Brian Dally: Congratulations on 10 years. That's a long run, a good run. And you were ahead of the curve on this stuff, too. When you say specialty finance, I think a lot of investors hear that term, it's a term that's used a lot, but I don't know that everybody really understands what we mean by specialty finance.

How do you define it, and why do you think it's become such an attractive area for institutional investors over time? You guys are flying in underneath the big checks, but what's even led the institutions there in the first place?

Jillian Murrish: Yeah, so, I think of specialty finance really as investing in niche cash flowing asset classes that sit outside of traditional corporate credit or real estate lending. So instead of lending to an operating business and getting repaid through cash flow from the company, a specialty finance lender can lend against a portfolio of assets. So in our case, we actually lend against [00:04:00] financial assets, so royalty streams, loans, receivables, advances, or other contractual cash flows.

And I think the reason the asset is so attractive is that these markets are less efficient. It really requires specialized knowledge, hands-on underwriting. These are very particular niche assets. There's not large volume. And so, there tends to be fewer capital providers and there aren't banks that are spending as much time in certain niche corners of the sector.

Brian Dally: Yeah, that creates the opportunity. And then, when you guys first got started, where did you get your start and how did you decide what to do first? You already knew a form of residential real estate lending for sure. Did you start there and then grow out or did you decide to go a different direction in the beginning?

Jillian Murrish: Yeah, so I co-founded the firm with my partner Conor Neu, and his expertise had been in consumer and small business lending, and mine was in real estate. And so between those three sectors, you really cover most of the niches. And so, we spent a [00:05:00] lot of time in broad-based consumer lending, like back in the LendingClub days and Funding Circle small business loan days, and then obviously fix and flip loans with my background. And then from there, really you can boil down like invoice factoring to a form of small business credit.

At the end of the day, it's all a cash flow underwriting exercise and stressing those in as many which ways you can, providing probabilities and timing of these cash flows. And so, a lot of those basic building blocks of consumer small business and real estate were what led us into a lot of the other more niche-y segments that we invest in today.

Brian Dally: So if I'm understanding, it sounds like when you guys assess opportunity, you're thinking, first of all, does it fly under the radar of the big capital sources? Because that creates the opportunity. And then you're looking at the cash flows and trying to risk adjust the cash flows and understand what could disrupt or enhance the cash flows on these investments. And you're really on a risk-adjusted basis [00:06:00] going to the places where you have the best underwrite on that.

Jillian Murrish: Absolutely. You said it better than I could.

Brian Dally: Well, I don't know about that. But when we get to the underwriting, so you've got cash flow. What are the metrics that tell you about the cash flows? How do investors think about that? I mean, I guess it's deal by deal, sector by sector, but are there certain metrics that you're paying attention to that put a deal down the fairway for you?

Jillian Murrish: Yeah, absolutely. There's industry standard curves that you expect to see. So when you look at a prime consumer loan, you expect to see a certain level of defaults. If you look at a subprime consumer loan, you're looking at a different default level.

And so it's really saying historical performance of this type of portfolio, is it behaving typically or is it behaving better? Is it behaving worse? And then, when you look at that, you say, what are the [00:07:00] reasons it could behave better? Ooh, those are real. Oh, those tailwinds should persist. That's something really interesting we could look into. Or, ooh, this is performing below industry averages. That's a non-starter. Let's not even dig in on that.

Brian Dally: Is it hard to get the industry average in some of these areas?

Jillian Murrish: Yes and no. It depends on the asset. Sometimes you have to take big broad data sets of all unsecured consumer lending where there are great data sources like dv01. They do incredible work in the space giving broad data sets and trends and it can really be useful. And then you have to modify it. Okay, this lending product doesn't do a down payment. How would that affect overall collections and length and duration? And so there's a lot of this modeling that just comes with experience of seeing so many derivations of the same product.

There's only so many ways you can cut a loan, an advance, a royalty. That's one of the reasons we've been so excited about music is that there's so much data coming [00:08:00] from these rich sources like YouTube, Spotify, Apple, all the DSPs. You get a data file on a song and look at what revenue it produces in a year, and that file will crash most people's computers because it has so many pieces of data. You're looking at every time the song's been played in every jurisdiction across the world on every platform every day.

Brian Dally: And that's the underwrite? That sounds like a really, computationally, a really heavy lift. That's fascinating.

Jillian Murrish: It is, but it gives you a much better ability to predict future cash flows when there's such rich data history to understand how assets perform. Music is one of those that caught Conor, my partner, I need to credit him with this, it caught his eye first, and he's a data junkie and said, "Gosh, there's even more data here than in consumer lending. I've got to spend some time in this asset class."

