00:21:08 · Martino Cadoni, Guillaume Moubeche
And one of that, unfortunately, is also economic cycles. And that's why we have seen these ups and down in different sectors. We've seen it in fintech. Right? Valuation were extremely rich between 2020, 2021. And then in 2022, with interest rates going up and uncertainty in the macro and geopolitical scenarios. And there was big adjustment where some companies got impacted more than others. Right? But I think each case should be also analyzed on on an individual basis because there are some drivers which are specific to a to a vertical or or to a specific company. Right? When it comes to fintech of the the interest rate environment plays a huge role, and and that's what, you know, impacted the valuation of a lot of fintech in in 2022 and beyond. [00:22:11] S1: Can you explain, like, why the the interest rate has an impact, you know, on on valuation? And basically, like, maybe share, you know, the narrative from an investor perspective.
00:22:24 · Martino Cadoni
[00:22:24] S0: Yeah. I mean, so very simple. So what a bank or a fintech does, or let's say a lending fintech does. Right? You are taking money, and then you are lending to somebody else. Right? So it's very critical at... When you are taking money at which rate, at which cost you are taking the money to then give it to others. Right? And what happens particularly if you are a bank, you have the ability to raise deposits from the public. So usually, the cost of money for those deposits is a function of the interest rates, which is set by the central banks. Right? So if I'm a bank and you have a bank account with me and you put your money in... Into my bank, if the central bank rates are very low, I'm able to pay you a very low interest rate. Let's say, I don't know, below 1% or even close to zero back then. So for me, it's very cheap to take your money and then lending it to somebody else at good enough high rate. I can make money on the spread. But if instead of the zero point something percent, I need to pay you four or 5% because that's what the market dictates, then it becomes much more expensive for me to take your money and relending. Also, because most likely, the spread they're gonna make on that loan is gonna be lower than it used to. Right? And also, there are demand offer. Yep. People also will be less interested in taking a loan if the interest rates are so high. Right? So there is a a funding... And that's why you had double issue in fintech because one is what I just described, where it's about the deposits. But also, there are a lot of companies in fintech, which they don't have a banking license, and therefore, they cannot take deposits. So instead of taking the money from you, they take it from, for example, from private credit investors where they are much more expensive even. And so you had fintech. I have worked with some of those as an adviser where they were trying to raise private credit money, but because the interest rates were so high, they couldn't find anything below 15 or 20%. But then you cannot do much when the cost of capital is so high. It's not really a good use of capital. So, yeah, for fintech specifically, high interest rates, yeah, is not a great scenario from a funding point of view. Right?
00:25:24 · Guillaume Moubeche, Martino Cadoni
[00:25:24] S1: And How do you how do you hedge yourself? Because obviously, like, the the rate is not something you decide as a company. It's like, it's totally outside of your control. Obviously, you can look at the macro and try to predict a little bit where it's going, but it's it's very hard. So how how do you hedge yourself as a company? [00:25:42] S0: So the the key is you need to divert... Differentiate your revenue streams. And for example, that's something that Revolut has done fantastically well. Right? Because as a fintech, as a bank, you have interest revenue, which is highly dependent on interest. And then you have fee revenue, which is like fees, subscription revenue. And for example, Revolut has done a fantastic job because if you look at the revenue mix, it's highly differentiated across fees, interest, and other things. So it doesn't matter what's happening in the macro environment. They are better prepared than others because they are so well diversified that they're gonna take advantage of any type of situation. Right? And they can navigate uncertainty in a much better than others. And so... And then also on the products, depending on the type of lending you you have, you can also take advantage of the very high interest rates. [00:26:49] S1: Okay. And how how would you do it? Like, the interest rates are, like, super high. Like, how do you take advantage? [00:26:56] S0: Well, I mean, you you can target, like like, shorter term lending where people are more, you know, open potentially to have higher interest rate.
00:26:56 · Martino Cadoni, Guillaume Moubeche
[00:26:56] S0: Well, I mean, you you can target, like like, shorter term lending where people are more, you know, open potentially to have higher interest rate. [00:27:10] S1: Okay. And when the when the valuation of Klarna, like, was... Went from, like, 45 to, I think, like, 15, like, how exactly do you do you manage, like, your investors? Because, you know, I think it happened to to a lot of startup as as per... I mean, scale up, especially in that era where, you know, like they had to do kind of a down round, etcetera, etcetera. But internally, like, how do you have like these discussions with the board? Like, are investor protected with with, I don't know, like, preference share or like kind of like, how how do you make it work for everyone basically? [00:27:49] S0: So what I would say, it really depends. Right? And and that was one of the strengths of Klarna. Right? Klarna never raised preferential shares or... Never issued preferential shares. And this is another thing that I think people don't really know about fintech and banking. Right? If you are a bank, like a regulated bank, right, and you are subject to capital requirements, which means that you need to put aside a lot of equity to comply with some banking ratios. Like, I'm not gonna go into the details, but there are ratios you need to meet in order to be able to keep operating as a bank. Right? [00:28:36] S1: And So basically, you need to have, like, some cash available for, like, certain reason. Let's say, like, because you're a bank, so you need to operate and have, like, certain cash on your balance sheet.
00:28:47 · Martino Cadoni
[00:28:47] S0: Yeah. For prudential, this comes to Basel regulation to prudential rules where... Because you are responsible for the money from from the public, you need to have equity against your your assets in order to meet these requirements. What these rules say is that if you have preferential equity, so equity which is linked to preference shares, you cannot account fully for this equity against the criteria. So if a company like Revolut raises 1,000,000,000, for example, and that 1,000,000,000 is common shares, then the full 1,000,000,000 can be used to comply with the rules. So all good, everyone happy. Right? But if the 1,000,000,000 is subject to... Is a true preferential shares, then actually that that 1,000,000,000 does not count to comply with the rules. So it's kind of useless. So it's great you raise 1,000,000,000, but it cannot be used to comply with the regulation, and therefore, it loses a lot of value. And that's why you had cases like, for example, Klarna never issued a preferential share. So with that common share, which is great from a regulation point of view. And and then you have cases like Revolut that at the early stage, they issued some preference shares. But then when they became they regulated, they decided that, hey. We cannot do this anymore, and they issue only common shares. Right? And and then as you grow and become public, you can have a mix of the two because you have so much equity that, you know, you can optimize. Right? Because, obviously, common share is more expensive. Because that's another thing people do not realize that happens and had happened during the the bubbles. Right? There is imagine you have two companies that are identical in tech. One issues only common shares, and one gives you the opportunity to buy preference shares. Which one of the two do you think is gonna have higher valuation?
00:31:14 · Guillaume Moubeche, Martino Cadoni
[00:31:14] S1: Yeah. The one with the preferreds. [00:31:16] S0: Exactly. So you had a lot of companies which they were raising at, they became unicorn, but they have a very high preference share thresholds. And then what happens is when the market turn upside down because of their preference thresholds, they became what we call zombie con. They are stuck. Right? Because they cannot raise at any valuation similar to the last round. They have these preference shared thresholds, which now put them in a corner. Right? While if you issued common share, yes, it was... You couldn't raise a so high valuation back then, but you are free now. You don't have this preference threshold, you know, behind you. Right? [00:32:04] S1: So your advice, like, for founder would be to to never raise preferred and always