After Xinja’s Pivot, I’m coining Sezzle’s Precipice to describe a company that stands on the knife edge of catastrophic failure. Whether Sezzle tips over the eponymous precipice or skates along the top before riding off into the sunset is yet to be seen. (I wrote some preliminary thoughts on the company late last year).
After yesterday’s result, the state of play is much the same as when I wrote last year. Provisions for bad loans have ticked up and reflected 50% of income for the quarter (41% over the last six months). The Merchant Interest Program (MIP) is still driving the business, with the MIP equivalent to 89% of merchant payables and 19% of underlying merchant sales. Sezzle works with small merchants, and back of the envelope maths (MIP / total sales) infers merchants have around two months of underlying merchant sales held by Sezzle.
The increase in provisions for bad loans reflects poor lending quality and in combination with merchants funding Sezzle’s growth, brings some interesting risks to the table.
The biggest risk is simply that merchants are unsecured lenders to Sezzle with at-call loans (Sezzle has now clarified that it would repay any size request within 7 days). If merchants figure out that Sezzle is re-lending their money and that the loans are poor, they could pull their funds. Unlike typical financing where you borrow from a bank, here the customer and investor relationships are intertwined. You can breach covenants with a lender and get away with it if you can find another source of capital – your business will still exist and customers will still use you. Here, if you fail to repay your merchants, you risk your entire franchise, not just the funding relationship. Merchants are more likely to leave, less likely to fund you, more likely to ask for repayment, less likely to accept your product in the first place.
If that trust starts to fail it is the beginning of the end. Funding dries up and it will be hard attract more. Without funding you can’t lend. There will be a drain on the coffers and it will accelerate. It becomes a run on the bank. You will pay grievous terms to plug that hole. This is the definition of catastrophic risk.
Sezzle merchants seem satisfied with the status quo. Some smart people I know suggest that this is because Sezzle’s customers don’t have a lot of choice other than to participate in the program. I’ll let them tell that story.
So how do you mitigate this risk? It is not complicated. Transparency is the cure. Come to Jesus and let the market price the risk. Sezzle’s program is great for Sezzle if it works, and ok for merchants. Set more stringent terms on merchants. Position it as a win-win. The lack of transparency around the MIP in my mind was initially a possible indicator of fraud. I am not so sure of that anymore, but the almost total lack of disclosure of the primary engine of Sezzle’s business is a warning sign.
If the atrocious loans don’t improve and if merchant trust ever starts to waver, you will be surprised at how quickly Sezzle finds itself on that Precipice.
Food for thought.
I do not have, and have never had, any position in Sezzle. I have no relationship with anyone who has any position in Sezzle stock. This is a disclosure and not a recommendation.