Asset-backed securities: a new financing channel for start-ups?

Collateralized securities offer start-ups additional access to the capital market. But the instrument is by no means suitable for every business model.

The electronics rental company Grover raised 270 million euros on the capital market at the end of September. A respectable sum, especially in the current difficult financing climate. The company did not achieve this with venture capital, but with so-called set-backed securities (ABS). With this financing instrument, the company issues a bond (security) that is secured with company property (asset-backed); in Grover's case, this is the electronic items that are available for rent. "We've done this before," explains Linda Rubin, Chief Investment Officer at Grover since 2021 and COO since 2022. As Grover is a start-up with a lot of physical assets, this form of financing lends itself well.

In a market where venture capital is no longer so loose, the question arises: is this financing option also interesting for other start-ups? It does indeed lend itself to a certain business model. However, ABS can involve high risks for both companies and investors. Startbase has taken a look at the most important advantages and disadvantages for you.

ABS are not a new phenomenon, as Jan Pieter Krahnen can explain. He heads the Leibniz Institute for Financial Market Research (SAFE) in Frankfurt am Main and has been studying ABS for many years. "In principle, every corporate bond is an asset-backed security," he says. In common parlance, however, it refers to a very specific construction. In this case, a company outsources some of its receivables to a special purpose entity - the receivables are the assets here. This special purpose entity then collects money, for example via a bond.

Interest rates can be high, especially for start-ups

"This model is used a lot in car leasing, for example," explains Krahnen: "The customer doesn't pay for the car in one go, but constantly via the leasing fees." Large car companies would use ABS to pre-finance the "purchase" of the cars they lease. Accordingly, business models comparable to Grover are particularly suitable for ABS. "A company needs a constant income stream that they can offer as security for the financing," says Krahnen. Grover's business model with rental fees for electronics is therefore a perfect fit.

Financiers are generally remunerated for their investment via an interest rate. How high this is depends on the seniority of the loan, i.e. how quickly the money is gone in the event of a business failure. "You have to imagine the financial resources of a company stacked on top of each other," explains Krahnen: "The funds at the top are the safest, while at the bottom are the so-called first loss pieces, which are the first to be used up." As a rule, this is the equity, so the highest risk lies with the company itself. "But it doesn't have to be that way," says the financial expert. The sale of high-risk ABS, including the first loss piece, triggered the 2008 financial crisis, for example.

Such a risk no longer exists on the market today. But does the model fundamentally make sense for start-ups? "I don't believe that investors will finance start-ups on a large scale via ABS," Krahnen points out. Future cash flows are often difficult to predict, so the financier would have to rely heavily on the start-up's forecasts.

Business models such as Grover's are likely to remain the exception. Especially as the Berliners' goods have a clearly assessable resale value. "The iPhones in our warehouse won't be worth nothing overnight," says Grover COO Rubin. Grover is correspondingly attractive for ABS investors.