Making alternative assets available to everyone with Nelson Chu of Cadence

Nelson Chu of Cadence - Podcast Transcript

Singer:	It’s Kruze Consulting. Founders and Friends with your host, Scottie Orn.
Scott:	Welcome to Founders and Friends Podcast, with Scott Orn at Kruze Consulting. Before we get to an excellent podcast with Nelson Chu of Cadence, a quick shout out to our friends at Rippling. Rippling makes payroll, benefits and also integrating into your IT stack super easy. We love them for payroll. We love them for benefits. They make working with an independent insurance broker so much easier, which then saves you a bunch of money, which is awesome. I don’t know how you guys manage ID or identity, Nelson, but Rippling allows you to spin up people. It’s kind of like [Octalight] and gives them IDs that then loop into all your favorite web services, so you don’t spend a bunch of time setting it up manually. It’s a really nice service.
Nelson:	Very cool.
Scott:	It’s an awesome service. We love it. With that, that was Nelson chiming in there. Welcome, Nelson Chu of Cadence.
Nelson:	Thanks for having me. Really glad to be here.
Scott:	We are just kind of getting to know each other, but what you guys are doing is awesome. I was totally nerding out, because I have a background in debt, too. Cadence is unbelievable. Can you tell everyone how you had the idea for Cadence and maybe retrace your career a little bit?
Nelson:	Absolutely. I would say that my career, everything I’ve done in my past has led me to this point, basically. I was like almost tailor-made to be doing this type of company. I have a traditional career in finance, albeit a very short period of my life. I was at Merrill Lynch for the last two months of Merrill Lynch’s life. That was my first job. That’s fantastic way to start.
Scott:	No correlation between you and them.
Nelson:	Then it became Bank of America, obviously. I stayed there for about a year and a half. Then everyone was nudging me towards the buy side. They were like, “Buy side’s better. Leave the sell side. Not worth it.” Jumped over to the, at the time, biggest buy-side shop on the street. Now it’s definitely the biggest buy-side shop on the street in BlackRock. I was in the fixed income portfolio management group. Then after a year there, I was like, “You know what? I can do so much better than this. I know exactly what I’m doing. I’m going to jump ship and do my own startup. It’s going to be fantastic.” This was like 2012, 2013. I left BlackRock with some money saved up. Then my parents decided to chip in something to get me off the ground. I proceeded to burn through all that cash very quickly. No idea what I was doing. No idea how to actually build a company. But over the course of trying to do a few haphazard startups, picked up design skills, picked up development skills, picked up management skills, sales skills, et cetera. As a single-person founder with a, call it lackadaisical two or three-person team, got to do everything. First of all, my cash was broke. When you’re broke, you become a consultant, because that is the easiest way to get some cash in the door. Leveraged my FinTech, or finance background at the time, leveraged my design skills and whatnot to build out a strategy consulting firm that ended up being my startup, if you will.
Scott:	Awesome.
Nelson:	We had about 15 people. We helped founders with very early stage companies get off the ground and get going. We had a very specific criterion around it. The goal was you had to have been a founder that had exited a company before. You also had to have an idea that we would personally be interested in investing in. If you hit those, that narrows the list down from like a hundred different companies to like two, basically. It did really well. We had a couple of good exits in terms of just us investing personally in the companies and then exiting our positions. But at the end of the day, I was thinking if I’m giving all these founders advice as to what to do and they’re raising money, I should probably just do it myself. For the right ideas, the right time, I assumed that I would take the plunge and do it the old-fashioned venture-backed way. That’s really how Cadence came to be. We started in May of 2018. That’s when the ideas first came to fruition. We saw a real big gap in the market when it came to private credit. Through your background, you’ve been there, people are searching for yields. That leads us down this path of creating opportunities for everybody as best we can. There’s a much deeper rabbit hole we can go into about the company as to what you see on the website. It’s not what we actually do.
Scott:	First of all, just going back to your previous experiences, it is so hard starting a company. I understand people taking the first leap and then it not working out, but the fact that you stuck with it and did another company is really amazing. Kudos to you for getting the strategy consulting firm off the ground and making that a profitable exit. That’s really amazing.
Nelson:	Stumbling forward, I think, is the best way to put it.
