Leandro (SixPoint):
What makes a debt deal special or different from other types of deals?
Armi (Partners for Growth):
Debt serves a specific purpose. It could be for working capital, expanding a loan book, or growing a specific asset base. We focus on all these areas, dealing with everything from corporate to asset-backed facilities. Typically, there is a clear intention behind taking on debt. For instance, asset-backed financing is often tailored to growing a loan book, receivables, or other assets that a company accumulates and then resells, where residual value is expected. This type of finance is segregated and distinct from equity.
Unlike equity, debt is not permanent capital—you must pay it back. This requires careful consideration of your business’s ability to generate cash flow to support the debt and ensure the underlying product can sustain the facility.
Understanding the terms and the associated costs is crucial.
Rich (Paul Hastings):
Debt is indeed more challenging to put in place. It is expensive and involves complex underwriting. Unlike venture capital, which can sometimes be more abstract, debt is rooted in numbers, metrics, and risk.
As a lender, you need to assess how collateral might lose value and what the potential risks are. This same mindset should apply when you are seeking debt—anticipating the lender's concerns and questions. Equity investors may tolerate some risk for potential upside, but debt investors are focused on not losing money. This requires a different approach altogether.
Armi (Partners for Growth):
To add some metrics, an equity fund might expect one or two deals out of ten to make money. However, in our case, we cannot afford to lose a single dollar. Our upside is capped, and our return profile to our LPs targets around 1.72x cash on cash and 20% IRR, which we achieve through limited equity gains on warrants and interest income facilities. There is no room for error.
AJ (SixPoint):
I completely agree. Debt investors are primarily concerned with downside protection. They only care about the upside if it proves that there is a sustainable model for scaling a loan book. If we commit capital, we want to be sure it is deployable, as it restricts us from investing in other opportunities. Unlike equity investors, who are interested in market potential, we focus on how you have built your business to ensure our capital is safeguarded. Debt deals are complex and expensive, with significant emphasis on structuring covenants and early warning mechanisms to prevent issues from escalating.
Pedro (Addem Capital):
It is operationally intensive. You need to be efficient while ensuring your infrastructure can scale long-term.
Balancing these aspects is challenging because you must repay the debt, so overspending is not an option.
Kyle (Cascade Debt):
Another aspect is the time it takes. Structuring debt deals involves a lot of data, legal work, and organization, which can be very time-consuming.
AJ (SixPoint):
Even after closing a deal, maintaining and monitoring it requires significant resources. Debt investors tend to be more solution-oriented, willing to work around risk issues, which makes the process longer and more costly. In equity deals, there is often a standard form with little need for structuring, but debt deals are much more customized.
Leandro (SixPoint):
For our last Mexican deal, we had twenty-nine individual documents, but when you include the different SPVs in the transaction, it amounted to fifty-eight legal documents.
This leads to my next question, why did we need fifty-eight legal documents?
Rich (Paul Hastings):
When evaluating a deal, the first step is to assess if the asset produces yield and has a stable credit profile at scale. If the answer is yes, we then evaluate the platform’s stability. The next step is determining the level of risk we are willing to take—whether it is corporate risk or segregating assets into a vehicle to avoid their entanglement in the platform's potential bankruptcy. The structuring process aims to remove corporate credit risk from the asset, beyond just servicing. This involves significant complexity and cost, especially in Latin America, where various trusts and SPVs are often used. It is important to ensure that the structuring is worthwhile in the long run.
AJ (SixPoint):
The cost of setting up a debt facility can be high, often ranging between $300,000 and $500,000. However, this investment can be leveraged for future credit facilities, reducing incremental costs for subsequent deals.
It is essential to view this as an investment that amortizes over the deal’s lifespan.
Armi (Partners for Growth):
Additionally, jurisdictional issues and hedging must be considered, especially in multi-jurisdictional deals. This adds complexity that equity deals typically do not face.
AJ (SixPoint):
Platforms new to this process often underestimate the complexity compared to equity deals. Preparing adequately for a debt deal, including having the necessary documentation and governance in place, can make a significant difference in the process's smoothness and cost.
