Q&A: Decathlon Capital On Revenue-Based Alternative Lending

Oct 30 2017 | 3:49pm ET

Editor’s note: The explosion in private credit activity since the end of the financial crisis is rapidly changing the capital formation landscape, says John Borchers of Palo Alto-based Decathlon Capital Partners, especially for established lower middle-market firms. Increasingly, companies that don’t fit the typical VC or traditional-lender profile are looking to non-dilutive, flexible and patient revenue-based funding structures that can underwrite growth acceleration and value creation. 

FINalternatives: Decathlon’s revenue-based financing approach seems like a mix between lower middle-market venture and private debt. Tell us a bit about your company and its niche.

Borchers: Decathlon was founded with the goal of supporting a large but materially underserved community of companies that, for a variety of reasons, don’t fit neatly into pre-existing institutional investment buckets. Our typical portfolio company is deeply focused on growth and enterprise value creation, but there is often some misalignment with the traditional institutional investment landscape during a portion of the company’s growth lifecycle.

For example, many of the companies with which we work have compelling growth rates, but they operate at a breakeven level and don’t have the EBITDA profile required by many lower middle market PE investors. Similarly, many deliver consistent growth with attractive margins, but they are not in “hot” sectors or segments with total available markets large enough to create the type of outsized potential returns that a venture capital investor would typically seek. Also, a good percentage have equity offers in hand from traditional institutional investors, but just do not like the dilution and loss of control that they are being asked to sign up for.

In order to address the growth capital needs of these “orphaned” companies, Decathlon’s approach effectively allows a company to take on equity-like capital that is patient and flexible. Instead of selling shares in the business to an investor, the company agrees to repay the obligation based on a fixed percentage of future revenues. Our model allows companies that would not normally consider taking institutional capital (due to the dilution and loss of control it would entail) to access long-term funding for growth acceleration and value creation. In short, we are a private debt investor that offers an “equity like” solution to non-sponsored, growth-oriented companies dissatisfied with the limited range of traditional capital formation options.

Interest in alternative credit structures has surged in the past five years. How and where does Decathlon fit into the marketplace? 

Despite many new alternative finance offerings and material enhancements to the capital formation process during the last five years, the simple fact remains that for the large majority of companies, the process of securing growth capital is both difficult and hugely inefficient.

If you break it down to a very basic level, the process that a company needs to go through to try to find a market-clearing price for capital is pretty ridiculous. Even if a company engages an advisor (and adds the associated fee overhead to their cost of capital), the number of management team cycles and dead-end meetings just in the “discovery” part of the process is a massive commitment.

As importantly, once a company has found an interested capital provider, the process of aligning interests around valuation, liquidation preferences, control features, governance, exit-thesis, etc. makes for a very adversarial dialog, even when everyone wants to get a deal done.

Decathlon engages in the market with a fundamentally different solution that allows everyone to side-step issues related to valuation, control and forced future liquidity, and instead focus on value creation. By utilizing revenue-based financing solutions, our approach aligns investor and company interests around realistic growth targets and long-term outcomes. Because our return models aren’t dependent on an exit, warrant value or liquidity, we focus instead on steady operational execution rather than hockey stick projections, or trying to handicap future comp multiples. 

While the evolutionary pace of the alternative credit world during the last several years has been breathtaking, almost all the innovation has been anchored around traditional working capital-oriented solutions. We don’t spend any time trying to position Decathlon in that part of the sandbox. Instead, we are working to bring alternative credit innovation to the equity end of the capital formation spectrum. By leveraging our revenue-based funding approach, we can displace equity providers with a fundamentally better solution for established, growth-focused companies.

Do your investors fund these transactions on a per-deal/SMA basis, or is investment capital pooled?

To serve our market effectively, we believe the agility and long-term perspective that comes from managing committed pools of capital is necessary.

Our limited partners are obviously interested in the consistent monthly yield that we attempt to provide via monthly distributions, but also understand that they are investing for cash-on-cash multiple returns and not exclusively just targeting attractive IRRs. A dedicated fund structure allows us to serve both masters effectively while working to provide a very flat J curve and consistent, repeatable returns.

What is the typical progression after you work with a company? Do you participate in subsequent PE/venture/debt rounds?

Because Decathlon’s offering is positioned as an alternative credit equity-replacement solution, most companies with which we work end up expanding their funding relationship with us over time, especially as additional visibility into their growth trajectory becomes available.

One feature of our approach that often resonates with companies is that we can start with a fairly modest initial funding package, yet have the capacity to grow with them over time. We don’t have any convertibility features and most of our portfolio companies don’t have institutional equity sponsorship, so we often fill the role of long-term “investor” and maintain a four- or five-year relationship with a company over an expanding series of capital commitments.

How is the fundraising environment? Is institutional interest growing, and from which segments is it coming (family office, RIA, asset manager, hedge fund, etc.)? Why is this niche attractive from an investor’s point of view?

We haven’t been active in the fundraising market for the last two years, so we are not well positioned to comment on current private debt fundraising trends. However, we do think that the fundamental cornerstones of Decathlon’s strategy offer some fairly attractive features to institutional investors looking for non-correlated yield. 

The core premise of our strategy is to deliver equity-like returns with debt-like risk. The only way to do that on a consistent and repeatable basis is to operate in a structurally inefficient market where a manager can deliver alpha without market-based dependencies.

At a more tactical level, institutional investors are attracted to the segment for a few key reasons. First, the strategy generates attractive yield in the form of monthly cash distributions without much exposure to changes to the interest rate environment. Secondly, it allows investors to generate equity-like returns without an exit event, healthy public markets or enterprise value creation at the company level. This “exit-less” return model means that the strategy is doesn’t suffer from tight correlations with other major asset classes and indices. Finally, investors like the counter-cyclical structure of the revenue-based funding construct. Because many loans are structured as IRR targeted notes, in a recessionary environment, a company may grow more slowly but as a result, will deliver a larger multiple.

How will rising interest rates impact Decathlon and/or its borrowers? Do you think traditional banks will return to the SMB space in enough scale to crowd out alternatives lenders?

Rising rates and the potential for a receding regulatory tide will certainly put additional pressure on alternative lenders who have successfully filled the vacuum during the last five years. That said, we believe a beachhead has been established and is here to stay. In the future, distinctions between alternative lenders and traditional banks may begin to blur in a range of areas, and the fusion will result in a series of more competitive offerings across the market spectrum.

Like everyone in the private debt category, Decathlon will certainly feel some impact from rate and regulatory changes, but we believe that we may be a bit more insulated from these types of externalities due to our positioning in the market. Unlike many private debt providers focused on the sponsored universe of companies or those dependent on the performance of warrants or other non-current pay features to drive their return targets, we’re largely focused on replacing equity in non-sponsored transactions. The cost of capital analysis done by the companies we work with is focused on comparing Decathlon’s revenue-based funding approach to the cost of dilution in the form of equity, so changes in the interest rate environment don’t really impact the math for companies in our segment.

While the large majority of the alternative credit crowd sees banks as frenemies with which they must both cooperate and compete, we are fairly agnostic to bank activity. We really compete against equity providers to fill the role of a company’s institutional funding partner. 

Despite all the innovations and advances from both banks and private lenders during the last several years, the large majority of growth companies still cite access to capital as one of their biggest challenges and bottlenecks to growth. We believe that there is still a huge opportunity for major improvements to the capital formation process, and that revenue-based funding models will capture an increasingly large percentage of the market’s activity over time.


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