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Private Equity

The 1 Thing Investment Bankers Must Remember When Approaching Lenders

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Lenders can be the most appropriate solution to capital requirements — even for a company that has historically relied on equity financing for support. RBS, AIG Asset Management Group, Hermes, and M&G Investments have all proffered mid-market loans, specifically targeting private equity-backed firms. And Great Rock’s recent launch of its alternative lending platform for asset-based and asset-backed loans to the mid-market both suggest that the borrowing option will become a larger consideration shortly. Sometimes, investors want to keep equity in the family.

But guess what: There are significant differences between debtors and investors. Investment bankers who don’t fully realize the distinction can walk away with poor deals or no deal. The instinct to push the investment to higher valuations and returns, or overburden the balance sheet with debt to substantially improve returns, falls flat. When you approach a lender with that grand vision, the lender can be turned off by the risks in the steep, uphill battle to market dominance.

Bottom line: Don’t think your equity pitch will work the same magic with creditors. That would be a faux pas on the level of addressing a Beijing conference room in Swahili. You need to go back to the drawing board and create a new presentation — from the ground up.

Less Reward, Less Risk

Using the same approach that works well with prospective investors is one of the biggest mistakes in front of a lender.  Investors buy into markets, returns, and the next big idea that will dominate. They look at the vehicle of growth, expansion, and capitalization. They look for revenue growth and exit strategies. They risk to gain.

When you talk to lenders, the perspective shifts from apple to orange. Like most investors, lenders are risk averse, but compared to investors, they have much less to gain and more to lose. At best, lenders will earn interest, and some fees, on the principal they lend, which is typically several levels of magnitude larger than the equity investment. On the other hand, investors, while they can lose their investment, have no limit on how much they can earn on that investment. Creditors are more concerned with preserving their principal, avoiding those scenarios in which they lose the whole dollar, and ensuring deal liquidity.

Bottom Line: Payback

Evolution is speculative; profitability is now. If revenues have exploded by 1,000%, that is great, but the real question is how much did the company spend to gain those revenues? What is the profitability? A bank is less concerned about what a company will look like in five or ten years than it is in the balance sheet and P&L statement now. If you sell them too much hype and hyperbole, they will turn away. Plenty of companies have filed for bankruptcy because they grew too quickly, and the company could not front enough cash for supply to keep up with demand, and lenders ended up funding losses, not assets. You can’t sell growth.

So when you talk to a lender, speak to the certainty of payback. Be conservative in your growth predictions, and then make those predictions even more conservative. Talk about the historical and current P&L statement and balance sheets. Talk about the assets and meaningful collateral, whether the lender has the first-lien position, and the real value today. Liquidity is a different language, but unless you’re looking for mezzanine lending, it’s the only one a lender will hear.

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