Investing in Private Credit in Today's Economy feat. Nelson Chu

Hello, future billionaires. Welcome back to another episode of our podcast. Today we brought on Nelson Chu, who's the CEO of Percent.com, which is an online marketplace for debt investments. And if you've been listening to the podcast for a while, especially the past few months, we've been talking about the capital stack and understanding as an investor where you are in the capital stack, right? And investing in debt is something a lot of people haven't thought about, but it's something that should be considered probably. And in this conversation, we kind of talk about the role of these non-bank lenders, and especially right now as credit is tightening from traditional banks, the role they play in helping keep our economy going and lending to different businesses, a whole host of other questions and, and thoughts. I think you're really going to appreciate this interview. And as always, when we have a guest on here that is potentially raising capital, we have to make the caveat and disclaimer that you need to do your own due diligence. We bring folks on our podcast that we think have an interesting story to tell, have something that we're curious about to talk about, but does not— we've done any diligence. We're not promoting them, and that is the case in this interview. So do your own due diligence if you're interested, and please enjoy this episode with Nelson Chu. This is the Invest Like a Billionaire podcast, where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you'll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments uncover strategies of the ultra-wealthy, discuss economics, and interview successful investors. Looking for passive investments done for you? With Aspen Funds, we help accredited investors that are looking for higher yields and diversification from the stock market. As a passive investor, we do all the work for you, making sure your money is working hard for you in alternative investments. In fact, our team invests alongside you in every deal, so our interests are aligned. We focus on macro-driven alternative investments so your portfolio is best positioned for this economic environment. Get started and download your free economic report today. Welcome back to the podcast. I'm your host, Ben Frazier, and today we're joined by Nelson Chu of Percent. Nelson, thanks for coming on.

Thanks for having me. Be fun.

That'd be great. So those that aren't familiar with Nelson, he is the CEO of Percent, Percent like the, like the symbol. And it's pretty cool. They're doing— they're building a platform for borrowers and investors to invest in asset-based lending or private credit and has been scaling quite a bit. So you guys have placed, I think it's over $1 billion in capital through your platform, which is a nice big number. And especially right now, it's a really interesting time to be looking at credit, right, as we're kind of entering into maybe a down cycle, maybe a credit tightening. We're already seeing that pretty aggressively in kind of the banking world. Private credit plays a very integral, integral role in continuing to finance and capitalize businesses through all credit cycles. So Nelson, thanks so much for joining us. Give us a little bit of your background and kind of how you, you know, started this company and, and kind of how you guys got to where you are Yeah, absolutely.

Well, since we are firmly in the capital markets space, I'd be remiss if I didn't have a little bit of a finance background. So yes, I do have a slight finance background. I started my career at Merrill Lynch. That kind of dates me in terms of how old I am. I was the last summer analyst class for Merrill Lynch, so I will hold on to that badge of honor. It became Bank of America after that. So I was on the business intelligence side for the wealth management business. And then, you know, there's a lot of rumblings of like, oh, sell side's not as good as the buy side. You should join the buy side. So I was like, All right, fine. I will join the largest buy-side shop on the street in BlackRock, and I'll see how it goes. And so I was on the operations side for fixed income portfolio management, and I realized very quickly that the buy-side is not better than the sell-side. As a matter of fact, no side is good, and I'm just going to leave finance altogether. So I left finance about 2012, 2013-ish, around there, and I decided to do my own thing, right? So the tech startup ecosystem was taking off in New York at the time, and I was stumbling around a little bit trying to figure out what I wanted to be when I grew up. And what I ended up creating was really a strategy consulting firm that helped other founders build their startups from the ground up. And so we built out a team of expert product managers, designers, engineers, et cetera, and gave these early-stage founders everything they needed to be able to get off the ground, essentially. And we had a really, you know, couple of really good case studies coming out of that as clients. Some of them became unicorns, which was fantastic. But that really got me thinking, right? We have a team that knows how to build products. We have good access to VCs. I think we have good ideas. And so for the right idea, the right time, we should do something the old-fashioned venture-backed way. And that's really how Percent came to be. So Percent really was the initial incarnation of a confluence of different things going around the fintech space at the time. But really it was just seeing alternative investments just take off in 2017, 2018. And we're recording this on May 15th. We actually just celebrated our 5-year anniversary today as a company, which is lovely. Yeah. But yeah, we saw the opportunity there to just build something that was honestly better for investors, shorter duration investments, lower minimum investments, comparable yielding investments focused on an asset class that we thought was poised to take off. We were maybe 4 years ahead of our time in terms of the asset class poised to take off. But, you know, this is the year of private credit, that's for sure. I'm excited to talk more about that.

