But advances in technology mean fintech can finally make inroads on credit markets’ tough shores. CAPX aims to tackle the inefficiencies that plague this industry. We don’t just simplify complex processes; we utilize technology to create smarter pathways to financing and deliver real-time transparency for borrowers and lenders alike. Our mission: to enable capital to flow smarter, faster, and more equitably.

Here are the pillars that shape everything we do:

Transparency: Bridging the Information Gap

The credit market has long been plagued by a lack of transparency. Borrowers often struggle to understand lenders’ requirements, while lenders face challenges sourcing qualified deals. This opacity drives higher costs: borrowers end up paying more for capital while lenders spend more to find the deal.

CAPX addresses this fundamental issue by creating a platform where all participants work from the same information. By democratizing access to critical data and insights, we reduce information asymmetry and foster a frictionless market. Transparency doesn’t just benefit individuals—it elevates the entire industry, making it more efficient, equitable, and dynamic.

Efficiency: Streamlining Time and Cost

Time is money, and traditional methods of securing financing—lengthy negotiations, repeated due diligence processes, and extensive networking—consume valuable resources. Put another way: the current way companies secure financing sucks up time from highly skilled and expensive resources (e.g. CFOs, bankers, lawyers, etc.) on mundane tasks that can and should be automated.

CAPX does that: we automate key steps and expedite deal flow. Borrowers can explore and secure the right-fit financing faster, while lenders can efficiently source and evaluate opportunities.

Expertise: Guiding the Way to Smarter Financing

Once you’ve freed up their time from data analysis and lengthy processes, your top experts can focus on higher-value (and more complex) work. CAPX puts that expertise in hyperdrive, empowering both borrowers and lenders with our own comprehensive understanding of deal structures, lender preferences, and financing trends.

Borrowers gain clarity on what deals are feasible and optimal, while lenders can confidently identify opportunities aligned with their risk appetite and goals.

Innovation with Impact: Leveraging Technology to Drive Change

At CAPX, we don’t invest in innovation for the sake of being cutting edge—it’s about making tangible, marked differences in how the credit market operates. Our platform leverages advanced algorithms and latest software technologies to match borrowers with the most suitable lenders, considering unique business needs and market conditions. By codifying and automating expertise that was once dispersed and manual, CAPX ensures that all participants can make informed decisions with confidence.

This technological approach allows CAPX to remove unnecessary friction, optimize workflows, and drive better outcomes for everyone involved. In a market ready for disruption, CAPX’s innovation delivers not just efficiency, but transformative impact.

Join CAPX in Shaping the Future

At CAPX, we believe in a future where technology empowers both lenders and borrowers to make smarter, faster, and more informed decisions. By championing expertise, transparency, and efficiency, we’re not just solving longstanding frustrations in the credit market—we’re setting a new standard for what’s possible.

Join us in transforming the credit market and unlocking its full potential. Together, we can create a financial ecosystem that’s optimized, equitable, and poised for growth.

Get in touch to learn how CAPX can help you unlock the credit markets.

The post The Inefficiency Trap: Why CAPX Matters appeared first on CAPX.

Financial Times: Bankers wary despite jump in corporate fundraising.

LCD: A record $727 billion in debt was issued in the syndicated debt markets through Jun’24.

Yet, a senior banker at one of the largest banks told me that 1H’24 has been the slowest in the last 30 years as per their internal analysis.

So, what is really going on in the capital markets and how can it impact you?

The real deal(s)

The LCD report is correct, the debt markets saw a massive uptick in volume, with two caveats:

• Almost 50% of loan volume was related to repricing, 30% related to refinancing and extensions and less than 20% related to new transactions. In fact, the new transaction related volume is less than half of what we saw in 2H ’21.
• LCD reports syndicated deals – typically $100MM+ deals with publicly available information. This data is not that relevant for most middle to lower middle market bilateral deals, which are almost always private.

We talk to lenders everyday for deals launched on CAPX. Here’s the real market update that matters to you.

Direct lenders have raised capital a while back but they have not been able to deploy it.

Supply of capital

Syndicated loan markets are clearly affected by the retail investor and institutional demand for securities earning higher rates than treasuries.

For the classic middle market, the dynamic is a bit different.

