've worked with now eight or nine different companies, some short term projects, some relatively long term, read almost every article, I've researched almost every company out there. I've been a big fan of your show. I've got lots of learnings from your show and your newsletter. So based on all my experience, I think what I have done is found what we think of best practices.

Brendan Le Grange 14:52

And the clients you've worked with have ranged in size as you said different markets as well. Are they any Stories from that, that you can maybe share that give her a good example of how your sort of work and change what it means to lend to modern ecommerce, small businesses,

Pratik Sawal 15:11

The challenges with different clients are actually quite different, and especially geographically.

For example, I'm working with one of the companies in Middle East. And they don't have open banking there. And it's such a hard way to underwrite customers, if you don't have open banking data. There's a French company I'm working with. And they recently moved their strategy from underwriting ecommerce businesses to underwriting overall small businesses. So they're building infrastructure so that they can capture as much data as possible. And then their risk team can decide the business you want to sell our business, we don't want to sell.

Brendan Le Grange 15:44

All these skills that you're describing this ability to understand the data is being laid in ecommerce, I assume, because that's where all the data is everything that happens online is immediately data. But actually, conceptually, you should be able to learn to any small business like this, if you can get the data from their businesses from the transactions in kind of the real bricks and mortar world. In a world where data was all available, you would be able to lend on the spaces to any business really.

Pratik Sawal 16:14

Yeah, completely.

The beauty about e commerce is a lot of data is available, right? Because obviously, everything is open. What it becomes challenging is if you have a physical restaurant, for example, a lot of transaction is happening in offline world. And that hence that data becomes slightly tricky to make it available. But you still get car sales API's, most of the point of sale devices have an open API, which they you can actually give access to a lender to get that data, almost every company will have more and more digital presence. And lenders can use that digital presence to make qualitative judgement around the quality of business.

Brendan Le Grange 16:48

When you look at a traditional loan, one of the problems with modelling is that you get very limited snapshots of data. So you've provided the loan upfront, and then each month you get one chance to see did they repay you? Or did they not, and suddenly, they start paying you it probably means that for a long time, the business has been in trouble and you can find them, you can try your best but if you're phoning them after they've missed two or three payments, it is probably too late to really recover much.

But with the view that you've got with the sales and the day to day repayments, you are not only getting a lot of data upfront to make the lending decision, you're actually getting data all the time that can help you manage it, if something is going in the wrong direction, you're going to see it so much earlier.

And of course, sometimes that's still too late, sometimes their business has no way to recover back in terms of being able to trigger collections processes, in terms of being able to trigger account management processes. You know, on Wednesday, the sales are not quite where we thought they were going to be Thursday, they're going down immediately, you can start working out what to do next. And I think that's also an exciting way forward. For lenders,

Pratik Sawal 17:58

You're completely right. So you can manage your quality of your loan book every day. And everything which is gone in the wrong direction, you can at least intervene and course correct.

Brendan Le Grange 18:10

Yeah, because most of the time people are trying to pay you and that is great.

But it does mean that if the missed payment is a thing that triggers action, which for most traditional lenders is the case, the thing is that customers gonna try avoid that to the best of their ability. So they may take out many of different parts of the business, they may not market to try and make that loan repayment, they've already stripped out all of that stuff, and it's maybe too late.

Pratik Sawal 18:34

So missed payment in revenue based financing. The way miss payments work is if someone cancels a direct debit, because it's a direct debit, people can cancel it, and they have all the right in the world to cancel it. contractually not, but technically they can. There is no other case of missed payment for us.

The good part about revenue based financing is there's very little time when customer gets the money and customer spends the money and we'd get paid. So for example, in Shopify, all the sale till you make till midnight customer gets money sometime let's say 10am and we withdraw the money at 12:00. So the risk level by all these actions reduces massively. And hence it's a beautiful model where customers are happy lenders are happy people who are given this debt facilities happy although the ecosystem is happy, and generally this is just going in right direction.

