Asset Backed Securities: A New Financing Channel for Startups?

Collateralized securities offer start-ups further access to the capital market. But the instrument is far from suitable for every business model.

Grover, an electronics rental company, raised 270 million euros on the capital market at the end of September. A respectable sum, especially in the current rather difficult financing climate. The company didn't raise it with venture capital, but with so-called set-backed securities (ABS). In this financing instrument, the company issues a bond (security) that is backed by company property (asset-backed); in Grover's case, this means the electronic items that are up for lease. "We've done this before," explains Linda Rubin, Grover's chief investment officer since 2021 and COO since 2022. Since Grover is a startup with a lot of physical assets, she says, this form of financing lends itself well.

Given a market where venture capital is no longer as loose, the question is: Is this financing option attractive to other startups? Indeed, it does lend itself to a particular business model. But for both the companies and the investors, ABS can come with high risks. Startbase took a look at the main 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 means a very specific construction. In it, 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 in turn, for example through a bond.

Interest rates can be high, especially for startups

"This model is used a lot in car leasing, for example," explains Krahnen: "After all, the customer doesn't pay for the car in one go, but constantly over the leasing fees." Large car companies would use ABS accordingly to pre-finance the "purchase" of the cars they put on lease. Accordingly, it's business models comparable to Grover's that lend themselves to ABS. "A company needs a consistent revenue stream that they can offer as collateral for financing," Krahnen says. So Grover's business model of loaning electronics is a perfect fit.

Financiers generally get paid for their investment through 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 company failure. "You have to imagine the financial resources of a company stacked on top of each other," Krahnen explains: "The resources at the top are the safest, and at the bottom, in turn, are the so-called first-loss pieces, which are the first to be eaten up." Usually, 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. Selling high-risk ABS, including the first-loss piece, triggered the 2008 financial crisis, for example.

There is no such risk in the market today. But does the model make fundamental sense for startups? "I don't think that capital providers will finance startups on a large scale via ABS," Krahnen points out. Future cash flows are often difficult to forecast, he says, so the financier would have to place a lot of trust in the startup's projections.

Business models like Grover's are likely to remain the exception. Especially since the Berliners' goods have a resale value that can be clearly assessed. "The iPhones in our warehouse will not be worth nothing overnight," says Grover COO Rubin. Accordingly, Grover is attractive to ABS investors, he says.