Financing explained

I have 30 years of financing experience so this post is to help my fellow Hotcopperites to further understand the financing piece.

BIG would have gone to FC Capital (and other financiers) and said "We have a product that we want you to finance, it's where SME's buy videos to promote their business". The finance companies would have looked at this and said "Sure, but as this is an unsecured product, as the video can't be resold, our interest rates will be circa 20% plus".

Why ? Because the financiers know what the default rates are for SME's (look at what Prospa and other fintech SME lenders are charging).

BIG would then have said "What can we do to get the interest rate lower for our clients ?"

To do this, the normal financing structure is that someone provides a first loss piece (or mezzanine debt). This means that the first loss piece absorbs all write-offs prior to the senior lender incurring any loss.

BIG would have said "How do we do that and can we issue you with Shares to provide that buffer"

My base case is that FC have accepted these shares as the first loss facility, and in doing so, this has allowed FC to provide loans at probably closer to a 10% interest rate (or lower), thereby making the financing package more attractive to SME's. This has in turn driven video sales, which has driven revenue, which has driven the share price.

From a cashflow perspective, here is how it works. SME signs up for $15k video, and pays cash which has been funded by an FC Capital loan. BIG recognise $15k of revenue. Because FC require a 10% first loss piece, BIG has to provide them with this, but does it via the issue of $1500 of shares, not handing back $1500 of the $15k it just received in cash.

So when you look at BIG's sales funded by loans, you will find circa 10% (but maybe higher) equates to what has been issued to FC in shares.

If we assume BIG has issued 4 million shares to FC at 25 cents, that's $1 million of shares that they thought would fund $10 million of loans. It would appear that they have written closer to $20 million in one quarter, so it may be that over the past 12 months, they have written closer to $40 million, noting that these loans amortise down on a monthly basis.

So the questions that BIG need to answer are
1. Have BIG provided a first loss piece to FC ? (via the issuance of shares)
2. Is the first loss piece valued using the market price for BIG shares or the issuance price ? This is an interesting question because if it is the market price, this works well on the way up, but not well if the price is falling and BIG need to issue more shares (assuming they don't have cash) to meet a growing first loss piece.

For all the conspiracy theorists, this funding structure is not unique, but its very clever as FC have taken shares as their collateral and are riding a very fast train. If all the SME's are actually paying back their loans (and not defaulting at the expected rates), they will be well in front. If SME's are not paying at the expected rates, FC may/will need to sell shares to recover the cash they have lent.

So the net result is that the upward spiral is great, but the downward spiral can be very nasty. Without greater disclosure on this structure, we will all be guessing. As FC are not listed, you're going to be in the dark for a lot longer, unless the PR team at BIG recognise the value of transparency to their longer term business model.