The Middle Market Review Insights on the Middle Market.
Since the financial crisis, small businesses have struggled to obtain standard loans. Thanks to investor risk aversion, stricter legislation, and overall economic uncertainty, many traditional lenders have become more particular about their loans.
Although the environment has eased slightly in recent months, loans can still be hard to come by. As Kenneth Walsleben, a professor at the Whitman School of Management at Syracuse University, told the New York Times last year, “The days of yesteryear when you could go to your corner bank are over. Small, emerging, growing businesses have few traditional sources to turn to.”
As a result, many alternative strategies began taking center stage — mezz loans, SBA-backed loans, and peer-to-peer loans. Still, other lending strategies have gained momentum as the capital gap remains unfilled. In addition to energy efficiency financing and sale leasebacks, deal professionals have been offering unique and innovative alternative lending options for small businesses and portfolio companies alike.
The Growth of Supply Chain Financing
One lending strategy offered by Axial Member Nancy Halwig of UPS Capital is a form of supply chain financing. “UPS’ global asset-based lending solution is a very traditional senior debt capital solution that encompasses lending against domestic accounts receivable and domestic inventory,” explained Halwig. “What makes it different is we go beyond the norm by also including inventory in transit, as well as some foreign inventory and credit insured foreign accounts receivable.”
She continued, “UPS creates and holds the documents needed to make sure the goods are titled to the borrower. It then uses its information systems to track shipments maintaining control of the goods.This extra layer of accountability is comforting to many banks and we help companies get more access to senior debt capital.”
While this access to senior debt is appealing to business owners, it is also appealing to private equity firms and financial sponsors. “At the end of the day, if a private equity firm is able to generate more senior debt eligibility, it will need less mezz and equity in the deal,” she explained. “PE firms are especially eager to optimize profitability and minimize the amount of equity they need to deploy an investment.”
The better financing options also create a distinct advantage for a PE firm participating in a broader auction. “The deal environment is competitive right now,’ explained Halwig. If a private equity firm can secure a larger senior loan, they will be able to pay higher multiples, which is a great competitive advantage.” She added, “Investment bankers would also be interested — they get more fees for higher multiples. In addition, investment bankers get fees for arranging capital for companies that may have had a hard time getting senior debt capital for goods moving through their supply chain.”
The Return of Subordinated Loans
Axial Member Matthew Cohen of Noble Lending Group has sought to alleviate the tight lending environment by offering “short-term, subordinated loans of up to $350,000.”
While the loans are relatively small, they can be valuable for businesses needing capital yesterday. “The loans are particularly attractive for small business owners that have a need for a quick infusion of capital,” explained Cohen. “The banks are still tight and the requirements of many asset-based lenders can be high for many businesses. Instead of requiring the expensive, lengthy due diligence process, the documentation requirements are pretty low and we typically fund within 3 business days.” However, like most junior debt without collateral, the loans can be on the expensive side.
While the subordinated loan program was borne out of need from small businesses, Cohen believes the arrangement is applicable for financial sponsors as well. “Although these loans may be too small for some deal professionals and their portfolio companies, they can be extremely valuable for due diligence or initial stages of an acquisition,” explained Cohen. “For example, if a company cannot pay the due diligence fees, it could bridge to afford the audits, appraisal reports, etc. Or, while a private equity firm transitions the company from an old lender to its own, there may be the need for a short-term loan to boost liquidity.”