Yeah, awesome. Well, thanks for sharing that. I think, you know, I'm probably a little biased towards kind of the debt side of investing because that's what we've been doing at our private equity firm, Aspen Funds, for the past 10 years. Buying discounted debt on mortgages. And, you know, as we've kind of been doing this podcast and exploring, you know, how do the ultra-wealthy invest, what are they doing differently than maybe the average retail investor? You know, one of the things that I've seen is, you know, as you kind of go up the scale of net worth or, you know, portfolio that you're investing in, what we've seen in talking with some pretty big institutional investors, a lot of them think a little bit differently as far as risk mitigation, right? They don't want to necessarily go and swing for the big home runs and every deal, they want to actually preserve portfolio becomes a bigger goal. And, you know, they start thinking a lot more about the capital stack, right? I've talked a lot about capital stack on this podcast. And so basically, where are you in the priority of repayment if, you know, something doesn't go right with whatever you're investing in, right? Where are you in that stack, right? Are you first to get paid? Are you last to get paid? And most, most investors, if they're investing in these kind of private investment alternatives, most of them are investing in common equity, right? Which generally has the most upside. There's a lot of good deals. I love common equity. I love, I love the big returns, but they're also the last to get paid. Right. So it's important to have balance in your portfolio, not just putting all your eggs in the basket of common equity, so to speak, but spreading out across the capital stack. I think you're kind of alluding to, I want to kind of hit in on, on, you know, why now? Why does private credit make sense now? Right. And, and we're seeing this economic cycle is starting to kind of turn potentially as the banks are starting to tighten their underwriting standards. They're not lending as much. And that creates a big need, right, for these businesses that continue to have operational needs while they want to continue to grow. They need capital to do that. And banks aren't doing that. So this is kind of where this, you know, market operates. And so talk a little bit about what types of deals are you guys originally— what types of investments are you guys making through the platform? And maybe differentiate too, because I think, you know, when I first heard about Percent, I was initially thinking, oh, it's another peer-to-peer lending kind of platform like we've heard of LendingClub. And I forget the other ones that kind of really had a big heyday, maybe even 8 or 10 years ago, I forget when they kind of really blew up, but this is different than that, right? It's not peer-to-peer lending. So talk a little bit about the types of deals that you're doing and why now makes sense.

Sure. And I think you did a great segue there into really sort of the history of private credit gives us a guide as to where it's headed, right? Private credit has been around for decades at this point, but the reality is it really took until the global financial crisis for it to really kind of come into the spotlight. And it came to the spotlight because the regulators came down hard on the banks to say, you know what, if you're going to do this type of lending for small businesses, for consumers, it's going to cost you a lot more. Your reserve requirements are a lot higher to be able to kind of do that. And so naturally, post-GFC, all these banks pulled back and they said, yeah, you know what, not that interesting anymore, don't want to do this. And that's what really led to the rise of non-bank lending. And you saw the likes of like LendingClub come up as a result of that as well, which is much more on the peer-to-peer side, as you said. Now we're seeing the same story play out right now as well, right? You had a lot of banks that were in trouble, a lot of banking crises that have been happening, banks getting shuttered or going into receivership. All that is— what that means is in the next coming months, you're going to see the regulators once again crack down on the banks, the way they're doing the lending practices. This time SVB was firmly in the corporate debt, venture debt space, right? I think you're going to see some rules come down around that as well. And so With that being said, you're going to leave or there is a huge void in the market that these banks are leaving once again because there's no money to support the ecosystem and the companies are desperate looking for this. So that's really sort of where we come in, right? And we are not a lender, right? We are an infrastructure provider for private credit. We help facilitate the transaction between the borrowers who need that capital, the underwriters who actually structure these deals. And the keyword there is structure, right? So it's not peer-to-peer lending. And the investors who invest in these products that these underwriters are structuring. So looking back and breaking down the asset class into kind of two component parts, you have like the asset backside, which you alluded to, right? Which means that you're essentially backing a portfolio of loans, for example, or portfolio of something that's generating yield, or you go on the corporate debt side, which is literally just you are advancing money to a company specifically. So our platform does do both. Historically, we started with the asset backside because it is a much harder transaction to do. You're essentially structuring at the asset level and sort of the underlying asset performance as well as the company itself and like how it's doing.