• Direct lenders have raised capital a while back but they have not been able to deploy it over the last 18 months (soon, 24 months) due to the lack of new M&A deals. So, direct lenders are seriously motivated to put money to work.
• Some direct lenders have faced challenges raising new funds, resulting in lower check sizes for new deals or even scaled back commitments right before closing a deal.
• Banks also have capital to deploy, but they have to strike a balance between higher capital costs due to higher interest paid on deposits and credit teams reluctant to do any deal that is not pristine.

Risk Appetite

Cautious is the right word to describe the credit environment.

Lenders do want to do deals – they have to deploy a mountain of capital – but they also have deals in their portfolios that have deteriorated over the last 18 months. This is true for banks and direct lenders.

• Lenders are focusing on high quality deals, i.e. companies with solid PE backing or solid financial track record. Quality deals can readily obtain aggressive structure and cheapest deal economics seen over the last few years.
• Deals with a story or uncertain equity commitment require broad market outreach to find a lender, unless they have sufficient assets to pursue an asset backed structure.
• Troubled deals in portfolio can color lender reactions to even quality deals – broad outreach is the only way to ensure successful execution.
• Combination of portfolio and fund raising issues have reduced check sizes for many banks and non-bank lenders. Even some small deals may need more than one lender to get to the finish line, which means multiple sets of bankers, underwriters, credit committees, lawyers and processes.Lenders are quite measured when it comes to deal structures.

Lenders are quite measured when it comes to deal structures.

Deal Structures

Despite the pressure to put capital to work, lenders are quite measured when it comes to deal structures. They compete for good deals with low pricing and accommodative documentation vs. high LTV, leverage or advance rates.

Leveraged / Cash Flow Deals

• For a performing credit with double digit EBITDA and solid PE backing, direct lenders can provide debt financing up to 70% of EV.
• For independent sponsors, 60% of EV is the most likely preference with some lenders insisting on 50% equity in every independent sponsor deal.
• For middle market corporates, if the transaction doesn’t involve new cash equity, lenders would want to stay below 60% of implied equity value.
• In terms of leverage, banks would want to stay well under 3.0x senior leverage and no more than 3.5x – 4.0x total leverage.
• While direct lenders are more flexible for a deal they really want to do, i.e. large sponsor, double digit EBITDA company, stable cash flows, etc., their leverage limits would be typically a turn higher than banks.
• Overall, the farther away a deal is from the ideal large company deal backed by a PE firm, the higher the required equity contribution and lower the leverage.

SaaS / ARR / Software Deals

• Tech slowdown has refocused credit teams at various lenders on their portfolios. The result is a more conservative outlook, smaller checks and enhanced focus on growth and mission critical nature of the borrower.
• In addition to PE backing, ideal stats for credit worthy SaaS companies are: (a) double digit YoY ARR growth, (b) 85%+ gross margins, (c) 90%+ gross ARR retention, and (d) 100%+ net ARR retention.
• A small but growing group of banks lend to enterprise SaaS firms through ARR underwriting methodology. Many of them will entertain only PE backed companies with funded debt under 1.0x ARR and most require a toggle to a leverage covenant within 2-3 years of closing.
• Direct lenders can lend up to 1.5x ARR, with exceptions to go up to 2.0x for a fast growing company with an entrenched market position and a meaningful investment from a PE firm.
• While the software lending is available to companies that do not fit the ideal profile, the number of available lenders drops quickly for companies without sponsor backing, lower growth rates and lower SaaS stats.

Asset Backed Deals

• Banks might be open to lending against unconventional collateral and reducing reporting burden, but advance rates are still remaining within the historic range.
• Direct lenders focused on ABL structures may offer higher advance rates, but for most companies, the difference between banks and direct lenders might not be too large.
• Direct lenders end up winning ABL deals when very few banks want to do the deal. If a bank likes an ABL deal, they can always outcompete a direct lender.

A few will go after story credits, for a price.

Pricing

Lenders need to deploy capital, if they can find the right deals. In this slow market, good deals are hard to come by. When they do, aggressive lender competition ensues, benefiting borrowers.

But, all deals are not the same. The all or nothing theme prevails in today’s market where all lenders want to do good deals while a few will go after story credits, for a price.

