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Lender Finance: How Data, Smart Growth & Good Management Make the Difference

Date: Jul 25, 2018 @ 07:00 AM
Filed Under: Lender Finance

When you have been in the lender finance business for some time, you review countless requests for financings from specialty finance companies. It’s a dynamic market with many potential deals coming from the surge of relatively new companies that have arisen since the latest economic downturn.

Yet the combination of less-seasoned companies and the current robust economy makes it more important than ever for our team to scrutinize deals, and determine which to pursue versus those that aren’t a good fit for us.

There are many factors Capital One in particular uses to decide which companies will make the best partners. Though the vetting process is complex, there are four vitally important considerations—and potential red flags—we look for every time a potential deal crosses our desks.

Dig in to the Data

They say information is power, and this probably rings true most at a finance company seeking to secure a loan. As a general rule, the more data points a customer can provide on its collateral performance, and the longer the track record, the better the deal structure that can be offered.

For every transaction, understanding the collateral—and its historical performance—is critical and the more granular the data, the better. The best finance companies come with every possible data point in hand—information that’s broken down by obligor, zip code, type of collateral, industry, date of default, the amount of recovery and time to recovery. Making the effort to parse all that data is better for the lender and the structure of the loan. If there isn’t enough of a performance track record, we will likely be more conservative when setting the terms of the financing.

Beware of the Hockey Stick

At Capital One, we look to work with experienced management teams with a history of smart, controlled growth. Growth is a good thing, no doubt about it. Growing any company shows promise and determination, but when companies provide growth projections with a very steep, sudden angle (that is, the shape of a hockey stick), it makes us pause and wonder how that company intends to grow so quickly. How exactly are they winning clients? Are they offering a service or product which is unique to the market? Are they giving “A” credit pricing to companies that have “C” credit performance? Maybe they’re extending the maturity on the underlying financing or providing looser transaction terms than the competition in order to gain market share.

Determining how a company plans to compete in its market, and if the company’s growth projections are reasonable, is a critical component in the overall decision-making process when looking to extend credit.

Skin in the Game

Another common pitfall that many newer companies fall into is the amount and structure of their capital. We understand that getting a new finance business off the ground is hard work, but there needs to be some meaningful equity in the company, and it would be nice to see the management have a sizeable equity stake invested to make sure their interests are aligned with ours, as the lender.

Recently, we have seen some start-up/de novo companies adding subordinated debt into their capital structure, typically from outside investors, as a means of creating equity-like capital. As a lender, we tend to consider subordinated debt as capital in our net worth requirements provided the maturity of the subordinated debt extends beyond the term of our loan and repayment terms are truly subordinated.

However, subordinated debt comes at a price—typically in the form of higher interest expense. The client needs to carefully consider its revenue expectations with the added expense of the higher-cost subordinated debt to ensure that it can cover the expense in a reasonable time period as it scales its platform. This is easier said than done, as projections are just what they are—projections. If originations fall short of projections, and the client is carrying too much subordinated debt, time to profitability can change and could result in the client failing to meet certain financial covenants. To mitigate this risk, companies should consider staging in any subordinated debt requirements in line with its growth in originations.

Management is Key

If these three considerations—historical data, controlled growth, and an acceptable capital structure—have a common thread, it’s that the management of a company is key. Seasoned management teams understand that in order to be successful they need to build a sustainable operating platform. They need to balance the desire for growth with the right infrastructure, the right cost structure and the right capital mix to support that growth.

Many of these managers have been through the last economic downturn and if nothing else, are cognizant of the mistakes similar companies made the last time around. Therefore, it is a little easier to consider providing financing to a de novo/restart company that is run by an experienced, cohesive management team, provided the platform continues to make sense. For these reasons, management will always be one of the key attributes to be considered when providing financing to a company.

Whether the company is well established or a denovo/restart, we cannot understate the importance of building strong relationships with prospective clients long before money exchanges hands. With that in mind, our best advice to borrowers is to look for a lender who will take the time to understand the collateral, the business and management. That open, two-way communication will mean that the business will not only be well funded, but also have a partner willing to work with borrowers at all times.

Matt Tallo
Managing Director | Capital One
Matt Tallo is a Managing Director in Capital One’s Financial Institutions Group and leads the Secured Business Credit team.
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