Adaptive financing for subscription business models - an interview with Timia's Mike Walkinshaw

Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.

Developing a subscription pricing model and driving recurring revenue are a strategic goal for many Ibbaka customers. Why the focus on the subscription model? Well, for one thing it has become shorthand for revenues which are predictable, scalable and support robust gross profits. This can be thought of as a cash flow annuity. Those are three attractive attributes of any business model. One reason for this is that they open new financing options beyond the conventional debt and equity models. Financing fuels growth, but there are compromises built into both the equity and debt models. The subscription models of SaaS (Software as a Service) or more generally XaaS (anything as a service) have opened the possibility of a new model, revenue financing.

Well, revenue financing is not new. It has been used in the energy industry for decades, whenever there is a revenue stream that is predictable and profitable enough to support a revenue royalty. Basically, the revenue financing firm advances funds, provides capital, and every month gets a percentage of revenue until some agreed upon amount has been paid back. It is that simple.

Revenue financing companies are well positioned to understand the dynamics of different subscription pricing models. They are also playing close attention to the impact of Covid 19 on the subscription economy. So we reached out to Mike Walkinshaw, founder and CEO of Timia Capital, to get his insights into the world of revenue financing during a pandemic.

Ibbaka: Mike, before we dive in, please tell us a bit about Timia Capital.

Mike: Timia Capital came about in 2014 and 2015 when a fellow named Greg Smith and myself wanted to innovate on the technology lending model. The technology lending model was in place and had been so for some time through companies like Espresso Capital, of which Greg was a founder, and companies in the US like Silicon Valley Bank or Lighter Capital. We thought there were some things we could do with the model that would push the boundaries and make products that are entrepreneur friendly while still providing investors with the returns they are looking for.

So, in August, 2015 we started the new model out of a public company called Green Angel Energy making our first investment into a company called Lambda. Since then we have grown to 28 deals with 20 deals currently in the portfolio. I think if you were to talk with any of our entrepreneurs, they would have a high level of satisfaction with our product and the flexibility it provides.  It also provides entrepreneurs with capital when they need it at a price that makes sense for them.

Ibbaka: So this is an interesting and important innovation for entrepreneurs. What brought you to this? How did you end up coming up with the idea for Timia Capital?

Mike: Prior to starting Timia, I was an equity venture capitalist for twelve years. From 2002 to 2013 I was investing in all kinds of pre revenue, high risk, home run deals. It is fair to say that the Canadian venture capital sector was not delivering the kind of returns that equity limited partners were looking for during that period of time. That target return for limited partners is 25%. So I started to look for ways to innovate on the model in order to provide those investors with the returns they were looking for.

At the same time, as a personal investor I was investing with Greg in the Espresso funds, I think I was the first external Espresso investor in 2008 or 2009, and there were just some great returns in those years. They were very early into the marketplace.

So on the one hand I was trying to innovate on the venture capital model, and on the other I was investing in a venture lending model on the side. The reality was that the venture lending model was delivering returns that were almost as good as equity venture capital returns for lower risk. The bell curve for the horizon of venture lending returns is tight, with returns ranging from 10-to-15%, while for venture equity the returns are anything from negative 50%, you could lose half your money, to +50%. Is it worth all that extra risk, or variability in returns, to get a median return that is only 4% to 7% higher?  I decided that for me it was not.

At the same time, there was a change happening with the entrepreneurs. The venture capital model is built for companies that are going to hit a home run and have a NASDAQ IPO. As you and I know, the vast majority of companies are not built for an IPO, they are going to grow then be sold for anywhere from 10-to-50 million dollars. For most entrepreneurs, the ones building companies that are not likely achieving an IPO,  the most sensible thing they can do is to figure out how to get to that $50M sale while holding on to as much equity as they can. 

Furthermore, in the software space, we have seen an increasing balkanization of business models, where companies have become more and more specialized. This niche market focus, while profitable and successful, will not lead likely to NASDAQ IPOs.  However, they can be  successful and generate good returns and wealth accumulation for the entrepreneurs and founders.

Equity venture capital players are not interested in these niche market companies. They can not make their return targets without some of their portfolio companies achieving IPOs. 

Just as we were getting into the market, equity venture capitalists were walking away and were not providing broad based funding to the level that they were before. So not only were we providing a new product, there was a new need for this product from a very specific group of companies that needed capital in order to grow.

Ibbaka: As you know, a good part of Ibbaka’s business is around enabling innovation of one type or another and what you have done here is to innovate. Can you tell us more about what it was about your background, the times, that made you able to see this innovation when many of your peers could not.

Mike: I think one of the valuable things we did in the early days was to sit down with a lot of people, ask questions about what they needed, and listen very carefully to the answers.  You (Steven Forth) were one of those people. We talked with people about how we could create something that would work for entrepreneurs. Being open to other people, listening to their experiences, was a big part of it. It was a collaborative team based approach. 

