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With Scott Orn

A Startup Podcast by Kruze Consulting

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Scott Orn

Scott Orn, CFA

Arc's new marketplace for venture debt

Posted on: 02/04/2024

Don Muir

Don Muir

CEO - Arc

Don Muir of Arc - Podcast Summary

Don Muir of Arc explains Arc Capital Markets, a marketplace for bespoke venture debt and startup-focused credit products. Arc Capital Markets joins Arc’s other products, including treasury management and financial solutions for startups.

Don Muir of Arc - Podcast Transcript

Healy: Hey, this is Healy Jones, VP of Financial Strategy here at Kruze Consulting, and  I want to say thanks to our podcast sponsor, ARC. At Kruze, we’ve got a number of clients successfully using ARC to manage their deposits, payments, access financing, all in one place. One of the things that ARC provides that’s really great is over a quarter of a million dollars in FDIC coverage. Their insurance program goes beyond the standard limit and it secures up to five and a quarter million dollars. So, startups that have even more cash than that can go and access treasury solutions to provide yield and safety. If you’re a startup looking for a secure financial solution that can help you scale, please check out our sponsor ARC at ARC.tech.
Scott: Welcome to Founders of Friends podcast. Scott Orn of Kruze Consulting, and today my very special guest is Don Muir of Arc. Welcome, Don.
Don: Hey Scott, great to be here. Thanks for having me.
Scott: My pleasure. I think this is like the maybe fourth time you’ve been on the podcast.
Don: The third, fourth. I lose track of the number of times we chat, Scott, I enjoy the conversation so much.
Scott: I love it, you’re buttering me up.
Don: Hopefully you take it easy on me.
Scott: Yeah. And just to let people know, I’m an investor in Arc, personal investor. That is what it is, and of course I’m excited about it. So wanted to have you on because you guys have a cool new product you just launched. Well, it’s going to take a week for us to edit this, but just launched yesterday, but maybe you can tell everyone about what you’re cooking over there.
Don: Sure. So, at the time of this recording, it’s Tuesday, Jan 9th. Yesterday we launched Arc Capital Markets, the first Marketplace for startups offering bespoke venture debt and other startup-focused credit products. It’s the culmination of 12 to 15 months of hard work, of spinning up a proprietary lender network, and the team’s really excited to finally introduce this product to the mass market.
Scott: That’s awesome. It’s such a good idea, because I get a lot of requests for this stuff. Kruze has a little website that we list a bunch of providers on, but it sounds like, we talked a long time ago about this, you’ve taken it to the next level and have built something really awesome. So maybe how’s it work? I’m a seed-stage startup or I’m a Series A startup with some good traction and I’m credit worthy. People should want to give me money. What do people do? What does the founder do?
Don: Sure. Well, to answer that question, it’s probably important to think about how we got here. You think 12 months ago, you are a recently funded high credit quality business in Silicon Valley and you raise your round and the GP points you in one direction, to one bank, and says, “This is where you’re doing your banking and this is where you’ll get your debt.” And that was 70% of the market, Scott. As of March 2023, everything was turned upside down in the market.
Scott: Totally. Believe me, you don’t have to lecture me on that. We had 550 clients at SCB and another 150 with First Republic. So, I lived it, my friend. I lived it.
Don: It’s hard to believe how much has changed over the last 12 months. And this market opportunity, really since we chatted about a year ago, it came out of the regional bank crisis. The unspoken story of the 2023 regional bank crisis was not the hundreds of billions of frozen deposits, the migration to two big-to-fail banks, but it was the dislocation of the venture debt markets.
Scott: That too, yeah, it’s a good point.
Don: What we saw is the uncontested market leader that owned 50 to 70% plus market share by some sources. Well, by the end of March of 2023, that was no longer the case. And so over the following handful of months, we saw all of these new entrants come into the venture debt space looking to get exposure distribution to the startup asset class, but don’t necessarily know where to access distribution. So, you have family offices, credit funds, new banks like HSBC and Stifel, spinning up venture debt practices, looking for opportunities to pull a capital against this attractive segment of the market. And on the other side of the equation, to answer your question, you have startup founders, CFOs and their board members, who simply don’t know where to go to access the vital funding they need to extend runway, whether the storm or the venture capital funding drought of 2022 through now into 2024. But these same businesses are more operationally efficient than ever before. And so, you have this culmination of factors where you have dislocated fragmented supply of capital who lack distribution and lack technology. And then you have all of these, now operationally efficient, but capital-starved premium technology companies who are looking for capital but don’t know where to go to get it. And if they were to run a process internally, it would be disjointed, manual and offline. So, the product we’ve built, the solution we’re offering is, okay, we’ll be here in the middle. We have access to all of the lenders, we know their credit box, we know what they’re looking for, and we have a data-driven ingestion and synthesis experience for a 10-minute onboarding process where you can tap into the full venture lending ecosystem in one simple 10-minute application.
