Earlier this month, Metacore, a Helsinki-based mobile games studio, announced that it has secured a $180MM (€150MM) line of credit from Supercell, the developer of Clash of Clans. The news of the credit line was met with some degree of bewilderment in the mobile gaming sphere, in part because the amount of money involved is remarkable but mostly because these types of arrangements usually happen quietly and are very rarely announced publicly as news. Metacore has stated that it intends to use the line of credit for the purposes of scaling its successful title, Merge Mansion, through performance user acquisition.
Debt financing can be an inexpensive and convenient funding tool for use in scaling a digital product through performance marketing. The benefits of debt over equity financing are obvious: lack of dilution of ownership and no increased operational oversight through eg. the addition of an equity holder to the company’s board. But one aspect of performance marketing naturally aligns it with debt financing: the money multiplier that is invoked in the compounding effect of reinvesting revenues into further marketing expenditure. This dynamic — of cohorts contributing revenues over (hopefully) predictable timelines — allows one dollar of performance marketing spend to produce some multiple of revenue over time, creating value in the form of top-line revenue growth while minimizing debt exposure for the borrower and limiting default risk for the lender.
But first, what is a line of credit? It allows a borrower to draw upon some pre-defined amount of credit as needed, usually within an explicit timeframe and for a specific borrowing cost. In other words, a line of credit enables a borrower to take a loan from the lender, in full or in partial amounts, as the borrower deems necessary over some period of time. A line of credit functions similarly to a credit card: it can be drawn upon (and paid back) flexibly, as the borrower needs the money, up to some limit for the outstanding balance. Lines of credit may be collateralized or not; in the case of a mobile games studio, a line of credit might be collateralized by existing cohorts that are expected to contribute revenue going forward. I named this concept of estimated future cash flows from existing cohorts the “projected receivable” in Building a marketing P&L using LTV and ROAS:
In the diagram above, where a cohort (“Cohort A”) tracks precisely to its predicted cumulative revenue model, the curve is roughly split in half into “Recorded Revenue,” which is the revenue that has been generated by the cohort to-date, and “Projected Receivable,” which is the amount of money that the advertiser believes that cohort will contribute through some future date (Day Z on the X axis). This amount of money, for any given cohort, can be thought of as a current asset: it is revenue that has been paid for (through acquisition marketing) but not yet received.
What this means is that any product with an existing user base of some size has assets against which debt can be collateralized. With enough data, and enough analytical sophistication, the lender is able to assess the risk of providing a loan to the borrower, because existing cohorts will continue to generate cash that can be used to pay back the loan, should new user acquisition prove uneconomical.
Of course, the purpose of these types of loans is to support continued product growth through performance marketing, and those aforementioned unit economics models are used to assess the viability of that project. If a borrower can exhibit reliable, dependable positive unit economics on performance marketing, then deploying cash against growing that product is often the best use of resources for the company. But because marketing expenses are realized in total upon cohort acquisition but recouped over time — a reality that I explore in LTV / CPI vs. cashflow — then, naturally, cash constraints can limit product growth. This is where external debt financing becomes relevant, as does the money multiplier of performance marketing.
Consider a product that reliably sees a 10% profit on marketing expenditure (that is: 110% ROAS) for cohorts on a three-month timeline. If $1,000 is borrowed for user acquisition at time
X0 and 110% of that loan ($1100) is returned three months later at time
X1, then that $1100 can be re-invested into marketing, with the process repeated on a rolling basis such that by the end of one year, when the loan comes due, the company has generated $1,464 from its most recent fully-paid cohort and will realize $464 in profit after re-paying the loan.
Ultimately, over the course of a year, this product has generated $5,105 in revenues while capturing that $464 in profit from the initial $1,000 in marketing expenditure:
The arithmetic used here is an application of annuity math based on marketing expenditure and the “rate of return,” or profit margin, on cohorts:
The equations above can be used to validate the formulae in the screenshotted spreadsheet. The example used here is oversimplified: in reality, a borrower would be funding acquisition on a continuous basis and not waiting for a cohort to be fully repaid before reinvesting its revenue into further marketing.
In monetary economics, the money multiplier is a measure of the total scope of economic capacity given a fractional reserve banking system. My application of the term here is conceptually related: given an understanding of how cohorts behave in a product and the timeline over which marketing expenditure can be dependably recovered, a multiple of marketing expenditure should be produced in revenue on a timeline that is longer than the recoup period, given that revenue is reinvested into marketing.
One assumption on which the construction of a user acquisition debt facility is predicated is that unit economics hold as the product is scaled and the audience is saturated, and this very well may not happen. But what’s especially convenient about a flexible instrument like a line of credit is that very little capital needs to be risked as cohorts are onboarded. Using an approach like the one I describe in this article, a marketing team can quickly observe marginal degradations in cohort quality and reduce or pause advertising spend, meaning credit simply goes unused.
Photo by Jorge Salvador on Unsplash