Just to be clear, we know from recent experience that there is a lender out there for pretty much any credit. However, the increase in economics from the ‘ideal’ credit to ‘less than ideal’ can be quite steep.

• Sponsor backed double digit EBITDA companies easily see SOFR + 5.50% pricing from direct lenders for leveraged deals. Increase the EBITDA and PE firm AUM, and you will see deals priced under SOFR + 5.00, pretty much in competition with the syndicated loan market.
• Less than pristine credits in the lower middle market should expect pricing above SOFR + 6.00%. As the borrower EBITDA moves towards $10MM or less, pricing is going to increase towards SOFR + 7.00%, and higher.
• If banks like a cash flow deal, their pricing floor would be around SOFR + 2.00%. Most wouldn’t price cash flow deals higher than SOFR + 4.50% – the deal would be too risky at that point for credit committee approval.
• Enterprise SaaS or ARR deals have similar pricing structure as leveraged deals. However, the pricing would climb a bit faster for story credits. As borrowers approach venture lenders for smaller deals, expect total interest to be in the mid-teens range, accompanied by exit fees and meaningful prepayment or call premiums.
• If you want cheap money, ABL is the structure to pursue. We have heard SOFR + 1.50% from banks as the new low, which is not that far above the all time lows. Most banks would still prefer to be in SOFR + 1.75% – 2.25% range. If you have to pay much more for a bank ABL, non-bank ABL lenders should be considered, who might be able to provide higher advance on collateral at SOFR + 4.50% and higher.

SOFR Floors and Call Premiums

SOFR will go back down toward 0.25% someday when the FED lowers rates. But, lenders don’t want SOFR to go much below 2.00%, which is the typical SOFR floor request. We have seen SOFR floors of 3.00% for story deals.

While this is an important yield enhancer for lenders, practically speaking, SOFR floors would have limited impact on debt service costs for borrowers, even if rates start declining in short order, as most loans are refinanced or repriced within 3 years.

Borrowers thinking about refinancing within a couple of years should think about the call premiums or pre-payment penalties. Most lower middle-market deals open with prepayment prohibition during the first year, followed by 2% call premium in year 2 and 1% in year 3. We have also seen 2% call premium in the first year and 1% in year 2 for better credits.

Conclusion

Lenders are eager to lend capital, but they are also seeing a lot of deals that their credit teams wouldn’t approve. Most lenders we know are really focusing on deals they can close, as there is no real consensus on how the rest of 2024 will turn out for the deal markets.

For under $50MM middle-market deals and larger story credits, expect a much longer deal process as lenders will take their time to provide feedback. And then again, you might have to approach many lenders to find a competitive and reliable solution.

If you have that ideal deal that all lenders want, congratulations, you get to close fast and cheap!

The post Debt market trends for sub $100MM deals appeared first on CAPX.

Given how critical covenants are to a lending agreement, borrowers need to understand negotiating best practices, lest they hamper their growth prospects with overly-restrictive terms. 

There are three classifications of covenants: financial, affirmative and negative. In this article, we will focus on best practices around financial covenants. Future articles will cover the other two classifications. 

Tips for Negotiating Financial Covenants

Below are six best practices for negotiating covenants with lenders:

1. Start with a 30% Cushion. Lenders want to set covenant levels that allow for a reasonable cushion (gap between a given period’s projected EBITDA, and the value used to calculate financial covenants). The typical range for a cushion is 20-30%, with banks on the lower end and direct lenders the higher end. So, if your projected EBITDA is $10 million, ask lenders to give you a 30% cushion, or use $7 million to calculate FCC and leverage covenants.
2. The Fewer the Merrier. More covenants afford lenders greater opportunity to monitor a business and achieve lower risk. Borrowers on the other hand, should maintain the flexibility to manage the business through cycles, and aim to negotiate as few covenants as possible. A balanced approach is outlined below.
3. Covenants and Levels for Leveraged Deals. Assume fixed charge coverage (FCC) and total leverage covenants as givens, and agree to add a senior leverage covenant if absolutely necessary. Most lenders want FCC to be greater than 1.1x, with 1.2x being the industry norm. Levels for leverage covenants would vary as per your projections, but it is typical to set at least 0.25x-0.50x higher than projections. 
4. Covenants and Levels for ABL Deals. A majority of lenders will agree to FCC of 1.0x, with more conservative lenders seeking a larger cushion of 1.1x. And with ABLs, liquidity forgives all sins. Thus, borrowers of ABLs should insist on having no covenant measurement unless liquidity is equal to, or greater than, 20%-30% of the line size. Once the liquidity trigger is activated, insist on FCC of 1.0x.
5. Covenant Cure. This allows a borrower to inject a certain amount of capital into the company to make up for the EBITDA shortfall responsible for a covenant breach. Negotiate a cure period of 30-45 days post covenant reporting date. Also, ask for the covenant cure amount (the injected capital) to be counted towards all future covenant periods (covenant measurement typically works off of TTM numbers).
6. Timing is Everything. Borrowers should insist on quarterly covenant reporting, due 30 days after the close of the quarter. Quarterly covenant reporting allows you to manage monthly business fluctuations, which are not readily predictable.