The second thing was that I had a depth of experience in funding companies and I understood what investors needed, as they would be providing the capital. . So combine a deep knowledge of what investors needed with insight, driven by asking questions and listening, into what the entrepreneurs needed, combined with an openness to exploring new ideas and you have a path to innovation.

Venture capitalists have put a lot of money into very innovative companies, but they have not been AS willing to innovate on their own model. The model hasn’t really changed for thirty years, so this was a sector that was ripe for innovation. There are other innovations going on now, but it was a long time spent doing the same thing over and over again.

Ibbaka: So they finance innovation but were not innovating themselves.  Why is that?

Mike: One of the root problems is the partnership model in which a group of partners makes all the decisions as a group. A group decision making model leads to a kind of stasis in terms of innovation. Organizations with a more entrepreneurial spirit, led by one or two people are better off when it comes to innovation as they are willing to take risks. Partnerships are designed to execute on an existing model and the more partners you add the worse it gets.

Ibbaka: Can you tell us more about the Timia model?

Mike: The human-based evaluation of a company is not as effective as many  think it is. By human-based evaluation, I mean investors sit down, talk to the founders, ask about their strategies and investors, ask if this is a space and a company we want to be investing in.  They then craft an investment memorandum and sit down in a group partnership meeting and vote.  That is the equity venture capital investment model and is focused on delivering 2 home runs out of ten investments, with 8 write-offs or near write-offs..  Much of the return is a gamble on what could happen over the next 12 months, not what has happened over the last 12 months.

But if your goal is to earn good returns on 9 out of 10 investments then a different kind of evaluation is important. In our case, we use a far more quantitative approach. We start with a little bit of data, make a decision, ask for a little more data, make a decision, then we get to the point where we make an investment decision.  At all points through our process, we are evaluating, on a quantitative basis, whether the next 12 months is likely to match the last 12 months.  This is a very different proposition then betting on a dramatic increase in performance.  The data is structured and analyzed using a proprietary and automated credit scoring system that we have developed based on the thousands of companies we have analyzed.

It is important to note that all we do is recurring revenue software companies. So the data is homogenous, all the companies look alike from a data perspective. This makes it easy for us to compare two companies and decide which is a better investment. This is good for us not only because it reduces risk and speeds up decision making, but it also is better for the entrepreneur, as we can get them an answer fast. It is not like a venture capital process in which smart people all try to dream up as many questions as they can. We just ask for what they have done in the past two years, and what the numbers are expected for the next two years.

Ibbaka: Do you have enough data to apply machine learning to this?

Mike: A really interesting question. In the Fintech space, which we are a part of, people are absolutely looking to apply AI and ML. For someone doing consumer loans, who has tens of thousands accounts, AI is absolutely being used. We have a far smaller number of deals, but a lot more data per deal. We are getting to the point where we are starting to be able to use AI and ML, mostly ML, but we will need a slightly larger data set to get full utilization.

Ibbaka: How would you characterize a company that is a good candidate for Timia?

Mike: We think recurring revenue companies are a very good bet and that they don’t get the credit they deserve (excuse the pun) from the regular banking system. I think that in today’s Covid world that is even more true. Most lenders over the past forty years or so have been very comfortable taking on relatively risky bets on real estate, but are shy to lend money to a software company. 

We are looking for recurring revenue based software companies with revenue of at least $1.5 million and a reasonable growth rate, and software gross margins of 70% or so. The company is spending money, and probably losing money, but the capital is going to fund growth not fix product development. When we are able to pull apart the data, we can see that the spend on sales and marketing is driving the revenue and that an increased spend would drive more revenue growth.

Ibbaka: Zuora has recently published a report on the resilience of the subscription economy in the Covid 19 downturn (see Are subscription businesses more resilient in a crisis?. What is Timia seeing in its portfolio?

Mike: Generally, sales growth is slowing down, new customers are taking longer to sign, pricing is under pressure, payment terms are under pressure, but what we are seeing is that the base business is not being dramatically affected. Renewals are running at the same rate as before and we have had some companies that have been able to raise growth equity rounds. Capital is still flowing for companies that are in a hot space.

For companies that target a Covid affected market, like travel,  we are seeing increasing churn rates, and pricing pressure, but not the kind of revenue drop off you would see in a company that does not have the recurring revenue model to depend on.  .

An interesting note, in Canada to get government assistance you have to have a 30% decline in revenue year-to-year. We are not seeing that. None of our Canadian companies have seen that kind of decline. Most Canadian software companies cannot access that government assistance. It is different in the US for the PPP, the Payroll Protection Program, where a number of our portfolio companies have successfully applied and some of them already have cash in the bank.

There has been a big difference between how the US and Canada have supported the angel backed innovation sector and that has been a disappointment. The BDC has supported venture capital backed businesses but has  provided the same support to the angel/founder backed innovation sector.

