If you've followed the rise of financial technology ("fintech") companies, you know that today's most innovative fintechs make it easier, faster, and/or less expensive to access financial services. Some companies streamline mobile payments. Others improve the way consumers or businesses manage their money. Still others work with banks to improve the tracking of money movement.
When it comes to cash flow volume, one category of companies dominates fintech: firms that help individuals and businesses access money. This isn't surprising; a fintech that issues loans to individuals will transfer several orders of magnitude more money, over the course of a month, than a fintech that creates financial management software.
So what types of companies fall in this broad category? Well, all credit card and "buy now, pay later" (BNPL) startups, for starters. But also companies in the red-hot property technology, alternative capital, and embedded finance spaces.
At the end of the day, a startup that helps individuals put all-cash offers on houses has a lot in common with a startup that helps eCommerce and SaaS businesses access non-dilutive funding. Both startups use technology to offer their customers access to capital suited to those customers' specific needs, and both startups rely on debt capital (from capital providers) to make these transactions possible.
Yet despite the billions of dollars that fintech startups have raised in equity and debt this year alone, the mechanics of fintech cash flows (especially around debt capital) remain opaque to most investors and operators. In this post, we'll show you how fintechs use credit facilities, SPVs, and asset-based finance to fuel their growth—and what happens behind the scenes when they do.
The three key players in fintech cash flows
Before we get into fintech cash flows, it's important to understand the three key players in fintech cash flows: capital providers (these are the institutions fintechs raise debt capital from, and they can be banks or private lenders), fintechs, and fintech customers.
In the diagram above, we show an example with a capital provider called Arbequina Asset Management, a birdwatcher-focused credit card startup called Owl Financial (unfortunately, this offering doesn't exist in real life yet, to our knowledge), and Owl Financial's customers.
Note that, for simplicity, we have purposely omitted a few players from this diagram, such as card issuers and payment processors—not to mention VC firms. This omission has the added benefit of making our explanation more broadly applicable to proptech and other fintech-adjacent companies. (Note: Because equity fundraising happens as a one-off, there is little confusion about how money moves in an equity fundraise: a VC firm simply wires money to a startup one time.)
So we know that Owl Financial uses its credit facility to fund cardholder purchases, but what type of bank accounts does it use, and how does the funding process work?
The four key accounts in fintech cash flows
Now that we understand the three key players in fintech cash flows, we can turn to the main bank accounts involved. For the purpose of this example, we'll assume that the capital provider and customers have single bank accounts. We'll further assume that the fintech has a single Parent Operating Account and has set up an SPV that administers a separate bank account.
The Parent Operating Account is the fintech's primary bank account, and is used for everything from paying bills to running payroll. The Borrower SPV Account—administered by the SPV—is used primarily for receiving payments from customers. In this example, when Owl Financial's customers pay down their credit card bill, the payments will go directly into the Borrower SPV Account.
You might expect the first step in fintech cash flows to be for a capital provider to transfer funds from a credit facility to the fintech's Parent Operating Account, but as we covered in our borrowing base post, the amount a fintech can draw from its credit facility is a function of the receivables it has assigned to the SPV. The capital provider views the SPV as collateral.
If a fintech has never conducted any business with customers, it has never generated any receivables, meaning its customers don't owe it anything. With no receivables, the fintech has no collateral, in the eyes of the capital provider. That means fintechs must "kick off" the credit facility by making disbursements to customers and assigning those receivables to an SPV. Which brings us to Step 1 of fintech cash flows: disbursement.
The five steps of fintech cash flows
Step 1: Disbursement. The fintech's Parent Operating Account makes the initial disbursement to the customers (or, more accurately, the businesses where the customers shop), creating the receivable. Think of it this way: when Owl cardholders swipe their cards at a nature preserve, Owl Financial is effectively wiring money to the nature preserve on its customers' behalf. At the same time, Owl Financial creates a record of a customer IOU. This IOU is called a receivable, and is initially owned by Owl's Parent Operating Account.
Step 2: Assignment. The Parent Operating Account assigns (sells) the receivable to the SPV. In this step, it's as if Owl Financial took the IOU and handed it to the SPV, saying, "When the customer pays down the credit card balance, that payment will go directly to the Borrower SPV Account."
Step 3: Funding. The Capital Provider sizes a borrower's maximum borrowing amount based on the total balance of receivables in the SPV. Let's say Owl's customers spend $10 million. Now, the value of the IOUs in the SPV is $10 million, and Owl can go to its capital provider to draw money against the IOUs of it customers (see our borrowing base or advance rate articles for a refresher on how this process works).
Step 4: Collection. This is when a fintech's customers (Owl cardholders, in our example) pay down their balances. When fintech customers pay back the fintech, the funds go directly into the Borrower SPV Account. This decreases the balance of IOUs, or receivables, held by the SPV, but increases the cash in the Borrower SPV Account.
Step 5: Waterfall. On each Settlement Date (the frequency of Settlement Dates is outlined in the credit agreement), collections are released to the lender and other parties for payment of interest and fees, and recycled for funding of additional receivables. This brings the process back to Step 1. However, the next time this cycle repeats, the fintech's disbursement will be funded by capital-provider funds. In other words, the funds used to kick off the next cycle are, in effect, coming from the credit facility, and will serve to increase the size of the borrowing base. This is how fintechs increase credit facility utilization over time.
Why should investors and operators understand how fintech cash flows work?
At Finley, we think of fintechs as having two sides: a customer-facing "front-end," which covers marketing, loan origination, and credit decisioning; and a capital provider-facing "back-end," which covers things like debt capital sourcing, reporting, and compliance monitoring.
Today, the fintech "front-end" is relatively accessible to entrepreneurs, even if there remain many customer segments and underwriting techniques for founders to explore. When entrepreneurs start a credit card company, for example, they can use card-issuing vendors like Lithic, Marqeta, or Stripe. These services reduce the burden of having to create and manage credit cards.
But when it comes to the fintech "back-end," companies that have to source and manage debt capital are on their own, even though debt capital reporting and compliance issues can reduce or cut off access to funding. By understanding how fintech cash flows work, investors and operators can adequately prepare for the financial and operational costs of debt capital management.
Software like Finley can significantly reduce the financial and operational burden of debt capital management by streamlining due diligence, ensuring compliance, and automating capital provider reporting.
Want to learn more?
Understanding—and optimizing—cash flow processes is a crucial part of building a successful fintech. If you're interested in learning more about software that can help you streamline your debt capital operations, just request a demo of Finley. We'd love to chat!