What to Do When You Breach a Covenant

Every business faces ups and downs, and sometimes, a downward phase results in a covenant breach. From the lender’s perspective, the key here is damage control. Lenders want to understand how safe their principal is, and to do that, they assess the following:

• The type of covenant infraction—certain covenants are more critical to lenders than others (more on this later)
• How severe is the magnitude of the violation?
• How important is this borrower to our portfolio—do we have a long-standing relationship worth salvaging? Is this a borrower we foresee a longstanding relationship with?

Once a covenant is breached, lenders may decide to perform a full reevaluation of the business’ credit profile, update current covenants or introduce new ones, and potentially increase interest rates on the loan.

Borrowers looking to avoid such punitive responses should take the following steps: 

1. Communicate. Lenders want to work with their borrowers to accommodate unforeseen negative events. If you expect to default on a covenant, call your lenders and let them know in advance. The more time you can give them, the greater the likelihood of achieving a negotiated solution.    
2. Consider the Hierarchy of Defaults. Lenders will be more accommodating on leverage covenant breaches than on an FCC breach. The worst type of breach is a payment default. Nothing stokes a lender’s wrath more—so avoid this at all costs.
3. Prolong Reporting. If your company’s financial performance is suffering due to macroeconomic issues beyond your control, ask for a waiver from the measurement of covenants in return for a simple liquidity trigger for a few quarters. Also, take a hard look at your projections, and ask to reset the covenant levels going forward.
4. Offer Lenders Security. If you have a leveraged or cash flow loan structure, explore the possibility of adding a borrowing base to provide an extra measure of risk management for lenders. And illustrate any pathways to additional liquidity through a well-reasoned financial projection revision.
5. Provide 13-Week Cash Flow Statements. Nothing makes a lender happier than visibility into the liquidity picture. Offer up a liquidity projection that you can revise weekly while you are in the covenant breach period, or until the new covenant measurement phase starts.

When a covenant is breached, borrowers should be prepared to pay fees for any waivers and amendments the lender will assign, as well as legal fees to draft those documents. 

The best you can hope for is to keep the amendment and waiver fee to a minimum–25 bps or less–by offering to reduce risk via one (or more) of the sweeteners listed above. In the case of an especially egregious default, expect to pay a default interest rate of 2-3% above your regular rate. The lender may also increase the interest rate of the loan to compensate for the additional risk they are assuming. 

If You Can’t Beat ‘Em, Replace ‘Em

If the suggestions in the section above sound too onerous and time-consuming, you can always explore options to replace your current lenders. This is especially true today, as credit committee processes are highly unpredictable–you don’t know what type of waivers will get approved. What’s more, the debt capital markets have never experienced so many lenders with so much dry powder to deploy, so borrowers have options. 

Instead of haggling with your lender, consider finding new lenders and starting afresh. Sometimes lenders react negatively due to issues in their loan portfolio that you are not aware of. It might be more productive and cost efficient to just refinance, reset covenants and turn the page with a new lending relationship.

CAPX can instantly scale your lender outreach nationally, at zero cost to the borrower. So you can quickly assess your refinancing options at no financial risk whatsoever.

To learn more, click the button below to speak with one of our debt experts.

The post The Do’s and Don’ts of Negotiating Financial Covenants appeared first on CAPX.