Brian Dally: How do you even get access to that data? I mean, I understand, Spotify certainly has a ton of [00:09:00] data. Apple has a ton of data. Do they publish that? Do the rights holders actually get it and therefore they can share it? Is that how that works?

Jillian Murrish: Yeah. The main source of data is really the distributor report. So, in specialty finance, a typical term that a lot of folks know is a loan servicer. That's a company that goes and actually collects on loans on behalf of the loan owner and goes and calls the borrower, "Hey, you've got to make your interest payment."

In music, there's something synonymous called a distributor, and the distributor is the firm that's tasked with going out and collecting all the cash that an intellectual property rights holder of music is owed. So they go to the DSPs, they go to Spotify, YouTube, Apple, and they say, "Hey, here are the payments that you should be paying us. Oh, look at the report that Spotify sends."

And so as a rights holder, you receive a massive report from the distributor that can go into detail on the DSP specifically, which have some of the [00:10:00] most rich data.

Brian Dally: Do the distributors become a source of deal flow for you? Or not so much? They're more just sort of the information. I mean, where does the deal flow come from? Always the issue in these specialty finance markets, right? It's like, okay, wait, you've spotted an opportunity. Where are the deals coming from? And deal flow really matters. So how about for you guys? How did you get your foot in the door there?

Jillian Murrish: So for us, being in Los Angeles is critical. You need to be in Nashville or Los Angeles to be a music buyer. You can be in New York. It's tougher for deal flow. All of the large funds in New York have presences in LA and Nashville. That's where you go to find the deals. That's where you're meeting the business managers. You're meeting artists. You're at events, meeting the accountants and the lawyers who represent these folks, these rights holders.

And so it really started as scrapping around in our own networks within Los Angeles. It sounds silly, but, truly on the T-ball field, you have an agent at CAA, dad of a kid, and [00:11:00] really it started that way.

And then, again, we're serving a deal size that's smaller than the large funds look at. And when you're offering a product to the market that isn't consistent, someone hears about it, "Oh, they'll actually buy something that's a $5 million purchase. Oh, they'll buy something that's a million."

Brian Dally: They refer it to their friend. And why are they selling their royalties? What is the reason that somebody on the other end of this, the seller of the royalty or the provider of the royalty, is willing to do that or interested in doing that?

Jillian Murrish: I'll back up and give a brief commentary on how this intellectual property comes to be, and then this will make more sense.

Brian Dally: Yeah, great.

Jillian Murrish: When a song is created, you have a singer, a backup singer, you've got a guitarist, a record label, the business manager, the accountant. There could be upwards of 20 people who own a piece of the intellectual property of a song when it's created.

So, imagine the guitar player on a Bruce Springsteen song owns a piece of [00:12:00] that song. That person dies, and their son owns that piece of intellectual property. The heir of a famous guitarist could be the owner of a right that's going out to sell it. So everyone thinks generally, "Oh, why would the artist sell their catalog? Do they not believe in it anymore?" This or that. It can be that, and it often is a lot of these other tangential owners of IP that have been in and around the song that aren't the actual artist themself. So, there can be record label deals where a record label has a huge portfolio of a lot of different artists.

It's a hard business to be in right now. Folks are needing liquidity for working capital, so if they own intellectual property of songs, that's a source of liquidity. There may be a smaller indie artist who says, "Hey, I'm ready to buy my first house. I need to get bunch of money for a down payment. I need to sell for a million dollars to live in this expensive city of Los Angeles."

And so there's just a plethora of reasons, we can't even comprehend or understand why, but they just come out of the woodwork and folks need liquidity and need [00:13:00] cash for their next tour. "Hey, I just made a new album. I'm ready to sell my back catalog so I can buy a van, spend on all the venues, and get this tour going."

Brian Dally: I mean, unsurprisingly, music is a business, and businesses need working capital, and frequently the people who are running these businesses have everything they own tied up in it. And so I guess it's not really surprising, and as entrepreneurs, we can identify with needing or wanting liquidity along the way. That makes perfect sense, doesn't it?

Jillian Murrish: Absolutely. Yes. And again, like we said, tangential things like the recording studio who got a piece of a song. That's a business they're running, and maybe they have a bunch of fractional rights in songs, and they need liquidity for that recording studio. The reasons continue to pop up.

Brian Dally: I think those are really good examples. How do you think about losses? So you're advancing some money for rights to this stream for a certain period of time, I would imagine. Can you [00:14:00] give me a feel for, what's the holding period typically like, and then what do you expect the loss ratio to be, or what causes losses on those advances?