And also kind of pause there and dig into what is asset-based lending, right? So we're throwing around a lot of terms that maybe a lot of folks aren't familiar with. So talk a little bit about kind of what you're lending against on those.

Yeah, I'll give examples. That's probably the easiest way to do it. So think about the ones that people have probably interacted with the most, like buy now, pay later. right? I think we're seeing various different shades of what's going to happen to BNPL over the next few months. But at the very least, it is something that was very popular and has consistently been very popular. So you as a consumer take out a buy now, pay later loan. Effectively, you are one of like tens of thousands of people that did it with this lender. That could be Affirm back in the day, could be any of these guys. Now Affirm has zero interest in selling this loan individually one by one to somebody, right? They'd rather actually take the entire pool of loans that they have across 10,000 different consumers who are borrowing from them and say, yeah, can somebody take over this position and essentially give me capital to be able to finance these loans that I'm making? And so they're going to be basically what's called securitizing the loans themselves and creating a structure around it to be able to protect the investor who wants to give them the money to finance this loan portfolio. So when you say asset-backed or asset-based, It literally is. There are assets underneath there that you're kind of pulling together that are designed to generate yields effectively. So it encompasses things like consumer loans, like buy now, pay later, small business loans, same concept, right? It's just for small business versus consumer. You have like equipment leasing, you have like factoring invoices, you have litigation finance, like the list goes on. And the reality is most individuals and investors may not know what private credit is, where they probably interacted with a private credit product in one way, shape, or form. They just didn't really realize it.

Yeah, got it. So on the consumer side of things, you have kind of two broad categories, right? You have, you have commercial, you have consumer. So consumer, it's the buy now, pay later. You're taking out those loans and we've all seen those like, hey, you don't want to pay this all right now, you can spread it out.

Yeah, there's also like earned wage access as well, right? So being able to basically advance a paycheck. So those are all things that are— if it didn't come from a bank, which doesn't have a— which has a balance sheet to be able to lend against, then it's probably a non-bank lender. And if it's a non-bank lender, then they're definitely firmly in the private credit space looking for debt capital to finance this portfolio of loans that they have.

Got it. And so what's the asset in that scenario on a consumer loan? The asset is just, you know, a person signing on it and you can go after them in a collection scenario if they don't— if they don't pay.

So the, the lender, the non-bank lender would do that, right? That's their job effectively to essentially underwrite a specific consumer, feel whether they're creditworthy or not. And then if they don't pay, then it's on them to be able to kind of chase them. Our job is to be able to essentially take not just that one consumer, but the tens of thousands of consumers that that non-bank lender has and the loans that they have out there and essentially leverage our platform and our technology to create essentially an investable product off of that. So let's just as a hypothetical, right, let's say the— this is very basic. We do a lot more than this, but let's say there's a loan pool of like $10 million, right? And historically the loan portfolio defaults like, oh, 10%, something like that, right? Then in that scenario, realistically, we as a capital infrastructure solution would never create a structure that gives them more money than 90% of the loan portfolio because 10% defaults, right? So theoretically, we'll probably give them 85%. And that's called an advance rate. Essentially, there's a, there's about 52 different attributes that we play with as a technology provider to give these underwriters the tools to be able to kind of adjust the structure in a way that protects the investors for investing in these products.

Okay. And then on the, on the commercial side, you mentioned factoring, invoicing. You know, there's a lot of kind of providers around this side as well. So I come from a commercial banking background. And, you know, it's— I have mixed feelings about this because a lot of times I see these like small businesses get into these kind of merchant capital type products and it kind of sometimes borderlines along predatory versus not. And you kind of get a small business owner that needs to make payroll and they're, you know, maybe you have a gap between the receivables and the payables, right? So how much they owe now for payroll versus the receivables that they got coming in from future sales. And so they kind of make a bridge loan, but they only get a certain amount of that future AR, the future accounts receivable, but they're giving up 100% of it to whoever's doing it. So it effectively becomes a pretty high effective interest rate and you can get into this negative spiral where it's difficult to get out of it. But at the same time, it's also, you know, coming from working a lot of small businesses, cash flow is the lifeblood of small business, right? And actually, I forget the stat exactly when I was in banking, but it was something like I think it was over two-thirds of businesses don't go out of business because of lack of customers. It's actually a lack of managing cash flow. So basically they have the customers coming in, but they can't meet the difference between when they have to make payroll or send funds out versus when the funds are coming in. Right. And that actually causes a lot of businesses to go out of business. So there's a real true need for it. Talk about that space a little bit of how does, you know, how do you guys look at that space? You know, especially now, I would imagine with the banks pulling back advance rates, pulling back lending, you know, these businesses still need to operate. They still need these kind of services. So there's, there's actually a pretty big gap to fill. Talk about that, the commercial side a little bit.