Here’s a horror story for you: You’re a private equity or corporate borrower looking for a loan. You approach your small network of bankers and find one eager to do the deal. So you commit to a nonrefundable underwriting deposit (in the neighborhood of $150,000) and months of legwork, only for your lender to reject the deal at the last moment over “concentration limits” or “exposure risk” (forces outside your control).

Instead of securing a multimillion-dollar loan, you’ve wasted months of time and $150,000.

With economic constraints prompting lenders to tread cautiously, this horror story is being lived out more often than people realize. Fortunately, borrowers can take two important steps to mitigate the risk in accepting a capital provider for their loan.

Step 1: Start From The End

Obtaining a loan is a negotiation. The more certainty you express at the outset, the higher the likelihood of the negotiation going your way.

Borrowers typically approach a lender with their own endpoint in mind—how much capital they need and for what purpose. But lenders are viewing the deal from a risk perspective. They aren’t “along for the ride,” the way equity participants are; their ultimate goal is to recapture their principal plus interest. That is why lenders strive to construct a deal with manageable risk.

This is a crucial point: Lenders are always seeking to manage risk.

So when a borrower pitches a deal and simply asks for an amount of money for a set purpose, this leaves too many variables open to the lender. Never pitch a lender without first knowing all of the structural options available, so you can select the best combination of cost and flexibility. Otherwise, the lender will decide those variables for you. The lender will devise multiple debt structures and come back with the one that offers the most manageable risk scenario coupled with the highest potential. In other words, you’ll end up with a deal that is most beneficial to the lender.

Borrowers need to understand ways to structure loans to not only lower their cost of capital, but also obtain long-term flexibility based on their business model and growth ambitions. For example, if a borrower plans to scale through acquisitions, it would be beneficial when obtaining secured debt to negotiate the ability to raise incremental pari-passu debt without having to obtain lender approval.

Now, imagine approaching a lender with the demand that pari-passu debt should be allowed under pre-negotiated conditions. The lender will be more likely to think, “This borrower has done their homework. Forget pitching the high-priced, conservative debt structure. We’ll offer something more reasonable.”

Step 2: Understand Who’s Calling The Shots

Borrowers often talk about their banker, or lender, as if this organization is a monolithic entity with a single set of priorities. “My banker said they can do the SOFR plus 2.5%,” or “my lender is willing to offer me flexible refinancing terms.”

The reality is, lenders are hierarchical organizations filled with various gatekeepers and decision-makers: the chief credit officer, the head of underwriting, whichever division head your deal falls under and so on. Each member of the credit committee has their own priorities, risk appetites, concentration limits, ROI targets, etc. And each of these gatekeepers can squash an otherwise promising deal for their own reasons.

For example, the head of credit might determine that the risk parameters of the deal simply don’t align with the lender’s macro vision. Or the portfolio manager may decide the deal is poorly structured and needs stronger terms to match similar deals in the portfolio or recent portfolio trends.

In addition to the above, you may also have product heads: asset-based lending, leveraged loan, capital markets professionals (if the deal is big enough), etc. They offer advice on market structure and pricing. They can throw a monkey wrench into a deal by noting what competitors are doing, prompting the deal leads to raise pricing or introduce new terms, accordingly.

If it sounds like a labyrinthine process, that’s because it is. There is a layer of dissonance between how borrowers think a loan approval process should go and how it actually goes; borrowers simply do not appreciate the layers of complexity involved. By understanding how a deal progresses through each of these stages, however, borrowers can position their deal with a narrative that enables the front-end banker to sell this deal internally, thus increasing the odds of the deal being approved.

Safeguarding Against Rejection

Given the complexities of the debt-sourcing process, borrowers can take steps to safeguard against a deal being rejected by a lender’s credit committee. First, they can anticipate what the priorities and concerns of each stakeholder will be and address those proactively with the front-end banker, so the banker can make a stronger pitch internally. Seeking expert advice can help with this.

Borrowers can also diversify their lender pool by targeting a wider range of capital providers (by type, size, geography, etc.), which helps de-risk from a late-stage rejection. Digital platforms can help by doing these simultaneously—helping position a deal to ensure the most favorable terms, while instantly scaling lender outreach.

