VC’s Launching Credit Funds: Opportunities and Conflicts
Over the last few months, I’ve had five conversations with different venture capital funds at various stages of exploring launching credit funds for funding user acquisition in mobile apps and gaming.
As a very early proponent of non-dilutive financing to scale apps/games back in 2014, I’m obviously delighted to see it being considered as a mainstream instrument. But I also have some reservations.
Everyone’s intention so far seems just to replicate the cohort financing model pioneered by GC’s Customer Value Fund. For those not familiar with the model, it involves the lender putting up normally 80% of the cost of the marketing spend, with the remaining 20% funded by the publisher from their own equity. In essence it’s like a standard 80% senior / 20% subordinated debt structure that banks have deployed for years, but focused on individual monthly user cohorts. The loan is repaid as the cohort matures on a pro-rata basis until fully repaid with either an agreed fixed fee or IRR target for larger borrowers. This caps the upside for the lender, but they also accept downside risk on future cohort performance. Think of it as a way of publishers introducing a form of leverage into their UA investments, based on historical performance data.
It feels like we are at the convergence of a few things happening in the market, so I wanted to explore the possible drivers for the increased interest and rate of adoption.
- Some VCs are turning into AUM Shops: Larger VCs are expanding beyond equity investments, seeking to grow their assets under management (AUM) with complementary, lower-risk lending products for their existing or new LPs.
- Deployment challenges for large 2020/21 Funds: Many gaming content-focused VCs that raised significant funds during the peak investment period are struggling to deploy capital into meaningful late-stage deals. Could they be looking to shift LP capital into a new asset class to compensate?
- Reluctance to deploy equity on UA Spend: In today’s market, founders and CFOs are increasingly unwilling to use equity for UA, opting instead for capital-efficient financing models — yet many still need guidance on their best options.
- VCs Seeking to maximize portfolio IRRs: Since the IRR on UA investments often falls below the target IRR of a VC fund, firms are actively pushing portfolio companies toward non-dilutive financing to scale without additional equity dilution.
But there’s a major challenge with this strategy: conflict of interest.
The Elephant in the Room: Conflicts of Interest in VC-led Credit Funds
For VC funds launching sidecar credit vehicles, balancing self-interest and fiduciary responsibility is tricky. While offering complementary financing to portfolio companies makes sense, extending it to non-portfolio companies is where things get complicated.
Would a founder be comfortable exposing their cohort performance data to a VC that isn’t an equity investor but might have a ownership stake in a direct competitor? Even with so-called “Chinese walls” in place, the potential for conflicts and friction is real.
The elephant in the room problem for VC funds raising these sidecar credit funds is how to handle perceived conflict of interest. It might be great for a VC to provide complimentary financing to its portfolio companies, but how should they offer the product under their brand to others outside the portfolio, where competitor cohort data forms the core part of underwriting?
Consider also the level of cross-investment by some of these funds who may have their own UA sidecar fund aspirations. Conflict of interest could cause real friction in these funds’ ability to deploy capital beyond their own “inner circle” portfolio companies.
Pricing Pitfalls: Understanding True Cost of Capital
One of the biggest traps founders and CFOs fall into is misinterpreting the cost of UA financing. A fixed revenue-share fee isn’t the same as an annualized interest rate.
Within MFC, we’ve been working to help finance teams convert fixed-rate structures into IRRs, ensuring they aren’t unknowingly paying exorbitant costs. A 1.1x repayment multiple might seem reasonable, but when mapped over a short-term cohort maturity, it can translate to an Annual Percentage Rate (APR) well into the 20s, 30s or even higher in percentage terms. In some cases, alternative credit products could offer better risk-reward trade-offs, yet they’re often overlooked.
What could possibly go wrong?
While capital-efficient growth is a win for the industry, I worry that the space is heating up too quickly. Many new lenders are entering the market, offering smaller ticket sizes while trying to replicate the GC model.
As competition increases, we risk seeing a race to the bottom — just like in every credit cycle before it — where lenders cut prices and increase risk to secure deals. In a commoditized lending world where all money is equally green, how do lenders differentiate? Should they?
From a credit perspective, I have another concern. All of these lenders are laser-focused on cohort underwriting, but there is a need to also revert to some good old-fashioned credit underwriting techniques, no matter how shiny and accurate the pLTV data model is. This is particularly true for longer duration cohorts where there is a risk to the studio of over-leverage. Lack of operating capital to run the studio coupled with funding the ~20% upfront investment in new cohorts can tie up a lot of capital if the scaling plan is too aggressive. Running out of operating runway could ultimately result in servers getting switched off — meaning a zero recovery for lenders, or at best getting into a messy workout situation.
For companies that have raised serious equity, have been around for years, and may even be profitable, it’s a very different proposition. Financing rates for these companies are typically mid-teens on an IRR basis, which more accurately reflects the risk/reward the lender is taking. For earlier stage companies that have less of an equity cushion, pricing is more aggressive, either on a fixed repayment schedule like 1.1x capital invested, or back-filled to an IRR target in the 20s or even 30s in percentage terms.
A Dangerous Mindset? The “Free Option” Mentality
Some founders treat cohort financing as a “free option.” One studio founder recently told me, “We’re trying to secure cohort financing, and if we can’t, we’ll sell the game to a roll-up.”
This thinking is problematic and highlights how some founders view the concept of cohort financing. If a game’s UA metrics don’t support cohort financing, it will not just be a financing issue, but more likely that the company is undercapitalised (possibly falling into the category of a “zombie game”, or just that their UA metrics are not that great. Cohort financing isn’t a magic bullet, and attempting to use it as such introduces serious risk to lenders and studios alike.
Where Do We Land? Exploring Alternatives to Cohort Financing
Cohort financing has its place, but it’s not a one-size-fits-all solution. Mobile gaming and subscription app businesses need financing solutions tailored to their broader business models, not just their UA spend.
More studios are starting to explore alternative models:
- Revolving credit facilities (better for cash flow but requires collateral, eg Accounts Receivable)
- Private credit solutions (higher-ticket, structured for specific needs but can use a wider collateral base eg cohort residuals)
- Embedded finance options (offered by SaaS providers leveraging their own data to underwrite risk)
In fact, I’ve spoken with several SaaS companies sitting on vast amounts of underwriting relevant data. Some are exploring embedded finance products as a natural bolt-on to their offerings, potentially taking a lower financing margin in exchange for SaaS revenue growth. Definitely an interesting space to watch — more on this in another post soon!
🎯 Want more conversations around articles like this?
The Mobile Finance Collective is where finance leaders in mobile apps and gaming go beyond the headlines, through virtual coffees, one-on-one chats, and invite-only events.
If your studio’s CFO, CEO or finance team would benefit from being part of the conversation, have a look at our website www.mobfin.co or DM me to discuss joining us 🚀
