Last week, CapitalFloat was reported to be in talks to raise $150MM for getting deeper into the SME market in India.
Small to Medium size enterprises are the cornerstone of the Indian economy. It employs 40% of the Indian workforce and accounts for a quarter of the Indian GDP. SMEs bring innovation and ensuring they are financed well oils the economy. The recent government push to promote SMEs has only accelerated it.
It is little wonder that the SME lending market is pegged at $200Bn, and growing at 11%.
Small to medium enterprises work in various sectors and need loans for a variety of purposes. The sectors are wide, from doctors who need to setup hospitals, to sellers who need to sell on Amazon. Many of them are able to start a business and find product-market fit, and do the first step right. Most need financing to grow and expand. At a small scale, this capital can become incredibly critical to help a company grow. The capital requirement is usually legitimate. The issue is that many of these companies do not have enough data to prove that can get financed.
Banks are unable to get comfort to finance these companies, and that makes it complex for SMEs.
Instead of providing financing to small companies with ease, banks are loathe to provide capital. As these small companies do not have enough history, they are (rightly) perceived as high risk. It is expectedly found that the cost of financing small companies is significantly higher than larger companies. Not only do small companies find it hard to get capital, even if they do, it’s usually very expensive.
This is the opportunity that Capital Float wants to tap.
Capital Float was started in 2013 by Stanford classmates Gaurav Hinduja and Sashank Rishyasringa. Inspired by what they saw in the US with companies such as Lending Club, they decided to replicate financing for small businesses in India. They observed a large market for financing small businesses, that was untapped by the financial system. In the fast-growing market of e-commerce sellers, they also saw a business model needing financing that was alien to banks. It was a market that was large, unorganized, untapped.
It was ripe for disruption.
Capital Float, as its clever name suggested, wanted to provide quick capital to small businesses. The value proposition was to give small businesses instant loans, without collateral. The critical piece here was the distribution channel – Capital Float decided to provide loans on the internet.
That would prove to be a wise move.
Right around the time Capital Float started, Indian e-commerce began to pick up rapidly. Circa 2014 would be the year e-commerce would explode, with Flipkart, Amazon, Snapdeal going into a three-way to dominate the market. Each of them would move aggressively to acquire customers, and sellers to sell on the platform. It would be clear that sellers would need to grow fast to service the explosive growth in customers. What would the sellers need to grow faster?
Financing, of course.
Within a year of starting, Capital Float had disbursed $6MM worth of loans to majorly e-commerce sellers. The company grew from 20 loans a month, to 200 loans a month, within a year. Capital Float ended up raising $12MM of capital that year seeing the enormous growth in the scale of its operations.
One is now rightly puzzled as to what Capital Float really does differently from a bank, and how its business model works.
Its model was born out of the need that the founders identified. Small businesses wouldn’t necessary get the loans from banks. Banks mistrusted businesses, and the problem to solve for was trust between bank and SME. Capital Float became the trusted intermediate that would identify and vet businesses for the banks, while providing an excellent experience for the businesses. Businesses would get loans approved in 10 minutes, and disbursed within 3 days.
Fast, friendly and affordable. Businesses would love it.
But there are risks associated with such magical experiences. Default rates are structurally high because the businesses are small, and cash flows unpredictable. Capital Float claims it uses thousands of data points to vet the quality of the businesses and accepted 20-30% of the applicants for loans. A 16-18% annual interest rate would bring it close to bank rates. Capital Float would raise the capital at an 8% interest rate, and this was the company’s “cost of capital”.
Within two years, Capital Float would originate $60MM of loans, with a monthly run rate of $10MM. This was largely fueled by the growth in e-commerce, and by 2016 Capital Float raised another round of $25MM. With more equity capital, the company could build out its product and market to a larger group of businesses. Capital Float also raised debt lines, using which it would finance more SMEs for loans. With the NBFC license that it had when it started, it increasingly began to disburse loans off its own balance sheet.
From an originator that would underwrite loans, Capital Float began to disburse loans itself. For sectors that banks thought were too risky to serve, Capital Float would start by disbursing loans and proving that loans to a particular sector were viable. Through a larger risk appetite, and analyzing data, the company would effectively serve underserved markets for credit.
2016 would prove to be a windfall year for financial technology companies. The government announced demonetization, which crippled the rural economy, but formalized a lot of business onto digital platforms. Combined with the GST rollout, a lot of small businesses onboarded onto Capital Float to tap into loans at attractive interest rates. Capital Float’s loan disbursal per month grew to $31MM, from $10MM just a year back. India set up a robust digital infrastructure (known as the India stack), that propelled India’s financial infrastructure to scale.
Capital Float was in big business.
In 2018-19, Capital Float plans to add $66MM per month to its loan portfolio. Per its 2017-18 filings, the company did a revenue of 135 Cr (~$20MM). Given most loans for the company are of a year or less, one can assume the interest revenue is generated directly from loans disbursed in a year. For the ~$200MM Capital Float generated in 2017, that is effectively a 10% annual interest rate on its loans. The company also wrote off INR 16 Cr ($2MM) worth of loans, implying that the “real” revenue is ~$18MM (or 9%). Given that interest revenue is dependent on both the interest rate and tenure of the loan, snoopy math would reveal that most loans are for half a year (9/18 = 0.5) . Assuming the same rates apply for this year, an $800MM disbursal would generate ~$72MM of revenue.
The $150MM raise, likely for 20% of the business, would value the company at 10x revenue. The advantage of financial technology businesses is that they are all about finding customers who will not default, and servicing them the appropriate loans. In the age of the internet, it’s about finding them digitally (customer acquisition) and servicing them (lifetime value). For 300,000 customers added, it’s ~$2,000 per customer ($800MM/0.3MM). With the effective 9% interest, it’s $180 of first-order revenue. With 8% being paid as cost of capital, contribution margin would ~$20. Over 5 years, if the customer got just one loan a year, that would be $100 of lifetime value. Acquiring customers at less than $100 would make Capital Float a money-making machine.
With a $200Bn lending market, and likely $20Bn of true revenue, the sky is the limit. Capital Float has only scratched the surface. As it locks in more customers, it will squeeze more lifetime value.
Capital Float will likely finance India, and itself, to economic success.