Scott:	I’ve definitely stumbled forward a lot in my career, too. Kruze started the same way as you started your company. Then making private credit accessible to investors is such a huge idea. I have that background in debt that we’ve talked about. How did you see this opportunity for making private credit accessible?
Nelson:	We actually had some clients that were in the private credit space on the consulting side. We had a firsthand look at all of this. When you were looking at factored receivables, which effectively means that you have a Costco or a Target or an Apple or a Google willing to pay a company for services. Then they pay 45 days later and you can make a spread off that. That becomes very interesting. These are deals that normally are reserved for hedge funds, credit funds, pension funds, et cetera. If you had the opportunity to give regular accredited investors the way to diversify their own portfolio, it’s fantastic. We saw that opportunity there. Then as we dug deeper and deeper into private credit, we realized how broken the entire market actually is. That’s when we started to enhance and build out the other parts of our business that are a lot more institutional than what you see on the website.
Scott:	You started off with like a credit investor, like I’m barely accredited investor, and then you were going up into more institutional focus?
Nelson:	Yeah, more institutional focus on both the buy side and the actual issuance side. Our actual vision for the company is to help out a private credit lender in every single stage of their growth using data, using software solutions, whatever it is, to be able to support that. On the retail platform, as you see it today, we have small up-and-coming tech-enabled private credit lenders doing small business lending, doing consumer loans in US, Mexico, Colombia, et cetera. That’s all well and good. They have a $5, $10 million portfolio of loans. As they get bigger and bigger, they need to get to that next level. Retail investors help them grow at that phase until they reach that next level. The next level is when they need real institutional capital, 40, 50, 60 million bucks. That’s when we bring them to the securities side of our business and help them close on those bigger ticket deals with the institutional investors that we have access to using software, using technology to be able to do that and leveraging the data that we’ve collected over the years to be able to actually help them sell that story. We actually did a $40 million public company whole business securitization in March. That was our first foray into the market, which was the first institutional deal that we’ve ever done.
Scott:	That’s awesome. I could be a little outdated, but back in the day when I was at Lighthouse, we would do a debt deal. We were debt, follow the VC equity, and then eventually they would outgrow us, because we were expensive and couldn’t get above $20 million in debt. Is this what you’re doing or even one step further? They would start doing like SPV financings, where they would put the loans that they made into another entity. Then someone like you or the people you’re representing would advance maybe 80% of that loan book. Is that how you’re growing? Or are you getting [crosstalk 00:07:57]?
Nelson:	Yeah, you could pull it that way. You can also do like term securitizations, which is just pretty standard. You can also find them credit facilities. There’s lots of different ways to play in that space. But when it comes to $30, $40, $50, $60 million in exposure, I don’t want that with retail investors. It becomes very risky just from a pure reputational standpoint. But when you get to that level, you can build in the bells and whistles that you’d expect from an institutional rated deal, effectively. A ratings agency can come in and actually provide their stamp of approval on it. That’s wondering if you feel a lot more comfortable. We don’t take on financial risk in that instance. We take on minimal reputational risk. We structure the deal. If it goes South, the problems with our structure. But it’s much more de-risked relative to the retail platform, where you have hundreds of investors in any given deal.
Scott:	The securitization makes sense. I invested in SoFi, not super early, but like decent timing. SoFi, this was probably 10 years, was actually pioneering these securitizations as startups. What is a securitization and who buys them and what protections are built into securitization for the investors?
Nelson:	Absolutely. Securitization, at its simplest level, is you have a single loan to a consumer, for example. It’s super risky to give and extend capital to that one consumer, because if it goes South, then you’re done for. The goal is to package all these consumer loans together into a product that becomes investible at a size that you can really deploy at scale. When it becomes securitized in that instance and packaged and collateralized and all that, then you have the ability to even potentially trade it, because it becomes a semi-liquid opportunity that has the ability to price it, based on the performance of the loans in all of those whole portfolios. That’s effectively what securitization is at its high level. For us in particular, we are creating micro-securitizations, which I think we are a pioneer. Our smallest ever notes that we issued was a $100,000 for one month.
Scott:	Wow!
