Balancing Sales and Risk in Fintech Lending

Fintech lenders function as tech-enabled investment firms, originating granular risk and packaging it for equity and debt investors. From our decade-long experience with fintech lenders, we've observed that the most successful companies maintain a healthy tension between sales and risk.

This balance is critical in lending and investment firms. At one end of the spectrum is a sales and growth culture focused solely on deployment and revenue growth. At the other end is a conservative risk culture that fails to meet investor mandates.

The board and CEO set the tone for this balance. If the board or investors push the CEO to grow despite limited opportunities, the CEO may pressure the team to take on more risk, expand into new products, or adopt broader credit standards. For instance, in consumer credit, this might involve lowering FICO score requirements, increasing loan durations and sizes, or expanding into new, less proven geographies.

The best-performing companies we've worked with have robust risk cultures that adapt their models to accommodate growth without significantly increasing risk. They foster a disciplined environment that prioritizes sustainable growth over immediate gains. Risk professionals in these firms skillfully navigate conflicts with growth advocates, including their CEO.

Conversely, companies that fail to balance growth with proper risk management jeopardize investor capital, sometimes facing existential challenges as a result.

CEOs with risk-oriented backgrounds may hesitate to venture beyond their core competencies, even when opportunities to expand their market are clear. Sometimes, taking on more risk is the right move. For example, a 0% loss rate on a $25 million loan portfolio generating $2.5 million in annual interest may be less beneficial (depending on the cost of capital) than a $50 million portfolio with a 2% default rate, which would generate $4.0 million in net revenue. In some instances, defaults are customer acquisition costs, which can be acceptable if it's a conscious strategy.

In such situations, a strong sales lead who can challenge the risk culture is crucial. They must advocate for strategic growth that boosts revenues and enterprise value without compromising portfolio stability. Without this balance, a business may fail to scale, limiting its ability to fulfill its promise to investors.

So how is this practically accomplished? Embracing confrontation and pressure testing the “how” behind your growth plans will be important. A company we partnered with had a great dynamic that set them up well to accomplish this balance: they had two co-founders, the CEO and the Head of Risk. They viewed each other as equals, with no power dynamic to force decisions. They could have a heated argument about a deal for approval and then get beers later that day. Those heated conversations lead to all the key points being debated and, in most instances, getting to the right answer. It forced compromise where one side was being too aggressive and created a healthy balance between how risk and sales were being managed. Not all teams can navigate confrontation in this way, but setting expectations that confrontation is healthy and learning how to manage it is a key building block for a good balance between sales and risk. Teams that fail at confrontation can sleepwalk into approving poor credit decisions.

Having a seasoned lending operator on the board who can temper growth expectations for long-term sustainable growth is another mechanism to ensure risk and sales are properly managed. In one board-level discussion, the lead venture investor from the most recent round pushed the company to hit its goal of 2x growth year over year. The CEO, eager to please his investors, was ready to accept this challenge when a seasoned operator on the board challenged him to ensure this was both possible and sustainable. After some discussion, it became clear that only by stretching credit standards could this growth be achieved. When pushing for growth, it's important to understand the "how" and be intellectually honest about the implications of pursuing that route.

An example of mismanaged balance can be seen in 2021 when revenue growth was the holy grail, driven by valuations and premiums for fast-growing businesses. In lending, growth can be feigned via originations, with the price not being paid until performance matures on those originations (which could be 6, 9, or 12 months down the line). One company saw continued 3x year over year, with unicorn status in their line of sight. They expanded products beyond their core competency and quickly expanded geographies. Growth continued at a blistering pace, but there was no strong risk voice to question "how". The company raised its round at a unicorn valuation, but when performance for those loans showed up, the equity paid the price. They had to work with their lenders to remedy underperforming assets. Growth halted, and the company had to start from scratch post-restructuring with its lenders.

Achieving this balance is challenging, especially if the CEO is inclined towards either a risk or sales culture and lacks a counterbalancing force. It's essential to recognize if one force is dominating and to implement systems to maintain equilibrium. This means always asking "how" when laying out growth plans and ensuring that compromising risk standards are done intentionally.