The Real Math on Cohort Financing (And Why You're Losing Money)

Let's say you you've done your research. You've tried and failed or you tried and you you've gotten some good payment terms for a little bit. And Martin's right. You it's very very hard to become a hundred million dollar plus mobile game studio without taking on some kind of financing. But you've now heard that the the effective annualized rate could be 14 or 40%. As a publisher, when you're talking to these financing companies that offer cohort financing, what are the first questions that you should ask every single financer?
You do need to understand the terms. Then I would also look and and see who else is is borrowing money off them. I would definitely talk to them just to understand what their experience is. And

ideally find someone where things didn't go according to plan. Right? If a cohort hasn't performed accordingly, are they really genuinely on your side? Are they getting really draconian immediately? I would also start understanding a bit if you've raised some VC money, have the VCs dealt with them? Do they have some information? I would do that and then I would compare what Martin has said is is the IRR put that into the calculator to get a good overview. What does your LTV curve look like? What's your payback periods? How are you going to monitor if you scale up how things are performing? Cuz I think that's how you save yourself in in in the best possible way.
For me I feel okay, cost is important but it's really not. You know, I mean you could quite happily be financing a an IRR in the low to mid twenties if you've got crazy good performance. If and this is almost the most important thing

is the flexibility of the instrument to do what you want it to do. Right? So, like duration matching, you know, I've got a 6-month break-even, you're prepared to do this, you're prepared to commit this much capital over time so that you can continue to scale up. You know, again, just working out as part of the overall thing. Too many people just get hung up and they're like, "Oh, why is this like 21%? I can't get a bank loan for seven." Go go get a bank loan, see how see how useful that is for you. I saw one company say, "Yeah, I'm going to raise a $2 million venture debt facility that amortizes over 5 years." I'm like, that doesn't help you because you're just going to be repaying this facility back over 5 years. So, the flexibility of the instrument to do what you want it to do, I think is the most important thing. So, that that and obviously price, but not I I don't think actually even price is at the top because if you've got half-decent unit economics, it trumps the second, flexibility trumps it. However, there's also a bunch of other stuff that people don't normally

check. It's like, you know, where is the source of capital for the lender? Is it some massive institutional warehouse facility or is it a bunch of guys who have, you know, made a bit of cash who are looking for some short-term investments who might happen to just pull that at any point in time. So, the the certainty and the commitment to the funding behind it, obviously the security, and then, you know, what what are you really giving up? How easy is it going to be to police covenants and things? And as Phil said, what happens when it goes wrong? This is not This is not like you're interviewing a bunch of VCs who have said, "Oh, yeah, tell me about all the amazing access you've had." Right? This is the polar opposite of that. It's like, "Okay, what happened when the hit the fan and how did you how did you conduct yourself and did you, you know, obviously you're a lender and you need to get repaid. You don't have the, you know, 100x return possibilities that a a VC has, which is why you're lending money whatever, but what you do need to make hell of sure of is that that money gets repaid. So, otherwise you're

wearing it and that affects your ability. So, it's a very different thing. So, it's a bit more nuanced in saying the things of what you have to to ask, but I think ultimately you're looking for a partner. If you both understand the alignment, you both understand, you know, why each other's doing it, what the risks, what the rewards are to do, you know, then that's a way better relationship than just like comparing a bunch of term sheets and picking the cheapest one because probably nine times out of 10 it's not going to be necessarily the right outcome um for the studio.
For first-time founders or first-time, I guess, scalers taking on debt, what are the most common terms you see that maybe they shouldn't have agreed to?
I mean, people doing fixed-rate deals so they didn't understand how to calculate an interest rate is going to stand out at the top. Again, I'm trying to caveat it. There's no point There's no problem with that. As long as you understand what
As long as it backs out.
Well, but but also keep in mind there's certain jurisdictions where that you're only allowed to do fixed-term.

Like a fixed interest that's pre-calculated, right? So, that don't exclude these because sometimes it's the only thing you can get based depending where where you're based.
Yeah, you get into the when is a loan not a loan because at Poland we're regulated in the US or rest of it and, you know, we have to report these things like really diligently. Well, most people can't Why? I say can't be bothered. It's a real pain. You have to go through a regulatory process to become a certified lender. It gives you a lot of operational overhead. So, generally what they do is like, "Hey, we're a revenue share agreement or revenue-based loans or whatever. Therefore, it's not lending. It might look like a loan and smell like a loan, but legally it's structured as a marketing co-investment agreement or something like that. So, yeah, so sometimes for vague reasons that has to be done on a fixed-term basis. And again, no problem as long as you can unpack and you can figure out what you are actually paying. I think then duration mismatch as well.