Brendan Le Grange 19:26

One thing it reminds me of a little is Damien Burke and Custom Credit, who I interviewed a while back on the show, and who have built a consumer lending product with some of the same philosophy in mind. And that's that we know that the revenues, the inflows, the salaries, whatever it may be, but the money that our customer makes is variable, and their expenses are variable by month, and then we set a rigid loan repayment. It's sometimes just the fact that we've got this rigid thing in a volatile flexible environment that causes people to have a month where they may be slightly missed. To payment.

And it triggers all sorts of other negative actions that happen and almost pushes us into a scenario we didn't want to have to need to have simply because the product design was a bit weak and hadn't taken into account something we all know there's some months, you will make more money than other months, you may have a product that doesn't sell well, in the summer months, or when people on school holidays and the revenue drops the sales drop for a month or for a few days, or whatever the case may be, you know, you're not suddenly missing payments having loans called in getting put on credit bureaus. And so in both scenarios, there was never any difference in the risk of the business. But in one, sort of a rigid product design forced a delinquency.

Pratik Sawal 20:42

It gives them that peace of mind that the only thing they have to worry about is maximising their business. That's the only thing they have to worry about.

And banks are moving in that direction. So if you look at Barclays, they have revenue based financing, if you look at like, almost every big bank has a revenue based finance calm, most of it is usually powered by one of the alternative lenders and they are just like a referral partner. But they are providing that service because they realise the need for the service.

Brendan Le Grange 21:07

Yeah. And so as you say, there's a lot of interest in this space and growing interest from people may be wanting to move into it, or at least understand it better as they partner up in the space. If they wanted to work with you, Pratik what's a good way for them to contact you for them to learn more about the work you do.

Pratik Sawal 21:24

LinkedIn is best, and I would love to learn what people are doing or thinking or even if someone wants to brainstorm about it, I'm more than happy to, because I'm quite passionate about this case, because I think there's somethign there.

Brendan Le Grange 21:35

I'll put that in the show notes. And that's Pratik Sawal - I can attest that you're very friendly and open online for discussion, so people should feel free to reach out.

And so Pratik, there's obviously two sides of this, you've got the business, but you've also got the marketplaces that they selling on. And I assume that they also want the sellers to have access to finance to drive more sales through their platform. So if somebody is a marketplace, they were looking to embed finance in their offering, I know that embedded finance is a buzzword we hear a lot on the consumer side, does that translate through to this world as well?

Pratik Sawal 22:14

Very true. So it's going in that direction.

There are few players in the market who are doing it any platform, which has access to sales data, or payments data can understand when a customer needs a financing product. For example, if you're in Seller Central on Amazon, you realise that you need more money. If you find a button there where you are eligible for X amount of money pre qualified, that works really well. The problem with almost every alternative lender is how do you find people who need money, right? In a very simple word, right. And this acts as a very good distribution channel for their product at the time they needed conversion increases massively.

It's been quite successful.

There's like Amazon has partnered with a company called paraffin in the US, you will end and UK which provides their sellers this particular data. It's not as tightly embedded in the ecosystem as I wanted. But I think it's moving in the right direction. And I know a lot of players in the market was been thinking about it.

Brendan Le Grange 23:15

It soundslike a no brainer that the world's moving that way, the more data there becomes available, the more industries will roll into that. And if we expect life to be unpredictable, to some degree, we should build products that are a bit flexible.

But Pratik, thank you so much for coming on for really getting me behind the scenes. I think I said earlier, I'd learned a bit about revenue based financing before it turns out I haven't I didn't understand all these mechanics, so thank you for your time and for your insights.

Pratik Sawal 23:43

Thank you Brendan. Really glad to be here.

Brendan Le Grange 23:45

Take care.

nd thank you all for listening.

Please do look for and follow the show on your favourite podcast platform and share the updates widely on LinkedIn where lending nerds are found in our largest concentration. Plus, send me a connection request while you're there.

This show is written and recorded by myself Brendan le Grange in Brighton, England and edited by Fina Charleson of FC Productions.

Show music is by Iam_wake, and you can find show notes and written transcripts at www.HowtoLendMoneytoStrangers.show and I'll see you again next Thursday.