Nelson:	Exactly. In that instance, we’ve created what are called short term note programs for all of our lenders. They have one-month, three-month, six-month notes that investors can invest in. It rolls over every single time it matures. In good times, pre-COVID, you have the ability to basically reprice it every single time, so that the cost of capital for the lender comes down. Every single month that they deliver, you deserve to get a benefit for that. In post-COVID, in this is new world that we live in today, that actually helps the investor. In this instance, we have the ability to reprice it as a result of these notes coming due in March and April and May. We spiked up the yield dramatically to account for this new world risk, but we’ve seen several of our originators do very well. We have factor receivables, like I mentioned earlier, with Apple and Google. They’re not going to not pay in 45 days. What was originally 8% jumps to 11%, 12% and is now back to 10%. We’re seeing this dynamic market shape itself as a result of this new world that we live in today. This is our way of playing the securitizations before we do the more traditional stuff like you talked about earlier.
Scott:	That’s amazing, though. The other thing, like for folks, securitization is really good for the lender and effectively the borrower, too, because by pooling all these loans, you get real diversification, which then brings the interest costs down. The people who buy these securitizations, investors, are effectively lending money. They’re saying, “You know what? Since you have a big pool, I know I won’t be hit just with one bad loan, therefore I can take a lower interest rate.” I love how you talked about how some of the borrowers were able to improve their interest rates and drive them down over time because they were showing good performance. It’s this really nice positive cycle where lenders who make good loans and can do a lot of volume can really drive their interest rate costs down.
Nelson:	Absolutely. We’re actually turning the model on its head, too. One of our lenders targets small businesses in, call it Middle America. As part of the COVID crisis, that book gets hit pretty hard, just in general. You would expect it to. At a portfolio level, you’ll see declines and deterioration in performance from the loans, but through our data and through our technology, we have the ability to see how every single underlying asset is performing on a daily basis. We can actually monitor it. This is a little bit counterintuitive, but in a crisis situation, as a lender, if I’m a credit fund, in bad times, I basically cut the credit and say, “You can’t lend anymore and I need my money back. Give me $3 million starting next week.” That will literally destroy most lenders. They don’t have cash on hand to be able to do that. They have to unwind their position. You effectively push them towards default. In our instance, because we have visibility into the data on a regular basis, the thesis goes, “If I give you more capital and you underwrite as part of this new COVID environment, your performance for that should begin to offset your deteriorating portfolio. The more money I give you, the better you’ll do and the better our investors are as a result of it.” We’ve seen the performance stabilize in this lender and their actual ability to collect has increased off their borrowers by just giving them the ability to extend it. The transparency helps also the investors. They get comfortable with the product. You’d expect a lot of our investors to run away from this type of originator in this environment. Because they see the reports on a daily basis, we make it available to all of the investors, they see the reporting, they see it stabilize. We actually upsized the amount that we were expecting to give this originator in the most recent notes, simply because people got comfortable with it. We’re changing the dynamic of how credit is extended and how investors have access to it across the board at every level.
Scott:	It makes so much sense. Basically, your technology gives the realtime view of, I’m paraphrasing here, and because you have a real time view, you actually know if they’re doing well enough or not. Do you have something that shows you the inbound requests? Because that’s really what you’re funding with the extra money. How do you know that the inbounds are good? Or is it just, “Hey, it’s hitting the underwriting thresholds”?
Nelson:	Yeah. We underwrite the underwriter in this instance. Our job is to assess the credit worthiness of the actual originators themselves. We don’t ever look at a specific loan within their 3000-loan portfolio. We’re expecting that we can track the performance of it and we can monitor it over time. As long as the underwriting standards are sound, then we’re in good shape. But we do, what we talked about earlier around protections that are in securitizations, have various different things in place for the retail investors and also for our bigger ticket deals. There’re things like a first loss coverage, for example. Essentially the originator is on the hook for X percentage of defaults, in this instance, and of the principal and interest that’s expected to be paid back. Because our notes are so short, we were able to restructure the first loss as a result of COVID to increase it based on the new risks that we’re taking. At the institutional level, there’s a whole lot more bells and whistles you can do as part of getting a rating, putting in place what’s called a lockbox, where effectively the money that is designed to be given back to the investor is in an account that they can’t touch and that we can’t touch until the time is right and everyone agrees we can touch it again, so it gets siphoned out. That is things that, again, if you add those in, you drop the yield. Retail expects, in this environment, probably like 12% to 19% in terms of yield, just based on what we’ve been seeing. For an institution, they expect way less than that. They will get the protection they want as a result of it. It kind of goes hand-in-hand.
