Rocky Gor is the founder and CEO of CAPX, a digital platform that instantly connects middle-market borrowers with bank and non-bank lenders.
As a young credit associate, I attended a risk management course where the chief credit office of the organization summarized our mutual profession with the statement: “Interest is important, but when there is no principal, there is no interest.”
In other words, credit professionals are primarily concerned with the risk of losing their principal, thus they issue loans with the intent of minimizing downside risk.
CEOs, CFOs and private equity investors each think about risk differently. You can take steps to improve the business valuation over time when you’re part of the management, and this can mean you’re more likely to want to take risks with capital.
Credit investors don’t have that luxury. They aren’t the ones making personnel or R&D decisions. All they can do is hand over the money and hope for the best (while restricting certain activities through covenants).
Such a hands-off approach naturally provokes a sense of risk aversion, as lenders lack the ability to influence their desired outcome.
Pitching The Credit Story
How can borrowers use this information to their advantage? Simple. By pitching the “credit story” of their deal.
When approaching the debt markets, most borrowers pitch the equity story–the forward-looking results the business plans to achieve with the capital being raised. But lenders are more concerned with where your business has been, rather than where it is going. Borrowers need to address their cash flow sustainability and strategy for navigating a recession if they are to maximize the probability of being approved for a loan.
Below is a three-step process I have developed to help borrowers pitch the credit story of their deal:
1. Perform a candid assessment of your ability to predict and manage cash flows.
If you have a high degree of confidence in your cash flow generation due to the strategic positioning of your business (proprietary product/technology, large market share, unique distribution channels, etc.), then consider yourself a strong candidate for a cash flow or EV loan.
Depending on the funding requirement, target national or regional banks for cash flow financing. Consider direct lenders if you can benefit from a debt capacity that would put your total debt to EBITDA above 3.0x-4.0x, or if you are considering a dividend.
If your degree of confidence is low, perhaps because your business is prone to severe competition, or cyclical downturns and lower margins, then consider asset-backed financing from banks or nonbank lenders.
2. Approach more lenders than you otherwise would.
This is true regardless of the type of loan you are looking for, and which capital providers (bank, nonbank) you approach. While lenders are growing more conservative given the macroeconomic picture, many are still actively searching for deals. After all, dry powder doesn’t earn interest.
Too many borrowers make the mistake of relying on their immediate network of banker relationships. These lenders may have provided favorable terms when the Fed was keeping interest rates near zero, but times have changed.
With the Fed juicing rates, all bets are off as to whether your current lender is still the right choice. You need options. That is the only way to ensure you are receiving the best terms and the lowest cost of capital.
3. Negotiate a flexible covenant structure.
Now is not the time to get locked into a contract with restrictive covenants. As we hurtle toward a recession, borrowers need the flexibility to account for unforeseen economic risks and capital needs.
Partnering with a debt expert can help–someone who might foresee the covenants that capital providers will try to place in a lending agreement, and what can (and should) be preempted or pushed back on.
The Benefits Of A Credit Perspective
Lenders behave very differently when economic conditions deteriorate, which is why it’s so important for borrowers to stack the deck in their favor as much as possible. After all, even if you’ve been through the capital acquisition ringer, you haven’t experienced what it’s like during a period of sustained inflation and looming recession (unless you were raising debt in the early 1980s).
As the leader of a firm offering digitization, I advocate for advancements like digital platforms to help borrowers. It’s important to understand there are digital platforms that scale lender outreach and provide debt expertise at no cost to the borrower. So busy CEOs and CFOs don’t have to rely on their immediate lender relationships to navigate the labyrinthine and opaque debt capital markets.
I have heard far too many horror stories from borrowers who were strung along by a lender, only to have their deal rejected at the last moment due to forces outside of their control. For example, the lender wanted less exposure to a certain market.
Without the benefit of digitization, borrowers are left to secure debt via manual, time-consuming and inefficient processes. Digitization can help even the playing field, enabling borrowers to position their deal from a credit perspective, and instantly scale their lender outreach. Together with understanding how lenders think about credit risk, digitization can help borrowers make the most of their deals.
And in the current economic environment, borrowers need all the support they can get.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.