Securing a loan is a lengthy, manual and sequential process. Borrowers should take steps to accelerate the process and expand their options, to ensure the best possible outcome.

The post The Middle Market Lending Process: You’ve Made the Pitch, What Happens Next? appeared first on CAPX.

You decide to approach the debt capital markets—maybe a portfolio company has hit a rough patch, or is considering an acquisition, or perhaps your firm is seeking a dividend recap—whatever the reason, you reach out to the handful of lenders with whom you have a prior relationship.

Your deal team makes the pitch, and you hear a mountain of positive feedback from your coverage banker. “Sure, sounds great! We can get this done in no time!”

Expectations are through the roof. So you begrudgingly endure a lengthy and sequential process of lender due diligence, until the moment arrives when you finally receive a term sheet. 

And it’s nothing like what you expected.

What Went Wrong?

There is a fundamental problem here. It has to do with the incentives inherent in your lender relationship.

You are the lender’s client, which to you—the PE firm—means monthly check-ins, dinner and drink invitations, perhaps the occasional golf outing, and competitive deal terms you can rely on. But to the coverage banker, your relationship is a source of deal flow. Loan originators need to bring deal flow to management, which means that even if the coverage bankers spot a potential pitfall, they won’t necessarily decline your offer or even raise the issue. 

Lenders exist to issue capital. No lender wants to sit on a mountain of dry powder.

Remember, one of the guiding principles of your banker is to keep you—the PE client—engaged. So bankers are incentivized to err on the side of cautious optimism and respond positively to your deal, even if at first-glance there are concerns that need to be addressed. 

This leads us to another incentive at play—that of the credit committee. Credit committees are incentivized to protect the firm’s principal, which implies a more conservative stance on deal origination than what you’re hearing from your banker (who again, is incentivized to bring in deal flow). Hence, the feedback from your coverage banker will almost always be more optimistic compared to the final term sheet the credit committee approves.

And with uncertainty looming over the broader economy, credit committees and underwriting teams must be extra cautious when considering a prospective deal. That is why, once the DD process is in full swing, the lender looks at your deal very differently… from a Credit Perspective. And that is when questions arise.   

• Barriers to entry aren’t as high as they seem, what happens when the big boys vertically integrate?
• The business’ cash flow is lumpy, how sustainable is FCF through a downturn?
• Are we sure this IP is as rock-solid as they say?

Then the term sheet comes back, and it looks nothing like what you expected.  

All of this doesn’t mean that lenders are acting maliciously. They are simply managing competing incentives, similar to many firms. Bankers / loan originators are incentivized to ‘put your deal on the board’ and prove to management that all of those fancy dinners and golf outings are yielding results. Credit committees / underwriting teams are incentivized to protect the firm’s principal, which at times necessitates pouring cold water on the coverage banker’s deal flow. 

The CAPX Solution

Most deal teams make the cardinal mistake of letting lenders control their risk narrative. PE firms provide the information lenders seek, and then sit back and wait while the lender assesses and positions the risk.  

You are ceding control of the deal, and you don’t even realize it.

Instead, PE firms need to develop a ‘Credit Perspective’ of their deal. This is crucial, as it will provide the coverage banker something other than a CIM and management presentation to relay to the credit committee. In crafting the ‘credit story’ of the deal, the PE firm can properly address the risk attributes, develop reasonable downside case projections, and position the business’ mitigating risk factors in such a way that the coverage banker can promote and defend the deal to the more conservative credit committee. 

CAPX works with PE firms to develop and refine a Credit Perspective, and maintain control of their deal’s narrative. Our step-by-step approach safeguards your deal team’s time, and ensures that capital is delivered as efficiently as possible. The credit environment is changing rapidly; the only way to guard against failure is to create options for your deal.

We are offering complimentary credit perspectives to PE firms in search of capital. 

For help clarifying your lending options, click the button below and set a time to speak with one of our credit experts. CAPX will provide a credit overview of your deal, and walk you through any deal positioning and debt structure questions you may have.  

There is no cost for this consultation, and you are under no obligations or commitments to join CAPX. Upon scheduling your free consultation, one of our debt experts will contact you to provide a credit overview of your business.

The post Why PE Firms Should Create a National Competition for Their Deal Flow appeared first on CAPX.

What’s going wrong: Lenders are controlling your risk narrative.

