When cryptocurrency evangelist Anthony Pompliano wanted cash to buy more bitcoin, he turned to a centuries-old financial practice that has suddenly found new audiences in Silicon Valley.
Within a few hours, Pompliano sold the rights to some future subscription income from his email newsletter The Pomp Letter. The middleman was a two-year company called Pipe, which connects companies with investors who offer to purchase their future earnings at discounted prices.
“That was me. I sold my recurring earnings to get cash upfront,” Pompliano wrote on Twitter after Pipe’s CEO disclosed anonymized details about the transaction. “Then I bought more Bitcoin.”
The Pompliano transaction was an extreme example of how the well-known practice of the calculation factor, which is more commonly used by manufacturers, is now being applied to technology startups that want quick cash without the cost of raising venture capital.
“I think we’ve unlocked the world’s largest untapped asset class,” said Harry Hurst, Pipe’s chief executive, who claimed his company eventually plans to securitize the revenue streams on offer. Investors can already buy and sell contracts in secondary trades on the platform, he said.
Last week, a group of blue-chip supporters, including the workplace chat app Slack, the e-commerce platform Shopify and Salesforce CEO Marc Benioff, cast a vote of confidence in the start-up and invested $ 50 million Dollars, some of which were used to buy shares in existing companies shareholders.
Hurst said hedge funds and other institutional backers have also raised more than $ 1 billion in capital to the market, and transaction volumes have more than doubled to tens of millions of dollars each month since June.
In five years, Pipe will have “made hundreds of billions of dollars in trade,” he said.
Hurst’s ambitions reflect the enthusiasm investors have shown for subscription-based software companies, whose sources of income, according to some, are as trustworthy as paying debts.
Public cloud software companies’ market capitalization more than doubled to $ 2.2 billion in the past year, according to the Bessemer State of the Cloud report, underscoring the value that has been rapidly accumulating behind their business models.
However, some financial experts warned that subscription revenue is not ready to be converted into a separate asset class. Pipe’s operations can also be more expensive than traditional debt, and investors may have limited options if the companies backing the contracts go out of business.
Companies on Pipe usually sell their monthly or quarterly subscription revenues at a discount of 2 to 8 percent on the full annual value, with the start-up cutting the transactions.
Michal Cieplinski, Pipe’s chief operating officer, said the deals are considered “real sales,” transferring rights to a company’s revenue stream to investors. Companies on Pipe do not need to notify customers of the offers.
Buyers can see internal returns in excess of 10 percent when they buy contracted revenue on pipe at 95 cents the dollar, said Justin Saslaw, a former investor at Jim Palottas Raptor Group, a hedge fund manager.
“If you can get a diversified package, those cash flow streams get really attractive,” said Saslaw, who recently joined Chamath Palihapitiya’s Social Capital. Raptor was involved in leading Pipe’s most recent funding and is one of the largest buyers on the platform.
However, John Griffin, a professor of finance at the University of Texas at Austin who has worked on asset-backed securities, said the complexity and variability of software contracts may not make them suitable for securitization.
Griffin said it can be difficult to monitor the performance of the contracts, noting that they vary widely depending on the type of business and that many startups fail.
“I don’t see how they can be easily securitized and given credit ratings,” Griffin said. “It may be you, but it seems like a recipe for disaster.”
Hurst said buyers on Pipe would only lose money if the companies stopped customer support. If an underlying customer cancels their subscription, companies using Pipe must replace it with an equivalent contract or refund the difference in cash.
“What we unlocked is one of the most predictable and secure assets,” said Hurst. According to the company, investors have not seen any losses since Pipe’s limited opening last February.
In the most expensive case, companies that sell their monthly contracts at 92 cents on the pipe dollar would pay more than 15 percent interest per year, according to calculations by the Financial Times.
In comparison, lenders to venture capital-backed companies typically charge interest rates of 6 to 13 percent and receive warrants that can be converted into a small stake in the startups.
Pipe said it was “significantly cheaper” on average than venture debt providers, considering the impact of warrants and loan agreements.
Some venture capitalists have drawn comparisons between Pipe and LendingClub, the one-time Silicon Valley darling who tried to create a new personal loan marketplace but ran into problems after being publicly listed in 2014.
After a foundation round last year, investors valued Pipe at USD 140 million. This is evident from founding documents and a person who was briefed on the deal, which is roughly ten times the typical valuation of startups of similar size. It was unclear how Pipe’s valuation changed with the last round of funding.
Pipe’s investors rejected the idea that the company might have trouble growing its trading platform.
Jillian Williams, a principal at Anthemis venture firm that led its investment in Pipe, said companies using Pipe have been matched with investors on the other side of the deal. “With LendingClub, a lot of things didn’t necessarily match in the same way.”