The New Definition of Success: Evolving Vendor/Captive Finance for a Fintech Future

by Patricia M. Voorhees May/June 2018

While fintech equipment finance is currently in stealth mode, The Alta Group expects efficient, well-designed fintechs to make their mark on the industry very soon. With the help of her colleagues, Patricia Voorhees explores what this will mean for vendor and captive finance companies.

Patricia Voorhees,
Director,
Management Consulting & Merger and Acquisition Advisory, The Alta Group

I am a sucker for cool technology. You may be, too. But there are practical reasons for feeling this way in our industry. B2C conveniences are now expected in the B2B marketplace. Technology is accelerating small-ticket transactions, fueling expectations for usage-based finance products and driving equipment finance in endless other ways. Especially fascinating is how technology is radically transforming the ability of vendor and captive finance organizations to add value to users through customized, integrated financing solutions for capital equipment.

In my work with The Alta Group, I closely follow the leading fintech firms active within equipment finance. This led me to attend LendIt Fintech USA 2018, which included the newly launched BlockFin Summit, focusing on blockchain and its promise to disrupt financial services. Meanwhile, in Chicago, my colleagues participated in two ELFA events: the Captive and Vendor Finance Best Practices Roundtable and the National Funding Conference. Key themes explored at each event tell us a lot about fintech in the vendor/captive space.

Why the Managed Solutions Challenge Eludes Fintech

This year’s ELFA National Funding Conference was very well attended, reinforcing the market attractiveness of leasing for capital providers. Competitors in the BB and above credit space, dominated by bank affiliates, reflected on the highly competitive market conditions compressing spreads. Yet each expected their volume to grow in 2018, evidencing the overall growth in the market. Spreads and return expectations widen sharply in the B-rated and below space where many of the fintech lenders focus.

The popular Captive and Vendor Finance Best Practices Roundtable, sponsored by Alta, focused on strategies for managing millennial employees and the challenges of managed solutions.

Roundtable attendees included the largest and most experienced captives and vendors, which provide financing solutions across the spectrum of transaction types and sizes — a tall order in which end-users increasingly demand managed services offerings combining equipment, software and services into a subscription or usage-based transaction. These as-a-service offerings often provide end-users with flexibility on usage and early termination. Most attendees are either pursuing or interested in launching projects to address the demand for managed services. Given the nature of these transactions, roundtable participants discussed similarities and differences in their approach to new roles, new risks and business transformation requirements unique to each company and offering. A single recipe for successfully implementing these programs doesn’t exist, but it is vital to develop a comprehensive plan to address common key criteria, including market and risk analysis, monetization, multi-party legal documentation, pricing, billing and accounting, to name a few.

Manufacturers, service providers and funders are eager to transform platforms and processes to seamlessly manage the ability to track assets, collect usage data, monitor and predict service maintenance, bill, collect and distribute funds. Effectively weaving these together requires aggressive collaboration between stakeholders. Alternatively, these challenges are prompting the emergence of turn-key service providers investing in technology to support new requirements.

It’s a transformational time in the vendor/captive world as demand increases for managed services. Fintech models also are evolving. The firm that unites the collective, deep knowledge of the vendor/captive space with the leading edge of fintech to sculpt technology-enabled solutions will be a big winner. To the victor go the spoils.

Managed services might be a perfect-use case for a private blockchain distributed ledger application to manage complex rules and track smart contracts and associated assets and usage. This would require a sophisticated coupling of blockchain and smart contract technologies and a consortium of industry players to agree on the rules governing the private blockchain.

While further exploration of this topic is too ambitious for this article, a pivotal question remains: how can vendor/captive and fintech players come together to solve this unique market challenge?

Fintech is a Decade Old — and Here to Stay

LendIt Fintech USA’s themes reflected the maturity of fintech business models and technologies. After all, some of the earlier models are a decade old! The survival of the fittest technology has resulted in the natural shake out of weaker fintech business models. Yet, others have survived, and some are more scalable, financing billions a year in transactions through proven retail and capital markets funding vehicles.

Key conference themes reflected this here to stay mentality, including financial health and inclusiveness through online lending models; successes in deploying artificial intelligence (AI) in customer acquisition, underwriting and portfolio performance; progress in partnerships between fintechs and banks and navigating regulatory/policy issues.

Equipment finance is a stealth fintech sector so far; a scant 100 minutes of the more than two-day conference was dedicated to the industry. Sessions included “Asset Backed Equipment Finance, a $1.1 Trillion Secret?” and panels on solar and auto finance. Does this reflect an oversight of the promise and performance of the equipment leasing industry or the lack of scale of fintech equipment leasing entrants to date? I’d argue the latter, although we’ll briefly profile a few fintechs. The equipment leasing asset class has not escaped the notice of well-heeled capital providers and fintech players. The delayed entrance is, in large part, due to the complexities of the three-party nature of the transactions (OEM/vendor, lessor and lessee) and the implications to origination, pricing, underwriting and documentation.