Kyle (Cascade Debt):
To minimize costs, companies should prepare as much as possible before involving debt investors. This preparation includes understanding asset quality and being ready to make constructive arguments to debt investors.
Leandro (SixPoint):
Do platforms usually have the information needed to produce that?
Kyle (Cascade Debt):
Most platforms should know their loan book's quality but presenting that information to debt investors requires a different level of detail and education.
Many founders leave money on the table because they struggle to negotiate effectively during this process.
AJ (SixPoint):
One of the challenges is that the documentation required by debt investors is often different from what equity investors care about. It is important for platforms to understand this and prepare accordingly.
Leandro (SixPoint):
What third-party providers are necessary for a debt deal, and what challenges arise in integrating them with the platform?
Pedro (Addem Capital):
One of the complexities is that despite high legal costs, you often deal with people who may not fully understand the process. Involving multiple actors, such as fiduciary services, operators, and CFOs, complicates things further. We have tried to minimize reliance on third-party services, instead embedding them into our solutions to reduce the burden on entrepreneurs. In Mexico, there is a lack of sophistication in private debt services due to the emerging market’s relatively recent exposure to VC money. However, I believe this will improve as the private debt market grows in these regions.
AJ (SixPoint):
Armi mentioned that the complexity and cost of transactions increase with the number of jurisdictions involved. For example, a typical Mexican corporate structure might involve entities in the Cayman Islands, Delaware, and Mexico, requiring legal representation in each jurisdiction. It is crucial to select the right borrower’s counsel, as choosing poorly can significantly increase costs and prolong the transaction.
Leandro (SixPoint):
How can a platform choose the right partner to provide legal counsel?
AJ (SixPoint):
When evaluating a platform, one of our first questions is about their legal representation. We assess whether the firm is equipped to manage structured debt transactions. If not, we recommend firms from our panel that we know can save time and reduce costs.
Rich (Paul Hastings):
If I were preparing for a debt deal, I would reach out to other fintech entrepreneurs to ask about their experiences with different law firms. Additionally, asking lenders for their recommendations can be insightful, as they often have a good sense of which firms are reliable.
AJ (SixPoint):
It is not about choosing a firm that will simply concede to every demand. You want a borrower’s counsel who understands the key issues and can address them predictably and sensibly, without complicating the process.
Armi (Partners for Growth):
Lawyers should focus on legal issues, not commercial terms, which can often lead to unnecessary complications.
Rich (Paul Hastings):
Predictability is key. Lenders want to work with borrower’s counsel who raises legitimate issues without turning every small detail into a negotiation. There is a line that, if crossed, could kill the deal, so it is crucial to know where that line is.
Leandro (SixPoint):
From your perspective, what kind of talent is indispensable when engaging in a debt deal? What expertise is necessary for you to proceed, and what skills can you afford to source externally?
Armi (Partners for Growth):
For us, a weak finance team is a deal breaker. It does not necessarily have to be a CFO, but there needs to be someone who deeply understands the numbers, the data, and can generate reports and answer our questions effectively.
We are often more involved in your business than your board or equity investors, so having someone on the other side who really gets it is crucial. This role might fall under finance or a combination of risk and finance, but strong financial knowledge is essential. Additionally, we need people who understand the asset class, whether through direct experience or from advisory roles in that space. These are the key areas we focus on.
Pedro (Addem Capital):
For us, having a product-oriented co-founder is crucial. At the end of the day, although it is money you are dealing with, the product must add value, especially in a recession environment. We have seen many products that, despite having excellent risk teams and allocation strategies, fail to consider if they are solving any problem or adding value to the recipient. A strong lending business is typically one where the product itself makes sense.