Yeah, it's important. And you brought up a good point as well, right? So the truth is the actual— if you were to normalize the APY out to a full year, yes, it probably is a little bit expensive. But most of these situations are like 30-day loans or 60-day loans, right? So the actual impact is significantly less. But it's also an opportunity because if you play that example forward, let's say, you know, there is a— let's say there's a granola bar manufacturing company, right? Something like that. Like, that's what they do. Let's say they can invoice from Whole Foods for $1 million that they want to get in inventory, right? The reality is that granola bar company does not have the $700,000 it's probably going to take to create that product and give it to Whole Foods, right? So this is essentially an opportunity for them to actually create the products because they're taking it, they're factoring the invoice. It's a real purchase order, right? They're creating the product and then they're going to be able to sell it and they'll lose a little bit. But this is revenue they would have never been able to generate on their own because they would have just normally throw the PO away, basically, because it's like, I would never be able to create this, right? So this really— private credit as an asset class kind of helps keep the economy going. It's the real economy. It's not the the one you see on the public stock markets. This is the one that actually powers the real engine of the US ecosystem. So to that end, right, I think private credit is a necessity and it's something that actually is, is primed to take off in this environment, like you mentioned, because the banks have stepped back. There were definitely back in the day, at least banks that could factor, banks that could do regular small business lending. They're just not doing it anymore. And in a tight credit environment like this, These companies need the capital now more than ever, and it's kind of made a lot of tailwinds for us as a company to be able to support that. Even unlike, for example, like the SVB situation, right? That weekend we had several hundred startups reach out to us saying they need bridge financing, they need senior secured term loan financing, they got to make payroll, right? And the reality is, you know, no bank is going to step in over a weekend and help you with that at the very least, right? We had dozens of underwriters that were ready to go. We had dozens of investors that wanted to support the ecosystem. By the end of that weekend, before the Treasury Department probably literally bailed out the global banking system, we had, you know, about two dozen startups with about $50 million in capital ready to go by Monday morning if nothing came through. Right. And so there is no world where anything outside of private credit will be able to support that type of activity over the course of 36, 48 hours. And that's a testament to sort of the power of the asset class and also the power of what we built as a technology solution to be able to move that quickly.

Yeah, absolutely. That's super helpful to kind of lay the landscape there. And just one other quick question on these asset-based loans with— on the commercial side, are these generally secured loans or are they unsecured?

Usually they're secured loans. Yeah, we always do it on our side. There's no unsecured loans on the platform itself. That's part of the requirements.

Okay, very cool. And then shifting to the corporate debt. So we're talking about SVB, Silicon Valley Bank. Obviously, if you haven't been watching the news, you know, what was it? How they were what, the fifth largest bank to ever fail or second largest bank ever?

So something like that. Yeah. Yeah. But they left a $6.7 billion hole in the venture debt ecosystem. So there's that.

So, so talk about what venture debt is, right? Because this is an area that I was kind of newer to coming from the commercial the commercial banking side of things, but an area has very been very fascinating to learn about and very attractive actually from an investment standpoint. But all of a sudden in SVB, they were the 800-pound gorilla in this space. They owned, I mean, probably 80% of the market, you know, or something close to that. And now they're just gone. Right. And to your point, these are venture-backed companies. These are bootstrap companies that are the lifeblood of our economy because, you know, two-thirds of our employment is produced by small businesses, right? It's not just the big Apples and Amazons of the world that keep the economy going. It's mostly small businesses, mostly, you know, entrepreneurs and small businesses. And if they don't have the capital that they have access to that they expect and are building their businesses on, that's very, very damaging, right, to the lifeblood of of our economy. So talk about that whole world a little bit, because that's a really interesting thing that's happening there. And, you know, I'm sure folks like you are excited, right? Because it creates opportunity when this huge player now creates this big vacuum.