Most borrowers,

1. provide information sought by lenders,
2. let lenders assess and position the risk, and
3. wait for lenders will come back to them, hopefully with capital.

In this process, borrowers relinquish the opportunity to proactively target lenders relevant for their firm’s risk and lose control of the narrative.

Borrowers need to understand risk, the way lenders do, in order to proactively control the narrative and to target lenders that can deliver capital efficiently.

30% Principal Loss on One Loan = Interest Income on 10+ New Loans

Why it matters:

Survival of banks depends on their ability to predict and control loss making events in order to recover principal. While non-regulated private lenders accept more uncertainty in return for higher cost of capital, for either group, the perception of their ability to predict and control loss making events is key.

If you are not viewing the risk the same way as your lenders, you are likely to waste a lot of time hoping for capital solutions that may never materialize.

Before you approach lenders for capital,

1. Identify key risk factors of your business,
2. Identify lenders and debt products suitable for your risk,
3. Control the narrative – proactively identify risks and your plans to mitigate them

The Cheat Sheet:

Use the following cheat sheet to quickly assess the type of debt products and lenders available to your business. This cheat sheet is relevant for middle – market, privately owned companies. While not a comprehensive risk analysis tool, the cheat sheet will help you target lenders that may provide capital solutions suitable for your business.

Combination of some of these factors can improve or worsen perception of credit risk, while private equity ownership may make lenders more flexible for a number of these factors.

Banks: National and regional regulated banks
Non-Bank Lenders: Private credit funds, SBICs or public or private Business Development Companies
CF: Secured debt structures dependent on cash flows of the borrower and enterprise value as a going concern
ABL: Secured debt structures dependent on cash flows of the borrower and appraised value of assets in the event of a liquidation
MEZ: Mezzanine or subordinated debt, which is unsecured, but is dependent on cash flows of the borrower and enterprise value as a going concern

Take Control of Your Capital

• Identify key risk factors of your business,
• Identify lenders and debt products suitable for your risk,
• Control the narrative – proactively identify risks and your plans to mitigate them

In the traditional lending process, you:

1. Give your firm’s info to the banker,
2. The banker creates a narrative based on their perception and pitches to the credit committee, and
3. The credit committee makes a decision.

This process is a classic game of “Telephone”

whereby you relinquish the control of the narrative and rely on the banker to position your deal.

You know your business better than anyone else, why allow someone else to position it for you? By understanding what lenders are looking for, you can proactively focus their attention on factors that can improve the perception of your firm’s risk.

CAPX can help you identify debt products, lenders suitable for your risk and help you position your deal to chosen lenders.

Designed for middle-market firms, CAPX is a digital marketplace that automatically and instantaneously converts capital markets data into valuable analysis. CAPX matches borrowers with lenders to secure $5MM – $100MM+ without having to call on lenders or sit through meetings.

Join over 5000+ subscribers for monthly insights designed to inform readers on capital markets, news, and trends.

The post Take Control of Your Capital – Risk Assessment and Lender Match appeared first on CAPX.

If you’re a CEO or CFO of a cyclical business facing market headwinds, you might be thinking about approaching lenders (or perhaps you’ve already started the process). Before you go any further, you need to pause a moment and consider how lenders think about risk. 

$277 Billion

– Amount of dry powder in the US Private Credit industry

source: Moody’s

Lending has worked on a very simple premise for thousands of years: a lender rents capital to a borrower, who in return agrees to (1) pay a specific amount of rent on specific dates, and (2) return the rented capital in full on a specific date. The rented capital, of course, is principal (P) and the rent is interest (I).

Many years ago, I was attending a risk management course as a young credit associate at GE Capital, where our Chief Credit Officer effectively summarized our profession in one sentence: “Interest is important, but when there is no P, there is no I.” 

The probability of not recovering the principal is the risk that credit professionals fret over most acutely, and their primary task is to issue loans that minimize such risk. 

Interest is important, but when there is no P, there is no I.

This is very different from how equity investors think about risk. Equity owners maintain a higher risk tolerance for their investments, because they are often involved in the management of the business, and can take steps to improve the valuation over time. Their investments are also smaller percentages of their overall portfolios as compared to debt investors, hence the downside of a single bad investment isn’t as calamitous.  