Scott:	That’s really good. It’s really cool that you can customize. You’re basically playing a matchmaking game and you’re like, “If you want, you’ll trade off a lower yield for more protection. We can do that for you,” which is super exciting. The first loss thing, that’s really powerful. I actually love covenants like that, that align the borrower and the lender, because without the first loss protection, the small business lender would just be out there doing every deal that came through.
Nelson:	Exactly.
Scott:	But because they know they’re holding the bag and eventually will have to pay the first big chunk of losses, they’re a lot more selective and a lot of smarter about the type of [crosstalk 00:16:18].
Nelson:	Absolutely. With this new age of like FinTech technology, I have visibility into their bank account. You need to make sure that first loss cover’s actually in your bank account at that point in time. We have the ability to do that, which makes it a lot easier. It’s using technology the way it was meant to be used in a traditional financial services space that has not innovated in decades.
Scott:	Amazing. Are the lenders that you’re underwriting, I’m assuming it’s the most advanced technological lenders as well. They’re probably getting QuickBook feeds and bank feeds from their borrowers, right?
Nelson:	Yep, absolutely. We try to only bring on board, call it the next generation Kabbage or BlueVines of the world. Very tech-enabled, very data-driven. That’s the reason why when COVID happens, we had confidence they could be able to weather this, because they can change their underwriting standards on a dime and have all the visibility into the ability for these guys to be able to pay.
Scott:	That’s so cool. What are the questions you ask potential originator or lenders on your platform? Tech-enabled, obviously, is one thing. Are there certain sectors you look at? How do you think about that?
Nelson:	We have a legal framework that lets us do securitizations in about two hours. That, in and of itself, helps a lot. But it’s based on various different asset classes that we already have. We can do factored receivables, we can do small business lending, we can do consumer lending, but we don’t, for the moment at least, want to go too far out of those buckets, because it ends up adding up the legal fees. We have that framework in place. Beyond that, we have a full-blown underwriting policies and procedures that we have to go through for each of these originators to bring them on board. The first go at it is usually about four to six weeks before one of these programs can get up and running. It’s a lot of work. We always start small. We need to get comfortable with them. We need to see how the data is performing. If it’s coming in the way they originally gave it to us as, then we’re in good shape. If it’s not, then we are not putting anybody’s money really at risk, because at the size, it’s really not that big a deal. But the most important thing for all of this is that they need to have bigger aspirations. We cannot just be extending capital to a mom and pop shop, if you will.
Scott:	That’s because you want them to get big enough to create enough volume for it to be a profitable client for you, right?
Nelson:	Correct. We look at lifetime value of an originator in the millions, because there is the goal to bring them from retail to institutional to, ultimately, our staff platform. Our staff platform is where we take a step back as a structuring agent in this instance. We hand over the keys to anybody who wants to do what we do. In that instance, the total lifetime value is tremendous. I’m not going to penny pinch them at the outset, but I also need to know that they want to get to that level. Generally, honestly, these are hundreds of thousands of VC-backed companies. They all are incentivized to get to that level. It’s really not too bad.
Scott:	That’s awesome. That’s really incredible. Is there another category? You talked about the factoring and small business lending. Is there something that you see on the horizon that you’re going to go after?
Nelson:	Yeah. We actually have it right now, but it’s called asset seasoning. This is like one of my favorite ones.
Scott:	Never heard of that.
Nelson:	We do it for power sports financing. We also are looking at it for solar financing. But basically, you have this period where the person on the other side, usually a bank or some sort of facility, is not recognizing it as a real asset, because it’s not at a certain stage. For solar, for example, there needs to be enough panels on the roof for it to qualify as an actual asset. That’s when they can take it over. It’s effectively a 100% takeover rate, as long as it’s a real asset. We can finance these, call it 30-, 60-, 90-day periods, where there’s very low risk, because as long as it reaches a certain point, someone’s going to be there to buy it out. We take on that initial period and investors can get access to that in a very short duration basis. We like that asset very, very much. We’re looking to add more to that in our portfolio.