Big players like OnDeck have already announced an intention to enter equipment leasing. Alta has fielded numerous inquiries from potential entrants about the attractiveness of the space. The sheer market size and historically consistent superior asset performance make equipment finance too attractive to ignore. It’s only a matter of time before efficient, well-designed fintechs significantly crack into the space.

In his LendIt presentation, “The Copernican Revolution in Banking,” Frank Rotman, founding partner of QED Investors, contended banks are falling prey to flawed a priori beliefs, just as Aristotle and Plato did in their conviction that the sun revolved around the earth. Rodman argued banks believe they must manage a full suite of products and serve all clients through all channels. He contended a profound shift is happening in the amount of product information available, and banks ought to be asking if consumers armed with perfect information would choose their product. Rodman concluded banks should make the Copernican leap now, offer their best products and capabilities to other institutions’ customers and replace non-core products and capabilities with best-in-class offerings from third parties.

Is it also time for a Copernican leap in the vendor finance space? The sustaining question for vendor organizations has always been how to help the parent/OEM sell more. The answer has taken many forms but began by understanding the channels for equipment sales and how to best integrate with each channel to drive finance penetration. Often the best results were with the direct sales force because of the deal size and the OEM’s ability to offer sales incentives for financing. How do these a priori assumptions change in a world where dynamics are shifting in customer acquisition preferences and capital availability?

Recent ELFA data shows financing through vendor channels has increased to nearly 50% of the equipment finance market, up from 38% at the turn of the century. Forrester Research estimates B2B ecommerce for equipment and supplies will exceed $1.2 trillion by 2021. Does this emerging online B2B purchasing demographic have the ability to shift demand away from the vendor’s traditional product offering? Should vendors seek alliances with emerging fintechs? What are the best-in-class, as-a-service options? What does this mean for the wider M&A market in terms of equity investments and acquisitions?

With this shift to online point of sale (POS) equipment purchases, captives must address whether their balance sheets — and/or those of their vendor finance partners — are aligned with pricing-risk-return models. Marketplace fintech platforms have facilitated integration of financing at POS and the introduction of retail and fund capital previously unavailable to many asset classes. Granted, these platforms haven’t been tested by a true credit cycle, and much is offered at very high cost of capital. Nonetheless, enough has been deployed and tested for funds interested in the equipment finance space to clearly define their credit appetite and fit into a technology-enabled origination scheme.

Fintech Models

Small business lending took off early in the fintech space with many models emerging. Some, like Kabbage and OnDeck have reached scale, while others, like Bizfi and Dealstruck, didn’t survive heavy losses or funding issues.

Fintech operators have begun to offer equipment finance products. Although they represent a small fraction of industry volume, they are gaining traction and respect as competitors. Offerings include marketplace types, like LeaseQ and KWIPPED, and hybrid or solely vendor-based or SaaS models, such as Currency Capital and LiftForward.

Currency Capital evolved from a broker model aspiring to bring the offline leasing model online. Customers can apply directly for equipment financing at currencycap.com, but a major focus of its business model is financing embedded at POS. Vendors can embed the Currency API within their own websites for private label business or utilize Currency lending services for origination, funding and servicing. Funding sources can participate in pre-defined transaction pools. One such SaaS relationship is with eBay, where Currency is the embedded finance provider for B2B equipment purchases.

LiftForward has a mission to change the future of ownership, focused on the subscription space. The fintech’s motto is “we don’t buy things anymore, we subscribe.” LiftForward’s enterprise hardware-as-a-service platform helps device manufacturers and resellers “turn one-time customers into lifetime fans,” which sounds a lot like managed solutions. LiftForward’s flagship relationship is with Microsoft for the Surface product. They offer services exclusively through vendor/OEM relationships and manage the credit application, funding servicing and product return and replacement services.

An old finance model — rentals — is appearing in fintech-enabled models. KWIPPED has evolved from originally offering only equipment rentals, the cost of which was passed through to end customers by contractors renting the equipment. KWIPPED now offers both rentals and leases through a marketplace model. Other examples are EquipmentShare in the construction space and Cohealo, which helps healthcare systems share equipment.

Vendor Captive Evolution — What’s Next?

Evolving fintech models and rising end-user demand for managed services offer opportunities — not just challenges — for vendor finance. Yet, vendor and captive finance companies continually invest in myriad ways to better serve their vendor/parent organizations. The question to weigh is the value of developing and maintaining such capabilities versus seeking best-in-class solutions to offer via alliances or acquisitions.

Vendor/captive finance organizations also must develop a new understanding of what it means to succeed in the marketplace. Past assumptions about the best way to sell more of the OEM/parent’s equipment must give way to the realities of changing customer acquisition preferences and capital availability. Can vendor/captive finance make the leap? It can, because it must.

Valerie L. Gerard, David S. Wiener and Diane Croessmann of The Alta Group contributed to this column.

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