To better understand how lenders think about risk, it helps to break up the risk spectrum into three categories:

1. Known Risk, Known Outcome

This is the type of risk that a lender can readily understand, predict, and quantify. Thus, it becomes a manageable type of risk. 

For example, let’s assume 40% of a borrower’s revenues come from one take or pay contract with a specific maturity date. The lender can readily quantify the potential reduction in revenue if such a contract was not renewed. The lender can also predict the timing and resulting impact on the borrower’s ability to repay the loan’s principal. 

The lender can then manage this risk by writing a covenant into the loan agreement that mandates the maturity of the loan, contingent on expiration of said contract. The lender might also introduce liquidity and collateral requirements leading up to the contract renewal date, to ensure that the company maintains enough cash, cash equivalents, or collateral to repay the principal, should the contract fail to renew. 

This is a prime example of credit risk, where the probability of not fully recovering the principal can be quantified and managed. Regulated financial institutions—banks—largely limit themselves to this kind of manageable credit risk.

2. Known Risk, Unknown Outcome

This second form of risk can be conceptually understood, but cannot be accurately predicted or quantified. 

Let’s again assume 40% of a borrower’s revenue comes from a single contract. But this time, let’s assume the contract can be canceled at any moment—as opposed to having a strict renewal or cancellation date. While the possibility of cancellation is clear (a known risk), the timing of the potential cancellation is unknowable. And because the contract can be canceled at any moment, the cancellation might coincide with other business or market factors (say, a large marketing or R&D expense related to the contract, or a period of cyclicality in the market) which could combine to generate a disproportionately higher loss than 40% of company revenue. So the real impact of the contact’s cancellation cannot be predicted with confidence (unknown outcome).

If risk cannot be predicted and quantified with confidence, it cannot be managed effectively. This is equity risk, and it is something that banks typically avoid. 

Direct lenders are more willing to assume equity risk, but not without a ‘credit story’ that highlights key elements of the deal as risk mitigants. Seeing your capital needs from a credit perspective can be difficult, which is why CAPX helps borrowers understand how lenders will think about their business (more on this below).

3. Unknown Risk, Unknown Outcome

Also known as a “black swan,” unknown risk is posed by events that cannot be foreseen, quantified, or managed.  

Consider the challenge of underwriting FY 2020 revenues of a borrower in a consumer services business that was forced to shut down during the COVID-19 crisis. At the time, there would have been no reliable way to predict when consumer services businesses would reopen, nor would it have been possible to predict the magnitude of company revenue once services finally resume, given the ‘black swan’ nature of the COVID-inspired lockdowns. 

As there was no way to predict or quantify the cash flows of such a borrower, the probability of losing the principal is quite high, making this a classic equity risk. In other words, only the equity owners of such businesses would have invested additional capital, assuming they were willing to bet on a certain recovery scenario.

The Credit Perspective

Before approaching financial institutions, it is critical that CEOs and CFOs think through their business from a credit perspective. 

This is more difficult than it sounds, as lenders tend to view businesses in a very different light than those running the day-to-day operations. Many CEOs and CFOs approach the debt capital markets with growth ambitions, assurances of deeper market penetration, and plans for increased customer acquisition. This is all wonderful, but it is the ‘equity story’ of your business. The ‘credit story’ tells a very different tale. 

Equity investors are looking at where your business is going. Lenders are looking at where your business has been.

At CAPX, we help borrowers understand their credit story. We partner with CEOs and CFOs to help frame their business from the lender’s point of view. And our end-to-end digital marketplace facilitates a national campaign for your deal, so you can be certain you’re obtaining the best possible terms.

We understand how time-intensive the loan sourcing process can be, so we are offering complimentary credit perspectives to middle-market CEOs and CFOs. If you would like help clarifying your lending options, click the button below and set a time to speak with one of our credit experts. 

CAPX will provide a credit overview of your deal, and help walk you through any deal positioning or debt structure questions you may have.  

There is no cost for this consultation, and you are under no obligations or commitments to join CAPX. Upon scheduling your free consultation, one of our debt experts will contact you to provide a credit overview of your business.

The post How Lenders Think About Credit Risk, and How it Differs from Equity Risk appeared first on CAPX.