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Business Unusual

How unicorns turn into donkeys

24 March 2021 7:15 PM

It is a good cautionary tale that just because something may sound good, does not make it good.

Unicorns are start-ups that rapidly become valued at over $1 billion, sometimes those valuations prove to be wrong especially when a business casts itself as a fintech disruptor in order to attract venture capital investments that was actually a regular business with a persuasive CEO and a good backstory. This is the story of Greensill Capital - the super abridged version.

In this story you will hear about small suppliers being hard done, you will hear about supply chain financing and you will hear about big investments and circular dealing.

Remember how good doing full blood diagnosis would be if you only had to use a tiny drop of blood. The amazing rise and fall of Theranos is not too dissimilar from what appears to have happened at Greensill Capital and its CEO Lex Greensill.

Power to the little supplier

Lex Greensill explains that his drive comes from growing up on a farm with his parents who would have to wait for months to be paid for their produce even as their own debts mounted up to produce the next year's crop.

Big suppliers could get financing to cover them while they waited for payment, but it was either not available or too expensive to use for small suppliers.

As a trained lawyer, Greensill set out to change that with a company that would do supply chain financing.

Supply Chain Financing

For as long as there has been trade a merchant would need to pay a supplier for his goods and would usually negotiate terms to allow the merchant to sell the goods before paying the supplier. Suppliers themselves would have agreements with those that supplied them and for when those debts would be settled.

Banks saw that the system could sometimes get stuck if a supplier could not send their products and so would agree to accept the invoice that was owing to them in exchange for the funds minus a percentage of the invoice for the bank.

The bank made some money, the supplier could create the goods and upon delivery the merchant would settle with the bank. This has many names but typically is called factoring.

These days those supply chains are long and the negotiated waiting times for settlement can be even longer. For many at the start of the supply chains or that are simply too small, banks are unwilling to take the risk for such a small reward and so sometimes the merchant looks to arrange the funds are available via a bank to ensure suppliers can deliver.

This is where supply chain financing is supposedly more clever. It takes the entire chain into account and can supply finance at all the points along the chain to ensure there are no issues to prevent the product being produced, which allows it to be sold and for the entire supply chain to be protected.

It requires a lot more information and it needs a lot more information to be processed to determine where a sticking point might arise and how to resolve it.

This does sound like the realm of fintech and when you set your artificial intelligence algorithms to determine where and when some intervention is required you can make supply chains big and small attractive to banks again.

If you bundle the collective invoices as assets that can be sold to investors who will make more from the unpaid invoices that have similar risk investments and you have yourself a great business.

To mitigate for the occasional time when the AI does not get it right, you buy insurance to cover any defaults.

The margins are smaller, but spread across many supply chains and so the risks are smaller too and for the most part you not only add stability to the manufacturing supply chain, you make a small profit from it too. Perfect.

Too much green in Greensill

A safe business can do well, but is unlikely to be called a disruptor, but when you believe your story is so good, you are bound to want to grow a little quicker and take a little more risk.

A decade after its founding and after rising to valuations of around $10 billion, Greensill filed for insolvency protection in March 2021.

The reason it failed was not some black swan event, it was that it did not use the smart financing it said it had, it was risky to begin with and grew more risky over time.

Rather than having lots of clients they had a very large part of its business focused on just one group, GFG Alliance a global commodities consortium headed by a maverick CEO Sanjeev Gupta.

It also offered a speculative form of financing that would forward funds to a business against assumed future sales and contracts. It did not make this clear to those who bought the assets nor did it specify this to the insurer who covered the risk.

It had received investment funding from the Softbank Vision fund of $600 million which also bought as much as $1,5 billion of the management fund that Greensill listed via Credit Suisse. Greensill then used the funds it received from Softbank and the management fund to supply financing to Softbank assets.

The wheels began to wobble when the manager of another fund was investigated for being too exposed to Greensill which also revealed that all was not well with the Greensill model.

It led to the insurers withdrawing their cover for the assets in the fund which saw investors question if their investment was as safe as they thought.

As confidence began to wane, the GFG Alliance that was reliant on flows of funding from Greensill became concerned that it might default on some of the payments it owed to suppliers, the very same suppliers that had been financed by Greensill.

This saw Credit Suisse suspend the flow of funds to Greensill and return the fund credit to investors effectively ensuring GFG would default which resulted in Greensill filing for insolvency protection in March 2021.

Was it destined to fail?

Margins in the supply financing world appear to be small so the first warning sign was Greensill operating with private jets, four of them.

The business would work best if it did have a focus on industries it could fully understand to ensure the correct provision of finance when and where needed, but it was so focussed it effectively had one client that itself was not that safe.

Getting involved with financing for future contracts is highly speculative as they are unsecured loans and so should not have been part of the business.

Lex Greensill appears to be a risk taker and may have become even more emboldened when he began to work with Softbank’s Masayoshi Son who is himself a big risk taker.

Had there been just one issue, the business could have course-corrected.

Had auditors and regulators been looking a bit more closely it may have stopped it getting out of hand.

Had regulators required operators like Greensill to operate in a similar way to banks, it would have been unlikely to have engaged in the deals the way they did.

But perhaps the largest element might be that markets and economies were doing much better than they were a decade before when the last financial crisis was still fresh in everyone’s minds.

What this one company did was not too different from what led to the subprime crisis with very risky assets being passed off as much better ones until they were finally exposed.

As long as we let our guard down while times are good, we can expect to see situations develop to make them bad.

24 March 2021 7:15 PM

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