It does for sure. So it's— venture debt is just honestly a subset of corporate debt, right? It's like very simple. So you're literally just essentially providing capital to a single borrower. It could be— it's probably a company. There are EBITDA profitable companies, in which case you're literally just loaning them money to be able to actually, based on their existing cash flows, expect that they can support the loan that you're giving them. Right. The interest is not too crazy and it's just more for them to be able to grow. For venture debt, it is the smallest side of corporate debt, right? So it is going to be earlier stage companies, probably not EBITDA profitable or positive, but you're kind of betting on the fact that they have great investors, they have a business that will be able to scale, they'll be able to raise more money. And that's kind of the bet you're willing to make. So the, the APY that you'd be doing for venture debt is likely significantly higher than somebody who's EBITDA positive. It just kind of naturally makes sense. Now, venture debt prior to kind of all this going on and prior to the Fed raising rates, prior to the current environment that we're in for just venture equity in general, used to be much more opportunistic. It was essentially, oh, I raised a great big equity round. Why don't I tack on some more venture debt to be able to just extend my runway without it being too dilutive? And look, I'm so flush with cash, the interest doesn't really matter. To me, right? So non-dilutive, a little top-up over their existing equity raise. But that all changed in 2022, right? When the venture equity market dried up, you had so many of these companies which were reaching the tail end of their runway and realizing that, geez, like, we're not going to make it unless we get more capital into the door. And, you know, I think most of these venture debt lenders, including SVB, are not in the business of saving and salvaging companies, but they are in the business of trying to find diamonds in the rough and be able to pick the ones that they think will be able to succeed and survive and raise another round of equity financing. So I think we've seen a ton of demand for venture debt coming through, but the quality is like all over the spectrum, right? You have definitely companies that are probably on the last 2 months of life. And to be perfectly frank, I wish they had reached out when they had like 6 months of life left or 9 months of life left. That would have been very nice. We probably could help them. But the ones who are, you know, in a good cash position, but realize that this may take longer than they expect, the next round may not be as fast as they think, then if that's the point, they're still well capitalized. They're worthy of taking on more venture debt just to be able to kind of survive and weather whatever comes their way. So we're seeing a lot of the underwriters in the ecosystem just say they're inundated with deal flow, but it's just hard to kind of pick and choose your battles in that instance because there is a lot of I would say, you know, more distressed deal flow coming their way than ever before.

Yeah, I think this is a good segue to— we've been talking about kind of the ecosystem of why this makes sense, you know, from a borrower's perspective, you know, taking out these loans. Let's shift kind of to the investor side of things, right? So how should an investor be thinking about this? Right. In my mind, this is, you know, these are a little bit riskier loans than maybe if you're investing in debt that's secured by real estate or something, obviously, right, as a hard asset that has a, you know, more fixed value. But at the same time, you're also maybe a little bit less risk than you're talking about common equity position in, you know, venture capitalized firm or even, you know, a heavy value-add real estate project or something.

Right.

There's this kind of risk, risk reward, risk levels. There's levels. Right. And so talk about it from an investor standpoint. A risk in this scenario, right? This is, this is different than a lot of our investors are, say, real estate investors predominantly. And, you know, you understand the asset, the location, the rents, the market, you know, but these are businesses. This is different than just real estate. So how do you, how do you quantify the risk in a business and how do you mitigate a lot of that from an investor standpoint?

Sure. Absolutely. And I will say the one caveat is real estate's looking a little shaky right now too, as well, for sure, given everything going on, especially CRE, right? So that, that day of reckoning will come given this concept of work from home is probably here to stay, not fully. But, you know, when you have occupancy rates under 50%, 40%, that's going to put a lot of stress on the, on the banking system as well, since a lot of them are the ones holding a lot of these loans.

So referencing the office. Yes.

Yes.

Yes. But yeah, that's definitely going to be some major turbulence there.

Yes. And so we'll see how that, how that goes. But to your point, right, common equity is the lowest on the cap stack. It's going to be the last to get paid. Private credit tends to be either in the senior position or the junior position. If you're senior, then you just get paid faster, right? But you're also going to get a lower rate inevitably from an APY standpoint. If you're junior, you take on higher risk. Senior has to get paid first before you get paid. And so you take on more APY because you want that kind of extra juice essentially. Now, when you think about sort of what's going on in private credit and why it's so interesting right now, it's really because the rates are where they are, right? So public credit or public market fixed income tends to have much longer durations. These are companies that most of them probably took advantage of the low rate environment, took on a ton of debt, but they're paying like 2 to 3% in investment grade interest, right? So they can let that ride all day, every day. There is zero reason for them to come back out right now and refinance. And so you're just not seeing a lot of activity on that side to even kind of be able to invest in it. On the private debt side, the durations are significantly shorter. These aren't 25, 30-year maturities, right? These are like 3-year maturities with like built-in structures that force them to come back out to market. So when you do that, you're effectively, it's not floating rate, but it's kind of close, right? You're seeing real-time reactions to the Fed, to the market and things like that. That's causing it to all kind of change. So when you think about it, the Fed funds rate, you know, is where it is today. Private credit on average, this is just a literal general average. Don't take my word for it, but it's about 10% higher than the Fed funds rate on average. Right. And so that's the risk premium that investors feel they deserve to be able to be compensated for the risk they're taking in this environment for private credit. That's not bad in this environment where that means they're tracking 15%, 16%, 17% right now. In this market, I— most people would probably take that in the grand scheme.

