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As a startup founder, you may have come across the term ‘securitisation’. In short, securitisation is the process of pooling future receivables like income arising under licensing arrangements into securities that investors can buy and sell. While securitisation has traditionally been a source of financing for large publicly traded companies, startups have begun accessing it as financing. This article will explain securitisation in more detail in the context of startups.
What is Securitisation?
Securitisation involves the transformation of future cash flows, such as contractual payments, recurring revenues, and royalties, into tradable securities, known as asset-backed securities (ABS).
Since these ABS derive their value from the underlying assets, startups can sell an ABS to investors. In this sense, securitisation allows startups to access capital by leveraging their anticipated revenue streams. Consider the following example.
Is Securitisation Suitable for My Business?
While securitisation seems like a viable option for businesses seeking to finance their ventures, it is not suitable for most startups. There are key characteristics that make certain startups more suitable for raising financing through securitisation.
Size and Growth of Your Startup
Securitisation is typically more suitable for larger startups that have:
- established a significant customer base;
- have consistent revenue streams; and
- exhibit growth potential.
Startups in the early stages of development may not have the necessary scale or predictable cash flows to make securitisation a viable option.
Quality and Quantity of Receivables
If you are considering securitisation, you should assess the quantity and quality of the receivables. This is because this process treats the receivables as collateral for the upfront financing.
Accordingly, the receivables should be substantial enough to attract investor interest and demonstrate a low risk of default. Startups with a diverse customer base and long-term contracts are more likely to meet these criteria.
Market Demand
Startups should evaluate the market demand for their asset-backed securities. Accordingly, investors will evaluate the creditworthiness of the underlying receivables and ensure they are sufficiently guaranteed to generate future cash flows. Nevertheless, before you consider securitisation, you should speak to a financial adviser.
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What Are the Advantages of Securitisation for Startups?
Securitisation offers several advantages that make it an appealing financing option for suitable startups.
| Benefit | Explanation |
| Access to Capital | By securitising their anticipated revenue streams, startups can access capital that may not be readily available through traditional financing. This means startups can more readily fund business expansion. |
| Diversification of Funding Sources | Securitisation allows startups to diversify their funding sources beyond traditional options like bank loans or equity investments. By tapping into the capital markets, startups can attract a broader range of investors and reduce their dependence on a single source of debt funding. |
| Improved Cash Flow Management | Securitisation provides startups with immediate cash inflows, enabling better cash flow management and addressing liquidity challenges. This capital infusion can cover operational expenses, invest in growth initiatives, or seize market opportunities. That said, securitisation is not usually a form of short-term financing. It is unlikely that using the proceeds of a securitisation to fund working capital is an efficient use of the funds. Instead, this is better served through short-term financing, like factoring, which can be thought of as a short-term form of securitisation. |
| Risk Mitigation | Through securitisation, startups can transfer the credit risk associated with their receivables to investors. This risk transfer mechanism, particularly in cases of non-recourse securitisation, can help protect the startup from potential defaults or non-payment by customers. However, investors will not invest in ABSs if the underlying credit risk is too high. |
What Are Some Practical Considerations?
There are other legal and operational considerations to bear in mind when you consider securitisation as a form of financing.
Legal and Regulatory Compliance
Securitisation transactions are subject to legal and regulatory requirements. As a result, startups must comply with:
- securities laws;
- disclosure obligations; and
- investor protection regulations.
Cost and Complexity
Securitisation transactions involve various costs, including:
- legal fees;
- due diligence expenses; and
- structuring costs.
Startups should carefully assess these costs and weigh them against the potential benefits.
Advisory Fees
In addition to legal fees, you must factor in the advisory fees your financial advisers will charge your startup. These fees are considerable and cover the expenses associated with:
- due diligence;
- structuring; and
- underwriting the financing.
Operational Capabilities
In most cases, your startup will have to actively ensure that the receivables are paid to the SPV managed by a trustee on behalf of the investors. This requires robust operational capabilities, including:
- efficient record-keeping;
- data management; and
- servicing the receivables.
Consider Alternative Financing For Your Startup
Securitisations are among the most complex forms of financing. The scale and quality of receivables mean that it is not appropriate for most startups, especially those in their earlier growth stages.
As a result, you may wish to consider other forms of financing, including:
- equity financing;
- debt financing;
- hybrid financing; and
- short-term financing like factoring and invoice discounting.
LegalVision’s Startup Manual is essential reading material for any startup founder looking to launch and grow a successful startup.
Key Takeaways
Securitisation can be a valuable financing option for startups with sufficient cash flow, substantial receivables, and underlying creditworthiness. It is the process of pooling future receivables like income arising under licensing arrangements into securities that investors can buy and sell. While navigating the legal and practical considerations is crucial, the potential benefits make it an attractive option for suitable startups.
If you need help with your startup, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
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