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Powerful Advantages: Private Equity & Equipment Finance

September 07, 2016, 09:00 AM

Company owners across all industries have turned to private equity for capital to drive growth, realize liquidity, shore up their balance sheet and expand operations. For equipment finance businesses, private equity funding is particularly advantageous to meet the equity capitalization requirements that banks and lenders require when extending credit. Nowhere is that more important than for rapidly growing finance companies where strong demand from customers such as contractors, equipment dealers, manufacturers and transportation companies can outstrip the availability of existing financing resources.

With adequate equity on hand, an equipment finance company can maintain its core origination, underwriting, administration and funding activities without interruption. Furthermore, an investment from an established, reputable private equity firm confers a powerful advantage: institutional credibility. By partnering with an outside investor, a company gains improved clout with lenders, and strengthens its ability to further grow its relationships with banks and other debt providers. Similarly, banks are comfortable with private equity-backed companies because if there is a problem that may impact performance, the outside investor can potentially provide backstop financing. 

While it’s easy to understand how equipment finance companies benefit from private equity investment, what may be less clear is how owners can make their businesses more appealing to sophisticated investors. Understanding what private investment groups look for when evaluating an investment opportunity beyond the basics – customer concentration, competitive positioning, capitalization and financial performance – can go a long way towards owners successfully positioning their company for outside investment.

Management Experience
Most private equity sponsors don’t expect small to mid-sized founder-operated equipment finance companies to have a well-rounded management team the way a large public company would. But, the presence of a strong foundational team that can steward a business’ strategic growth, finance and operations is mission critical.

Private equity investors, in turn, can help support this effort by identifying and hiring talented management that can augment a business’ existing senior executive team. This is especially important for managing the operational challenges that fast growing equipment finance companies face when seeking to build and manage scale.

Credit Performance
An equipment finance company with a broad, well-diversified portfolio will be more attractive to private equity investors than one built on serving customers in a single industry. The ideal diversified portfolio is characterized by different types of collateral, loan sizes, various credit types and maturities.

It’s worth noting that diversity simply for diversity’s sake isn’t good from a portfolio construction standpoint. For example, lending into different areas of the market where a firm does not have prior experience isn’t as important as a solid portfolio and proven track record. However, by diversifying loans across different industries where a specialty finance company’s team has experience can help mitigate the impact of a cyclical downturn in a particular industry.

When it comes to portfolio performance private equity investors will want to see a static pool analysis of the credit portfolio, which outlines the performance of a pool of loans originated during a specific time period, and also includes charge off data, delinquencies, loan types, and the overall performance of different loan pools.

Distribution Strategy
Equipment finance companies that source their loans or leasing opportunities through a direct sales source, or generate transactions from relationships with vendors or other partnership channels, are typically viewed more favorably by private equity sponsors than financings sourced through loan brokers.

Funding Relationships
The number of relationships that a specialty finance company has with banks and other lenders that provide it with debt for its own equipment financing activities, is crucial.

In many instances, specialty finance businesses have just a single banking relationship. However, a company that relies on one funding source is less desirable to private equity investors because of the potential risk of losing its funding. Therefore, it is ideal to maintain diversity of funding sources and banking relationships.

Private equity investors also like to see that an equipment finance business has maintained long-standing and stable relationships with its banking and lending partners. Even if a business is well-run and profitable, jumping from lender to lender can send the wrong signal and may indicate problems at the executive level that have the potential to impact performance down the line.

A closely related issue is management’s ability to clearly articulate how the team plans to grow the company’s number of funding sources over time.

Audited Financial Statements
The authentication of a company’s numbers by a reputable accounting firm will go a long way in bolstering credibility in the eyes of outside investors. Owners of equipment finance companies should expect that a private equity team will ask for two to three years of audited financial statements, which can be beneficial in helping establish further integrity with potential lending sources as well.

While it’s important to address areas where an equipment finance business can be improved ahead of seeking private equity funding, this effort should be viewed as long term value creation and strategic growth planning in the course of growing the business. By pursuing this path, owners of equipment finance companies will be better positioned to benefit from private equity investment – not only to improve their capital resources to execute upon growth plans, but also to compete more effectively in the marketplace.

John D. Cochran
Partner | Lovell Minnick Partners
John D. Cochran is a Partner of LMP and a member of its Investment Committee. Cochran joined the firm in 2008. Prior to joining LMP, he was a Principal at SV Investment Partners (formerly Schroder Ventures US), a private equity firm focused on investing in mid-market business services companies. Prior to SV Investment Partners, he worked as an Associate at J.W. Childs Associates. Cochran started his career in the financial services industry at Salomon Brothers Inc in the Mergers and Acquisitions group.

He is a member of the Boards of Directors of Seaside National Bank & Trust, Commercial Credit Inc., and LSQ Group Holding LLC. Prior board positions include ALPS Holdings Inc., Mercer Advisors Inc., and PlanMember Financial Corporation.
Comments From Our Members

Kimberly Esposito
Thank you for a concise overview of what private equity firms want and need from smaller equipment finance firms. Your article may help the small guys with an often intimidating issue.
9.8.2016 @ 8:54 AM
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