Yeah, that's, that's what a lot of equity investors were happy to make, you know, on the other side of it.

Yeah, exactly. Exactly. So again, does not come without risks though, right? Like in the event of a default, there is a usually somewhat lengthy, depending on how it defaulted, workout process to try and get the money back. There's like legal that gets involved. There's bankruptcy courts that sometimes get involved. It can get messy, right? And so you have to make sure that you're partnered up with the right group to be able to kind of facilitate that recovery and workout process. We've gone through ourselves a few times. We have, you know, the ability and we've had instances recently where the workout actually worked out very well. And so it is kind of part and parcel with what you get when you're in private markets versus public markets, which are effectively liquid in the grand scheme of things. But to your question around how do you protect investors and mitigate risk, it is kind of what I was mentioning earlier. Around, you know, if the portfolio of loans defaults 10%, just don't ever give them 95%. That's just a very bad idea. So those levers that we have at our disposal, that's part of our infrastructure package, right? We have all these different underwriters who can take advantage of all those attributes, the levers they can pull up, down, left, right, to be able to create a structure they think based on historical performance will protect investors the best they can. And so versus I would say common equity. If you're investing equity in a startup, for example, you're kind of just, you know, praying it goes well and hopefully it goes well, but you're expecting a bunch of zeros in your portfolio inevitably. That's just what happens. That's the risk that you take with the debt side. If you structure the risk away and you structure it properly, you should have a fairly decently performing portfolio in good times and bad.

Yeah, that makes sense. And I think, you know, coming again from a banking background, you know, defaults were the ultimate dirty word, right? You didn't want to have any defaults. And as we've kind of shifted on the private equity side, you know, buying distressed debt, a lot of times that's expected. A lot of times we're actually buying non-performing loans, but you buy them at enough of a discount to where you can—

you like it.

We love it. We project a certain level of probabilities of what is our exit going to be and, you know, what if they reinstate, etc., etc. And we expect, you know, a certain level of default, but we're underwriting to a much more conservative number that we never come close to. So it's all, it's all about— you got to take it all in context, right? What's your, what's your risk-adjusted return, right? I always like to bring investors back to understand what the returns are getting adjusted by the risk you're taking, right? If you're earning a 15 or 16% yield and you're, you know, in the secured debt position, that's a pretty good tradeoff, right? And obviously if we go into an economic cycle and businesses start going out of business and higher unemployment and, you know, these interest rates, if they stay higher longer, it's going to create some more turmoil. So probably expect a higher default rate. But in a portfolio situation, you can mitigate a lot of that.

So the yield would go up in that instance, right? So then you're getting paid 19, 20 if that's the case, when you see that level of performance. So it is offsetting. But to your point, this is just portfolio construction theory at the end of the day, right? Like, in this instance, in the same way that let's say you have $5 million to invest, uh, some people would put $5 million on Tesla, right? For sure. Would that— is that a recommended strategy? Probably not. And so they're going to want to diversify across 10, 15 different positions, and that'll give them the kind of weighted adjusted return that they probably expected, right? A little bit of Apple, a little bit of Amazon, a little bit of You know, something in the Dow, things like that. In the same way here in private credit, if you have $5 million, you dump it all into one position, that's probably not the right idea. So even for us, you know, we know that. And so we actually offer investors the ability to invest in what's called our blended notes. And the blended notes give them essentially the ability to choose based on theme, whether it's high yield only. So high risk, higher risk, US only, senior positions only, whatever it may be, or total market. And they invest a little bit in every position. It's kind of a one-time investment to get 15, 20 different borrowers, different deals inside that. And so the yield is lower, but again, it's kind of the more diversified position you'd probably want in private credit to begin with.