When I see a cohort financing company trying to do 30-day break-even deals, it's just like, "Dude, it's the wrong instrument." So, I know you might have a sales guy. And the sales guy is from one of these guys and they're reaching out, they're hitting out hard, right? You see
them every day. And they're good.
Yeah. They're they're good. Yeah, yeah, they're good. So, but ultimately they're sales guys with one of these in their pockets and it's like, "Hey, I've got this. How many do you want to buy?" Right? So, they're not necessarily thinking, "Okay, what is the What do you actually need?" And if I've got If I'm a sales guy with a target and I need to deploy X amount because I've got my investors all over me to deploy it, you know, if you've got a two-month break-even period, hey, cohort financing might be a the answer to all your all your prayers, right? So, I think it's really important to say to take a step back and figure out what you want and what you need, what the most appropriate instrument is, duration match it. And look, if you've got six months of data, you're growing at 20% a month, and you just need to put more more on the gas, you've only got a

certain amount of cash in the bank, it's a brilliant instrument. You can get four, three, four, five times leverage in your existing investment, and it works like a dream. And there are multiple companies that have used this to deploy a huge amount of capital and scale them to really big businesses. All good.
What were you saying, Martin? This is exactly the reason why I actually think that flexibility in a partner that's easy to work with is probably the most important long-term thing, even if it costs you a couple points a year. And the reason is simple. I have no way of knowing, if this is my first or second ever finance deal, what I'm going to need. You know, most founders and most people running a business scaling up, this won't have been their 15th or 20th time where they have tons of reps in this. The likelihood that the deal you sign is the deal you need in 12 months is probably fairly low, I imagine. Is that Is that right, Martin?

So I'm So I'm working with someone right now and it's basically like, look, for the next 3 to 6 months you need a factoring deal because you've got lowish volumes, short paybacks, factoring is perfect. At a certain point in time, you'll be dialing up the spend, pushing back the payment terms, in which case you sort of let's say you go from a a 2-month to a 6-month period, which is fine, but the product you need then changes from factoring into core financing. Right? And so that might take you from, you know, when you go 6 months even to 9 months, even a 1-year breaking piece, if you can still do it and and, you know, you look at your cost of capital versus your return and you can keep doing that and hit the gas and all of a sudden you are, you know, you're doing 7, 8, 9, 10 million bucks a month. You're like a $100 million run rate revenue company. All good. What you then may find is you need more flexibility and it becomes back to more like a corporate facility.

So you've reached a certain level of scale, you've achieved a lot of residual value in your cohorts, and then you can effectively put in place a more flexible and lower cost facility, right? So you're You don't need to be paying in the 20s anymore. You're not using future cohorts as the collateral, you're using the residual value in your existing cohorts, and it means that you don't have to self-amortize every cohort, you don't have to pay it back every month. You might have a 20 or 30 or 50 million dollar facility, you just deploy that capital where it's needed in the business. It may be to make an acquisition. It's not prescribed to have to go into user acquisition. So you can you know, put it into product development, scale you know, build up a new game, or I've seen this a number of times is like a studio wants to pump UA in a new game that it really believes in, but you can only use UA for ancillary cohort financing on one that's already got the data. So, this way approach allows you to cross-collateralize and say, "Look, I'm taking this company facility and it's more like a traditional credit facility,

but I've got a hell of a lot more ability to deploy that capital where it's needed in my business as opposed to just like a one-and-done into new cohorts." So, I really see it as an evolution of the source of capital you need at different times and different stages. There is not a one-size-fits-all in this in this world.
That's the challenge though, because there aren't really lenders out there. I mean, some specific ones, but the the standard candidates for the UA cohort financing, it's not what they're doing. I mean, what Martin said makes a lot of sense. That's kind of where where we sort of ended up. So, we're helping some of our bigger customers to do exactly that right now, cuz we have all the data, we've got the finance contacts now for the debt funds, so we can help them with that. But, I think one other thing you guys haven't mentioned that I think is really important is given how these things change in your requirements, how do you get out of a contract? Right? Because I think Martin touched on it very briefly at the beginning. It's

like if you have this deal, often you can't take any other money. Right? Because they have first dibs. So, they don't want you to go to another lender, lay another level of debt on top. So, that's very important and often really tricky to get out. Can you buy them out? Can the next lender just, you know, pay off the outstanding cohorts? Can you have a deal where you do pay them back as they pay over time, and then you you you bring on additional debt. So, that's the clause and times you really need to check.
There should always be a prepayment clause so you can effectively prepay out of that cohort. Again, if you've got relatively short duration, three, four, five months, you might have a handful of cohorts to pay out, but maybe you've just refinanced that cohort ended with a corporate facility and it's, you know, it's whatever. If you've got, you know, a dozen cohorts that have still like, you know, low

monetization whatever, that's going to cost you materially more to get out of.
But these are not the standard terms, at least not what I've seen.
Well, well, prepayment clauses in lending are totally, you know, totally standard, right? So, if you've got a big facility, you prepay out of
being waved around in in the gaming space.
Right. So, here here's like, and Phil, you're you're probably closer to than me, but someone who's trying to effectively do if there's any kind of vendor lock-in and there's any kind of like trying to force to spend money, these should be massive red flags because if the UA's not working and you're seeing the signals, you need to have the ability to dial back. You don't want to be like chucking cash off the cliff because you know you're going to lose it. So, you need to make sure that facility is scalable with what you need that doesn't try and sort of force you into something you don't want to do in terms of longer payment periods. In terms of I haven't seen anything too nefarious in terms of the lock-in side, but
I've seen a few and often they scale up,