Scott: I love it. There’s one other factor which you didn’t touch on, which I think is important too. Which is, as interest rates have gone up, the banks have less of an advantage in the venture debt market than they used to. When you’re a bank and you’ve got deposits earning nothing, you’re not paying your deposit anything, interest rates are really low, then you can afford to loan money out at five or 6% because you’re making a five or 6% spread. That’s easy money. And then the venture debt cost of capital for the startups is pretty low. Now with, I don’t even know what prime’s at, probably like five or 6% these days, all of a sudden that spread is about equal to what the historical venture, the funds, like the private equity fund, the venture debt funds, where I worked at, we would be around 12%. So now there’s kind of this price parity, or it’s close, maybe not quite price parity, but it’s close. And what got me thinking about this was you mentioned the family offices because historically they haven’t been a very big player in the venture debt market, but they’re probably sitting there going like, “Wait a second, I can get a 12% coupon on some pretty good credit. And if I have a diversified portfolio, I should be able to play here, and Arc is going to be my distribution channel.” That’s pretty interesting. So, I think every trend is working your guys’ way. It is actually really exciting.
Don: The high interest rate environment has created a lot of really interesting trends in the market. For one, we can work alongside these non-bank lenders and provide them not only technology for a more frictionless onboarding experience, not only distribution and access to the startup ecosystem where Arc lives and breathes, but we can pair their loan products, a custom loan solution, with a tier one cash management solution. So, these same lenders now have 5% T-Bills that they can tack on a loan, effectively offsetting the headline price by 300 to 500 basis points. Making them, again, more competitive with traditional depository financial institutions.
Scott: That’s a really good point. So, you’re saying, just to make sure I understand, you’re saying, I think I’ll rephrase what I’m thinking. Historically, when I was at Lighthouse and we were a fund, cash management wasn’t something we could dabble in, or we didn’t have a product there. But now because Arc has a cash management solution, the borrower keeps their money in Arc and earns 5% or a high yield, and everyone’s happy because the lender knows where the money is, and the borrower is getting a high yield, right? That’s kind of what you’re saying?
Don: That’s right. And we’ve productized to streamline this full DACA, SACA experience. We pre-authorized all of our lenders against a standardized DACA construct. What that allows is for our non-bank lenders to compete with depositories in a more direct way for the first time, where they have the power of Arc’s cash management platform. Which is the highest yielding institutional grade treasury platform in the market. We can pass through 5% plus APY to our banking customers who are now borrowing debt through our capital markets from non-bank credit funds, family offices, and high-net-worth individuals.
Scott: That’s really cool. For those who don’t know, a DACA is a cash control agreement. So basically, if I’m a lender and I give a company a million bucks, I want to make sure that that company can’t move those million dollars to some other random bank or random place. At one time when I was at Lighthouse, we had a company that got really weird on us and transferred $2 million to their Chinese subsidiary without telling us. So that’s where the cash control agreement comes in place. This is before China was cool, by the way. This was like 2002. So, this is when, before, there was a lot going on in China. This was a place to hide your money.
Don: As a lender, you don’t love to see that.
Scott: No, you definitely don’t want to see that, when they’re about to go out of business. So that’s where the DACA or cash control agreement comes in place. That’s cool that you guys have pre-negotiated that too. That’s really cool.
Don: The whole goal here is to rip out inefficiencies from the traditional debt capital raising experience. And so, from legal spends to DACAs and SACAs which are required by effectively all credit funds and banks alike, we’ve eliminated as much of that inefficiency as possible, so that not only can we get you to a faster, better loan qualification decision from a prospective lender. But even in the post-term-sheet phase to funding, we can eliminate a whole bunch of inefficiency there as well through a virtual data room for confirmatory diligence, to standardized DACA and SACA and other legal agreements, again to reduce legal spend and accelerate timelines to close.
Scott: I love it, man. That’s really cool. Well, so how does someone sign up? Do they go to Arc’s website? Maybe walk them through just the nuts and bolts of how to apply.