Yeah. How have you guys stressed, you know, the default rate? So obviously if you're expecting a 10% default rate, you know, um, that's the long-term average. Well, that's going to ebb and flow, right? It may accordion up to 20% or more, you know, in a, in a down economy. How do you kind of think about that? Right. When you're, you know, because the long-term averages can be deceiving when you have— for sure.

I mean, we had COVID where literally you had companies that had never defaulted in their life and they just had no cash flows and they just all wanted to default. Right. And so you don't think and factor in those types of standard deviations because it just has never happened before. So just to be clear, that 10% obviously was just an example. Our platform default rate is under 2%. So, you know, we've weathered COVID, we've weathered high rates, we've weathered a war. We've read like it's been— there's been a lot going on the last couple of years. And so that has been, I think, something that we're pretty proud of. But having said that, there are plenty of borrowers on the platform who have loan portfolio default rates closer to 10%. Right. But that's okay. That's totally okay because you can structure around that if you know that. And at the same time, because this is private credit, you also can generally see it coming from a mile away. So we actually provide weekly reporting for all of our borrowers. And so investors who make that investment can see the underlying asset performance. Let's say there's 1,000 loans in that portfolio. They can see how it's doing. And if it's starting to see, oh, this like default rate is ticking up, there's like more— there's more loans that are delinquent, like there's something going on here. The reality is that investment is probably going to come due in the next, call it, 2 months, 3 months, or something like that, right? And at that point, if that performance persists, rate's going to go up, structure is going to be more tight. Like, all these things you're going to be able to do to be able to almost like structure away that new risk that has come into the market based upon what you're seeing in the underlying asset performance. That's the beauty of private credit. Public debt, like, good luck, you're sitting on that for another couple years, right? Uh, but again, these are Fortune 50 companies, generally it's probably fine, but still, it's not going to be without stress on the public debt markets too in the coming months.

Yeah. What would you say is different about the types of products and portfolios you're putting out there versus, you know, the CDOs that were being promoted, you know, before the Great Financial Crisis, right, where they're, they're bringing all these collateralized debt obligations out to the market and creating tranches of these subprime mortgages. And, and ultimately there's a lot of, a lot of, you know, players at fault there. Right. The ratings agencies weren't accurately reflecting the risk. But I think it left a very bad taste in investors' mouths. Right. Of, well, that's what caused this whole, you know, huge, you know, pretty severe recession is these kind of collateralized loans. And so how do you guys think you're different than that, and how is this different, if it is at all?

Yeah, it's a great point. Um, I think this is actually, in hindsight, the benefit of technology at this point. We are, you call it, 15 years post that, right? And when you look at what's out there today versus what was there back then, from a tech standpoint, the reporting itself was so delayed. Like, you were shopping Excel spreadsheets back and forth. You just didn't have consistency, reliability, and even trust in the data that was coming out. And so your reaction time was significantly slower as a result of that, right? These days, with all the infrastructure that's been built on the fintech side, you can get effectively quasi-real-time reporting if you really want to. And so when you see this type of changes happening, if you see homeowners start to want to not pay or whatever it may be, right, like that inevitably is going to put you in a situation where you're going to be able to actually take advantage of it. You'll be able to seize the assets. You'll do a lot of different things that just weren't quite available back then. Because you were 45 days behind on what was going on. And so that has changed the way we do things. On top of that, I think there is just much more legal frameworks here in place to be able to kind of better protect both the investor and also better create a better product. To be perfectly frank, the ability to now actually like confirm that there's no like double commitments on, on the assets, right? You can't have a borrower commit and pledge these assets to that guy, but then pledge those assets to the same guy somewhere else. Right. You can't do that anymore. And you can see that when that happens, there was definitely, I would imagine, a ton of that going around in '08. And so everyone just wanted to make money. Right. So I think 15 years of regulatory overhauls, 15 years of technology enhancements just in general have made this a better product. And the reality is the ability for that to happen again in the way it did in '08 probably just likely is much more difficult based on sort of what's been changed in that time frame. So it's just time, honestly, for better or worse.

It makes sense. I mean, there's a whole cottage farm of, you know, derivatives and everything else that's created off these kind of base products and you're trading on who knows what you even own at this point. And I'd imagine in this scenario, you're not— investors aren't investing in any type of derivative, right? You're investing in the actual promissory notes.

Exactly. The actual assets. Yeah. And the interest coming out of the assets.