but very rarely they scale downwards, right? At least what what I've seen. And and maybe they're adapting now and that's a good thing, but I think that's definitely where the market needs to head, right? That you as the game can start changing if a better deal comes along or the partner isn't quite the right fit or the game doesn't scale the way you predicted.
The UA is not working, you don't want anyone trying to force you to spend or or you in your forecast you said this was going to happen, right? So, a lender is going to want to have capital deployed. That's how they get paid. So, if all these cohorts are amortizing, that means that their capital deployed is going down. So, understandably, they want to keep it you know, they want to keep it deployed. So, it's a two-way argument and I'm very much I see things very much from a lender point of view as well because I spent you know, 10 years as a lender, but I also have a lot of empathy on the other side, which is why you need to build in this this resilience or these ratchets that if it's not working, you have the ability to repay. If it's

working, you have the ability to dial up more. So, that's where you get back to the partnership angle as well, which is super [clears throat] important. There was one point I wanted to make about modeling and what happens when it goes wrong cuz this could be the real sting. Again, I'm I'm not trying to be negative here. I just want to I want to get it out there cuz I've seen it and seen someone almost got roasted on it.
This is an incredibly complicated area and the hardest part is the skills that founders have and studios have to get to the point where they need UA financing have relatively little crossover with the skills required to use a UA financing deal appropriately. And that means it can be easy to to make a mistake. So, but first of all, Martin, we're going to put your IRR calculator link in in the podcast description. So, if you're thinking about that, go down and and use that because I think that's that's the the key. And another thing that we we said here

is I just want to stress this again, delaying and if you can, don't think about UA financing as a as single tool. Use it as a range of options, especially as a new game comes live. Funding it yourself as long as you can to learn what the cohort what the maturation looks like is great. That might mean I'm type break even. As you gain confidence, expanding your break even window out a little bit, maybe your receivables loan to allow you to kind of go through that, build up more confidence. And as you see 6, 9, 12 months and you kind of like where this is going, getting into a co-fi- core financing situation can start to be extremely scalable. The The question is understanding what those things cost. And so, is that a good framework and then for publishers to think about? How do you think about making those transitions from an IR perspective and what kind of problems can you get into?

It depends very much on break evens and what the right instrument is for what you're trying to do and that may that will change over time, right? And factoring is not actually too different in cost and it's more driven by kind of scarcity of people who really understand it. It's more about, you know, again, I keep coming back to the flexibility of the instrument. One thing I did want to call out because naturally people are sort of fairly optimistic, right? So, if you're looking at say, "Hey, I've got this cohort filling financing and it's going to be able to deploy 100 or 200 or 500 or a million dollars a month, whatever." So, when you're doing your planning, you're going to assume you've got the reference cohort, it's all met, it's all good and therefore instead of doing 200 grand this month, you can now do a million and that's what your projections are based on and, you know, what free cash flow is like send off to pay the team and all the rest of it. Most people run their gaming businesses where they've got known fixed costs and everything else goes into UA provided they are pretty certain that UA's possible,

right? So, it's normally run, you know, fairly close to wire. The thing I want to call out is if your cohort start to not perform and all of the sudden they go into aggressive amortization, you know, not unreasonably by the lender and they take 100% of the core revenue, if you were then left high and dry and you don't have enough money to pay people, pay servers, you know, all the rest of it, then the whole thing can implode. And this is where it getting back to like proper underwriting by the cohort lenders is really important. So, if you fail to meet these projections, you can't meet your obligations, the servers get switched off, people don't get paid. And by the way, the cohort lenders don't recover either. So, I think there's been a propensity for people to look too much at just the cohort and not think these are very often fairly fragile businesses in terms of people with bills to pay. And if everything's been modeled on the slightly more um rosy performance curve and things start to pull back, right? Then the cohort lender's going to say, "Right, I go aggressive amortization on these cohorts

that are underperforming." And guess what? I'm not going to put any money into new ones, then you as a founder or a CFO or as a team or whatever, you've got some bigger decisions to make. And some of this stuff can compound very quickly. So, just be super conservative in the modeling and don't always assume everything's going to be all rosy. Try and sort of figure out these situations like if I have to amortize, if I get no more financing for new cohorts, and just be like fairly conservative in your modeling.
But that's also where the maturity of the lender comes in, right? Because you should not underwrite someone that hasn't had enough money in the bank to keep the lights on for at least, you know, couple of months. I But we've seen this where we looked at some teams, they had one or two months and they got a deal. And it's just a bit too close to the wire as you said. So, um but that's again where the VCs might want to work a bit more closely with some of the cohort lenders, right? You raise a bit of equity to get your OPEX

in the bank, and then the scaling comes from the UA lending. So, I would love to see that a little bit more that people are just doing their due diligence a bit more and making sure that the financial foundation is actually solid.
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