Don: Sure. So, we’re pretty rigorous around pre-qualification. We don’t want to waste founders’ or CFOs’ time and we don’t want to waste our lender’s time either. So what we do is, debt is not for everyone. We look for companies that have strong fundamentals and or recently raised an equity round that falls within our sweet spot for the credit box across our lender network. Assuming that you’re fundamentally strong business, assuming that you recently raised a round or you have a path to being cash flow positive, with near a hundred percent certainty, we can get you indicative terms within just a few business days. And so you’ll go to our website, just Google Arc Capital Markets, you’ll submit a very short lead capture form, we’ll pre-qualify you as a customer, and then you’ll run you through a fully programmatic onboarding experience. You’ll connect your banking, billing, accounting, financial APIs. We have a secure virtual data room product where you can upload financial projections and other relevant legal documentation. We’ll use artificial intelligence and machine learning to synthesize, anonymize, and standardize all of these qualitative and quantitative inputs into a standard data packet. Which then, we will select a curated group of lenders from a hundred billion AUM lender network and we’ll share, on a very selective basis, with lenders who we think of the highest probability of transacting on the terms you’re looking for on an accelerated timeline. And from there, we can make the market, we can facilitate the transaction between the buy-side lender and the sell-side software company.
Scott: I love how you’re doing it to the, there’s like, it sounds like you have some scoring mechanism for the lenders too because you don’t really, if you’re a startup, you don’t want just the throw your information way out there, you want to have a targeted list of who you think…
Don: Spray and pray, yeah.
Scott: That’s cool that Arc’s basically doing that work for you. It’s only going to go to the five or 10 lenders that you think are the best fit for the borrower.
Don: That’s exactly right, Scott. This is not the kayak.com for capital. This is the Uber Black for venture debt.
Scott: I like that.
Don: It’s a dedicated concierge service purpose-built for the startup ICP with the most reliable tech lenders in the world on the buy-side lender network, who are contractually committed and under service level agreements and mutual NDAs, to reach mutual terms quickly. And if they’re not going to get there, then they won’t be included in the process. So, we don’t want to waste anyone’s time through ACM.
Scott: That’s really smart. The reliable part of that, just for everyone who doesn’t know, is the last thing you want to do is run a process, if you’re a startup, get a bunch of term sheets, negotiate the term sheets, pick the term sheet you want, and then you have the lender does the old re-trade at the 11th hour kind of thing. So that’s also, I can see how you guys probably score them on their behavior too, and you can put them in the penalty box, so to speak, if they’re doing a lot of re-trading or getting weird.
Don: That’s exactly right. Just like Uber Black or any other premium marketplace, if the driver or if that side of the marketplace is acting not in the best interest of the customer, their rating will decline, and ultimately that will result in them being exited from the platform. And so, by taking a marketplace approach, by having multiple lenders in network, if they want future deal flow, then they better treat our customers the right way and behave in a professional manner, even in a downside scenario.
Scott: A quick, “no,” is better than a giant process, a re-trade, and all that kind of stuff. That’s really cool.
Don: Couldn’t agree more.
Scott: Good for you, man. This is exciting. Besides the new product, is there anything new on Arc you want to share? I mean, that’s a big thing, but it sounds like your money management stuff is going well, cash management, and it sounds like you guys are in the 5% yield on cash these days.
Don: Yeah, 2023 was a transformative year for the business and really unlocked this Arc Capital Markets opportunity. Our banking business, where we’ve invested heavily over the last year and a half, and really in a meaningful way, following the Silicon Valley Bank collapse in March of 2023 was banking. We launched our Platinum, we launched a treasury, we launched 5 million of FDIC and SIPC coverage. This resulted in plus 12 x year-over-year growth in terms of bank deposits. And some multiple of that on user account, thousands of new users, hundreds of millions of dollars of volume flowing into the platform, the banking side. What that created, Scott, is this untapped community of premium software companies who are under leverage and who don’t know where to go for debt. And so, this Arc Capital Markets launch is really bottoms-up. It came from the CFOs and the founders of our banking customers who are looking for debt but simply don’t know where to turn. Those are the earliest customers of Arc Capital Markets, that’s who we’re providing pre-qualified loans to.
Scott: I love it. All the synergies are coming together now. It’s exciting. I watched you build this company. It’s very, very cool.
Don: It’s been a great ride.
Scott: Well, I got to respect your time here a little bit because you’re doing a lot of promotion right now because this is an exciting new product. But give my best to the Arc team, because I know it’s a team effort there, and maybe just give everyone the website and how they can reach out and maybe they can hit you on LinkedIn if they have questions or just go to the website.
Don: Yeah, definitely, www.joinarc.com. From there you can find the Arc Capital Market sign up page and the Arc Platinum sign up page as well. But we’re here to help and help build the startup ecosystem. So great to do that hand-in-hand with Kruze. Thanks for your time, Scott.
Scott: Love it, Buddy. My pleasure. Congrats. I’m very excited for you.
Don: Thank you.
Scott: Take care. Bye.
Don: Bye.

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