Yeah. So talk about your model a little bit. So your platform model, you're not you know, taking, you know, investors would invest into your fund, but you're investing directly with the providers of these, these loans. Talk a little bit about the model.

Yeah. Yeah. This goes back into more of the history of the company. So at its core, the reason why we are venture-backed and a tech company is because we've built capital markets infrastructure for private credit. Right. So that means that everything from sourcing a deal to structuring something that's investable to syndicating out to an investor base, to the closing, post-close surveillance, monitoring, and servicing of that deal. That's what we're known for. That's what we actually do as a company. To get here though has been an exercise in, I think, resilience and futility, depending on what day you ask me. But the reality is we spent 4 years learning how to do these deals by underwriting deals ourselves, playing that role of that intermediary, between the borrower and the investor and learning what it takes, right? So fast forward to what you had mentioned earlier, over $1 billion in deal flow. We did over 400 deals. We learned a lot about sort of what is the market standard we can set in terms of a structure that everybody can use to make it that much more efficient. What is the data standard around reporting to be able to actually give investors confidence that after they make an investment, they understand what's going on and what are the pain points and value props that the borrower feels, the underwriter feels, and the investor feels Those are all kind of learnings that were used to be able to get to where we are today. So historically, we underwrote all the deals, investors could invest in it, and that was all good. These days, because we're much more of a technology solution, a platform, we actually don't underwrite deals anymore for any kind of new borrowers coming to market. We have no shortage of underwriters who are— some of them are pretty well known, some of them less well known, but they all have experience in the space. They are private credit experts at the end of the day. They're bringing positions to market from borrowers that they may know, borrowers that are picking up from us, and be able to actually leverage their skill set, expertise, and our technology to kind of bring products out to market and get investors to invest in it. So it is a, I would say, a shift in our business model into what it is today. But it took 4 years to be able to get here. But now we're pretty proud of sort of the scalability that we offer. And at the end of the day, for investors, the name of the game is really not every product on our platform is for you. Like, you should— I mean, we do have, I think, one guy who invests $500 in every single deal we've ever came out with, which is definitely one strategy. But the reality is you should pick and choose the one that's suited for you, right? And our job is to give you as much disclosure, transparency, and tooling to be able to make that decision for yourself, to be able to do that portfolio construction theory we were talking about earlier.

Got it. So do you guys service all the loans in the portfolio or no?

We don't service the loans because otherwise these non-bank lenders wouldn't need to exist because we would just be the non-bank lender. But no. So the non-bank lenders are the ones who actually service the loans themselves and then we service the actual investment product itself. So all the cash flows, distributions, things like that that come out of it, we're the ones that facilitate it, kind of manage all that and have it go out to investors and vice versa.

And the reporting, I'm assuming, between borrower and all that.

Yep. Yeah. So we have an entire borrower portal that they can use to be able to provide us the information. We standardize it, normalize it, ingest it, and then spit out the reporting on a weekly basis for investors to kind of take a look at.

Got it. And then is this for accredited investors only or is this a Reg A or—

Yeah, this is for accredited investors only. Reg D private placements, kind of pretty standard. I think the amount of work that would require to get Reg A or Reg CF going was just way too much in terms of what we are offering. So we haven't been able to do that at the moment. Having said that, the accredited investor rules have gotten a little bit more lax over time. Like, the SEC has recognized that there's ways to, you know, if you're just well-educated on the, the, the markets, then you should be able to invest, right? So you can get series licensed and then you can now invest in these products, right? Those are things that just were not available before. And that does open up the accredited investor market to be significantly larger than it used to be.

Yeah, absolutely. Awesome. Well, what's the best way for folks to kind of check out more what you guys are doing?

Yeah, so you said we are Percent, the icon or the logo. We're also percent.com, so that's not bad. So very easy to find us. Definitely take a look. We have no shortage of resources, no shortage of reports that we push out. I think the reality is it's one of those things that you just got to get educated and learn more. But we're trying to provide as much information as possible and it's also free to sign up. And so you can literally just sign up, take a look at all the deals we have, take a look at all the reporting that we have, get comfortable with it. And the minimums on a lot of these deals are actually $500. And so it's a bit of a, you know, try before you buy mentality. It won't hurt you. So definitely encourage people to kind of take a look. And I'm always around if they want to ask questions. Our client solutions team is always around to be able to answer any questions as well. So feel free to reach out to us. Is there anything you want to learn more about?

Awesome. Thanks so much, Nelson, for coming on and sharing about this market. Very cool stuff.

Thanks for having me.