AJ (SixPoint):
Armi and I share the view that a strong finance person is essential. I always use this classic debt mantra: It is easy to lend money, but hard to get it back. If a platform does not prioritize collections and risk management, that is a huge red flag. It is uncomfortable to engage with a platform that does not emphasize these aspects. Moreover, there is an inherent tension between credit investors and equity investors. Equity investors might push for rapid growth at any cost, while debt investors care about how they might lose their money and how risks are mitigated. I would rather see a solid, stable track record than rapid, risky growth. This approach requires having someone within the business who focuses on these priorities because we need to ensure our capital is well-managed and that we will be repaid.
Kyle (Cascade Debt):
My perspective might be unconventional, but it is crucial not to rush through deals without proper back testing. We recently dealt with a situation where a deal signed in the summer was not tested until January, leading to the need for amendments simply because no one had back tested. Pausing to thoroughly understand your data is critical.
Rich (Paul Hastings):
I will answer this from a different angle, as a lawyer deciding whether to take on a platform as a client. We handle a lot of these deals, and it requires a significant investment in learning about the company. The first deal is often a slog, involving extensive time with the management team, much like lenders evaluating the scalability and profitability of a business. Sometimes we turn down clients if we do not see a willingness to understand the deal’s complexities. If the primary funding source is debt capital and the platform does not grasp these deals, they are taking on strategic risks they do not comprehend. If we think a business is likely to fail because it will not pay attention to details, it is not worth our time. However, sometimes explaining these concerns to founders leads them to change their approach.
Question from the audience:
Could you share your thoughts on which terms you try to agree from the start and which ones you prefer to leave open for future negotiations?
Armi (Partners for Growth):
Term sheets are usually not very long—about four or five pages—but we try to capture as many commercial terms as possible in that document. We aim to finalize terms as closely as possible, whether it is a percentage, a trigger, or any other metric. Although there are often ranges or estimates that get refined during due diligence and finalization, the boundaries tend to be relatively accurate. We do not want to waste anyone’s time.
AJ (SixPoint):
Our term sheets range from 18 to 20 pages and are very detailed. However, we emphasize to our platforms that only two provisions are binding: expense reimbursement and exclusivity. The rest is non-binding, subject to formal due diligence and final approval. We include detailed cash flow models and waterfall calculations to ensure platforms understand the deal fully before signing. Although we cannot always provide exact trigger levels initially, we work closely with platforms to educate them on these metrics once they are determined.
Pedro (Addem Capital):
In our case, with less capital, we take a different approach. We tend to be quick with smaller tickets, where we have sufficient protection to make fast decisions. We keep the process simple, setting specific thresholds where we start adding complexity to the deal as needed. This allows us to scale effectively while maintaining a straightforward initial structure.
Rich (Paul Hastings):
From the platform perspective, if you need money in six months, know that deals with any structuring can take three to four months to finalize.
The risk of signing a term sheet is that you are locked into exclusivity, unable to talk to other lenders for 90 to 120 days. It is important to include every material term in the term sheet to ensure there is a general agreement before going exclusive. This balance is crucial to avoid getting stuck in exclusivity without a deal.
AJ (SixPoint):
Sometimes platforms ask for a bridge loan while the main deal is being finalized. However, we often discourage this because the due diligence and documentation for a bridge loan are as extensive as for the main deal. Instead, we suggest going back to equity investors for a bridge, as they know the platform better than we do at that stage. Once we are further along, we might be open to some degree of double leverage or working with other lenders for on-balance sheet financing, but it is essential to be mindful of the time these deals take.
Rich (Paul Hastings):
It is not about having every detail in the term sheet, but about having a mutual understanding and trust with the lender. You need a term sheet that covers the essentials, but you also need to trust that the lender is aligned with your goals before entering exclusivity.
Moderator:
Leandro Marcarian – Head of Macro Research and Due Diligence at SixPoint
Panel:
Kyle Meade – COO at Cascade Debt
Rich Davis – Partner at Paul Hastings
Pedro Cetina Bernal – Partner at Addem Capital
Armineh Baghoomian – Co-Head Global Fintech at Partners for Growth (PfG)
AJ Davidson – Co-Founder and CEO at SixPoint Capital