Scott:	Solar continues to grow so fast. That’s really amazing. I apologize, but what’s your investor base like? Are you VC-backed as well?
Nelson:	We are. We raised a pre-seed round in January last year. Then we raised a seed round in January of this year. Then we shored up our balance sheets a little bit as a result of COVID recently. We took on a little bit more capital as well. We’re well positioned to be able to weather this storm and anything that may come our way. We feel very fortunate. But all of our investors are generally institutional. That tells you where our head is at and where we’re looking to aspire to be. But we have taken investment from Argo, the public insurance company. We’ve taken investment from Dick Parsons, former chairman of Citi, just down the office. We’ve taken investment from another major hedge fund at their family office. We have a board that consists of the former president of E-Trade, the former co-CEO of a $20 billion structure credit fund, in addition to the other board members who are the leads from the prior rounds. We’re very, very institutionally-minded. That’s where we need to get to for retail, it’s a very important step for us to be able to reach that point.
Scott:	I love it. You made a point about shoring up your balance sheet right now. It’s such a great observation because this, and especially the lenders you work with, this is like the moment. For the next couple of years, this will be a great time to be doing business for them and for you. That’s really smart to add some more capital and make sure you’re well-positioned.
Nelson:	Absolutely. I think we were very fortunate that we were oversubscribed for the seed round. We had the ability to tap into it. We actually raised at a premium for this safe note relative to our round that we closed in January. Granted, we are now a different company, having closed that $40 million whole business securitization for the public company. That, I think, was convincing for a lot of these people.
Scott:	That is probably a really nice profit hit for you, too. The interesting thing about securitizations is it accelerates the profit. A normal bond portfolio, if you just visualize cash flows and a certain percentage of that would be profits every year or every month down the line, so doing the securitization actually is like a nice onetime hit for you, I assume.
Nelson:	Absolutely. That’s the beauty of capital markets in general, which I think a lot of VCs don’t have a good handle on, just because it’s not their forte. The numbers are so large that basis points mean a lot in that instance. Their revenues are substantial. In this instance, having done that $40 million deal, we are now the number 21 largest US structuring agent for ABS in the United States.
Scott:	That’s so awesome.
Nelson:	We have three full Guggenheims, so you can tell where we’re gunning for. But it’s fantastic of an opportunity here that we’ve presented for ourselves. We use the retail platform as a great funnel to get these originators to that level.
Scott:	Nelson, this is super cool. I love this. I actually think now I need to put some money on your platform, too. I know you’re not going after retail, but I’m a retail investor. It’s super exciting. Maybe you can tell everyone where they can find Cadence, how to reach out to you and what you’re looking for.
Nelson:	Absolutely. I would encourage anyone who is accredited, legally I have to say that, to take a look at our platform, sign up for it, just poke around. I would like to think that we are the only platform out there that allows for a short-duration, high-yield investments. The minimum is $500. We allow people to try before they buy, if you will. We’ve seen plenty of investors put in $500 for a month, comes back with $4 of interest. Then they withdraw it to see if it works. Then they put in $10,000, $15,000, $20,000. We’ve seen that happen. You can come check it out. It’s withcadence.io. That’s where you can log in, sign up and see all of our deals. If you have any questions for me, personally, I’m always happy to answer them. You can reach me at nelson@withcadence.io. Otherwise our support team would be happy to hear from you. They’re just at hello@withcadence.io. It’s a fantastic opportunity. Retail is core to what we do, because it’s the only way we can get to that next level. It will continue to support the other parts of our business.
Scott:	I actually know some institutional investors who listen to this, too, so you’re hitting both the retail market and institutional markets. This is really cool. Thanks for coming on the podcast. I really like what you’re doing. All the positive alarm bells are going off in my head that this is the real deal. Congrats on starting it and congrats on having the perseverance to do another company after the first one didn’t work. That’s really the moment where you determine if you’re an entrepreneur or not. I have a lot of respect for you.
Nelson:	I can do this all over again, every single time. We’re in a good place. Thank you so much for having me. It was fantastic to be here.
Scott:	Nelson, take care.
Nelson:	Take care.
Singer:	It’s Kruze Consulting. Founders and Friends with your host, Scottie Orn.

Making alternative assets available to everyone with Nelson Chu of Cadence

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