Ibbaka: As you know, Ibbaka advises companies on their monetization and pricing strategies. How does Timia look at that when assessing investments?

Mike: You have taught us a lot about that and it has been very useful for how we look at our investments. We are focussed on recurring revenue models, so the cost of acquiring a customer is important for us. We have started to figure out ways to segment the customer base. The classic example is a company that sells to small and medium businesses and has one pricing model for the small companies and another for the medium-sized companies with different service levels. When our data set first comes in that is often one homogenous data set. So how do we, as an automated lender figure out a way to adapt so that we can pull apart those numbers and see the segmentation so that we can see the pricing and churn rates on the different segments, which are important to making decisions on investments. Sometimes, when there are meaningful differences, between the segments, we will fund them differently. A company may have one segment that is larger but growing more slowly and another that is smaller but growing faster. The growth segment will play a larger role in determining how much money to advance and under what terms. The depth of the management’s understanding of the pricing for the different segments gives us confidence in how well they understand their business. So pricing understanding by the management team leads to a higher credit score which let’s us lend them more money. 

Ibbaka: Coming back to the impact of Covid 19, what are the responses you are seeing in your portfolio companies that have been successful?

Mike: It starts with the mindset of the entrepreneur. A wise man once said to me that “the CEO’s job is the constant pursuit of the truth.” We find that only a certain percentage of people act on that maxim. In a situation where there is an economic crisis, we find there is one group that has a solid grasp of the facts and is willing to take action and there is another group that is still hoping that the crisis will go away.  . We are more comfortable with the entrepreneurs who have taken action early and are conserving cash.

Make sure you have a realistic revenue growth curve that reflects the new reality, then reduce costs so that you can live within that curve, looking especially hard at sales and marketing expenses, and look for extra sources of cash wherever you can find them.

Ibbaka: Some jurisdictions are moving out of at least phase one, the BC numbers are encouraging, so as the world moves out of Covid 19 where do you expect to see innovation?

Mike: My equity venture capital past was in clean energy technologies. I think a lot of the basic assumptions we used to have are changing. For example, travelling to face-to-face meetings is no longer assumed and has been replaced by, what? Zoom meetings and … there is a tremendous amount of innovation that is going to happen around how we do business without meeting face-to-face and that will be good for the planet. 

That reality is different for software companies dealing with other software companies than it is in the financial community. Investors, bankers, and lawyers are used to meeting in person. That world will have more change and be subject to more innovation as it is a bigger road and they have been more entrenched in the travel model of doing business. Take the investment roadshow for example, where a company and its bankers would hit five or six cities over a couple of weeks. There are tremendous opportunities for virtual roadshows. We need to figure out how to deliver the roadshow experience, and value virtually.

Next, there needs to be a tremendous amount of innovation around trust. I need to figure out ways to trust people I want to do business with when I cannot go to meet them.

Third, I think the old ways of strategic planning are going to go out the window. Clearly we were not prepared for what just happened. I have the Christmas edition of Maclean’s magazine from 2019 telling us what 2020 is going to be like. It is funny to read it now, given what 2020 has really turned out to be. The way we plan and forecast is going to have to include ways to plan for the unplannable, the so-called black swan event. 

When these things start to happen we have to have planning systems in place so that we know how to react and can react quickly. We had experienced previous pandemics and thought that life would basically continue as normal. It didn’t. We have to assume that there are other large risks that we can’t see sitting out there waiting for us. We need systems that help us prepare for that.

Ibbaka: Shell is supposed to publish its next generation of scenarios soon. I wonder how they are changing their scenarios based on Covid 19.

Mike: I have some knowledge of how Shell uses scenarios as they were an investor in one of my previous funds. I am just guessing but I would say they will have one scenario where things go back to normal, another where there are profound and long lasting changes to the structure of demand, probably some middle ground scenario. As an oil company, they will be asking when we all come out of this, will we get back into our cars and onto planes or has something deeper changed? It is going to be of critical importance to them.

Ibbaka: On a personal level, how have you been coping with all the changes?

Mike: One of the hardest things is that your separation of work and home life is not as well defined as it was when you rode your bike home from the office at the end of the day . So we need to more actively manage the transition into and out of work while working at home. I didn’t do that very well at first and felt I was working 24 hours a day.. My wife, god bless her, started insisting that we end the Covid work day by going down to the beach and watching the sunset. Then we would come home and have dinner and my day was over.

It’s been a joy spending time with my kids around the house but this pandemic has been hard on them as well, just in different ways.  Social connections, important to any teenager, are turned upside down.  So spending time helping them adjust has been important as well.

BC has done a good job with phase one. I do question what phase two and phase three could be like in the fall as we have not developed herd immunity. I am grateful for how the community pulled together on this and the commitment we showed to each other. That has proven to be of great value to us and our economy.