Jillian Murrish: Yeah. So, interestingly, music behaves typically in a very predictable way. So when a song is created, it typically in the first year produces the most revenue it will ever produce. So years one and two are up high producing the most revenue that it'll ever produce. It drops off a cliff to year two, off a cliff to year four. And by about year four, you're pretty stable. The decay, it's called, from the next year to the next is very minimal, if anything. It could be flat.

And so, there's various ways to invest in music. You can act like a venture investor and invest in a song right as it's made before you have any idea what that revenue is going to look like. And wow, it made top start up here and you've a real big jump. A scary place to buy is one year after a song's created [00:15:00] and it's starting to jump off the decay and you're like, "Well, how long will this decay go and what will it be next year?" So investing early in a song's life feels a lot more like venture investing.

We're much more interested in songs typically in the 4- to 10-year age, you call it a song's age. And we really like that because typically the artist is still actually going and producing music, which always gives a pop to the back catalog. So we own something someone made four years ago, they make a new album, people start listening to the old music too.

Brian Dally: Oh, so you're underwriting the likelihood that they are going to have another success.

Jillian Murrish: No. We are underwriting that anyone who's still listening to a song years 4 to 10 after it's been made will continue listening to it.

Brian Dally: And anything on top of that is a pop.

Jillian Murrish: Yeah, it's great. You can get a readjustment in your baseline curve. There are artists that may never make music again. We have an old gospel catalog, and those bands are not together anymore. a 30-year-old catalog, and that's just whoever listens to that still [00:16:00] listens to it, and it's wonderful. And there's not going to likely be a pop.

There's other sources of revenue, like sync, if a song gets put in a movie or gets put in a commercial, that's big one-time revenue. And for any of the investment banking, corporate credit junkies out there, that's one-time revenue you have to normalize, right? You take that out of the stream before you start pricing a deal. And music trades off of trailing 12-month revenue. So you have to normalize the revenue, then apply your multiple and purchase it.

And if you're down here on a curve on the low part where the song has been around 4 to 10 years and the decay is very flat, applying a multiple to that is much more predictable. You say, "Hey, this should be the baseline going forward." The idea of thinking about losses in this asset class, it's more like, did you miss on how fast the decay's happening? Was there more decay than you intended?

Brian Dally: But if you're investing at year four, you've selected out of that [00:17:00] particular risk.

Jillian Murrish: You should have selected out of most of the decay. Certainly. Yeah, that's how most music behaves.

Brian Dally: And have you guys had to become tastemakers in music at this point?

Jillian Murrish: Well, let me tell you, we own music I love, and we own music I can't listen to. We are financial buyers at Pier. First and foremost, we look at the cash flow, look at how the decay behaves.

Brian Dally: So give me a sense, and then we can wrap up. I'll stop pummeling you with questions about this fascinating topic. But I love learning about this stuff, so I really appreciate you sharing. Can you give me a feel for, how broad is the catalog you own? And how broad do you want it to be? Is there an optimal size?

Jillian Murrish: I think size really as you're investing in asset class comes down to pricing at deal size. So the whole thesis behind our business has been investing in these smaller transactions that the larger [00:18:00] firms overlook. And so we go in and we say, "Hey, we're willing to do the work on a $1 million catalog. We're willing to do the work on a $2 million, a $500,000, a $5 million." And hopefully, again, as we said, by not competing against others, that allows us to have a little bit more pricing power. I mean, we have thousands of songs. A catalog can have hundreds of songs in it. You can buy a back catalog from a recording artist or a recording studio that has thousands of fractional pieces of a song. We also have larger banner assets that we like to buy that are a single artist that people would know of. And then, there's no-name indie artists that have a great smaller following.

I think the name of the game, again, at Pier, across all of our strategies, we always try to harp on diversification, whether that's genre, deal size, deal count. And the easiest way to diversify is simply by having a larger count of deals that you're getting exposure to.

Brian Dally: For sure. I love this. This is so fascinating. Great start to our conversation. [00:19:00] Thank you very much. We're going to pause here. When we come back for part two, we can talk some more about the market I think it'd be interesting to get into.

For our audience, you can connect with Jillian via her LinkedIn, which we'll include in the show notes, or you can visit pieram.com. You can check out all episodes of our podcast at groundfloor.com/podcast, and we hope if you like what you're hearing, you'll like and subscribe in order to help us get more visibility for what we're doing here. Jillian, thanks for being here, and thanks everybody for joining us on Beyond the Stock Market.

Jillian Murrish: Thank you, Brian.