5 Ways to Attract More Lenders to Your Mid-Market Loan
Mid-Market Lending Insights
The world of middle-market lending has changed. Before COVID-19, traditional lenders showed flexibility as they worked to expand their books of business and compete head on with private lenders and emerging alternative lenders. They set up borrower-friendly structures and relaxed the requirements for financial covenants and collateral for middle-market businesses. Some offered secondary and tertiary programs to approve applicants who were either denied by a primary lender or have challenging credit issues.
Today, the pendulum has swung back to a more conservative place. Economic uncertainty surrounding COVID-19 means lenders have tightened their business loan criteria across the board, the Federal Reserve reported in a recent bank survey. Lenders are also rebalancing their portfolios to get rid of loans that aren’t working for them, and are getting their choice of new borrowers to work with.
The good news is that mid-market borrowers with strong financials are still able to secure a loan. The best way to improve your chances is to put your deal in front of multiple lenders that are looking for borrowers that match your criteria. You can also make some smart adjustments to your loan package to make your deal even more attractive—and perhaps garner some competition for your business.
Here are five ways to fine-tune your loan application and obtain the funding you need.
1. Start with reasonable expectations
Think about buying a home. You might covet a pricey mansion but your mortgage lender offers you just enough to buy a starter home. Lenders know what you can and can’t afford and their analysis of your loan pitch is based strictly on your past and current financials, not your hopes and dreams for the future. Asking for a $10 million commercial loan when you can only support the cost of $5 million will cause lenders to bypass your application.
“The rule of thumb is that a lender won’t waste time on a deal that either push above EBITDA of 4x cash flow or below 1.25x debt service coverage. That’s considered high risk,” says Matt Bjonerud, founder and CEO of Cerebro Capital. The best way to attract lenders is to make sure the loan request fits inside their criteria. More often than not, the deals that get financed in today’s environment are less than 4x EBITDA, above 1.25x debt service coverage and have collateral sufficient to support the loan size.
2. Stay away from "just-in-case" capital
Asking for ‘just-in-case’ capital—like an extra few million you might not actually use—gives lenders a bad impression. It makes a borrower look reckless in comparison to applicants who know exactly how they are going to use every single dollar of a loan.
A lender is most excited to lend to a company that is going to profitably grow. They prefer to lend to projects where you are going to expand something tangible to drive profits, rather than say, hire salespeople in the hopes that it will improve sales.
Showing that you have concrete plans on how you’re going to use every dollar of their money in a way that will provide a good return for their investment is the best way to get the funds you need. You’ll want to specifically state what the capital is for, whether to expand a factory or make an acquisition. This statement can be worked into your narrative, the upfront story you tell that helps lenders learn more about you.
For example, Cerebro worked with a financially strong company with $5 million EBITDA and seeking a $7 million loan—less than 2x cash-flow leverage. Lenders argued that the company would never use the loan facility, and the company only received offers that were less than half of their ask. However, Cerebro has worked with other companies that have much weaker financials, but were able to win a much larger loan because the proceeds were going to be used for specific purposes that would improve the business cash flows and balance sheet.
“Banks rarely make money on just-in-case capital. By shooting too high, you may miss lenders who are willing to work with you under certain loan caps or conditions,” Bjonerud says.
3. Do more scenario modeling
Lenders would like you to paint a picture of your business, but not just a rosy one. They want to see realistic upside and downside financial projections in wider ranges, especially due to the unknown timing of the economic recovery. This shows lenders that you’ve done the homework to understand their risk.
When creating financial models for your company, Bjonerud suggests creating three cases: bull, base and bear. The bull case is your ideal projected scenario for achieving your objectives. The base case is your expected scenario. The bear case considers the most serious or severe outcome that may happen. You should take into account the COVID-19 impact and spend the most time on preparing the bear case for a lender’s review.
Lenders are realistic, and they don’t expect you to have perfect numbers. They do want to make sure you understand what could happen to your business if the economy takes a downturn. In this scenario, you’ll need to have the cash to repay your debt or you could lose your collateralized assets.
Bjonerud recommends highlighting how you’ll thrive if the economy goes south. Examples include cash preservation steps like canceling your office lease, reducing your workforce, or cutting management team compensation. You want to show how you would pare down the longer term growth oriented elements of your business, like R&D and product development so you can weather the storm and make your cash last.
4. Consider a deal sweetener
It’s a lenders’ market right now. To embellish your loan proposal, you may want to offer ancillary business.
If you’re working with a commercial bank, you can offer to move over your business banking relationships, including deposit accounts, cash management, treasury services, commercial cards, asset management, foreign exchange, and investment banking services. It also helps to show you’re willing to move any significant personal wealth you may have over to their bank. Believe it or not, banks consider revenues generated from treasury management and related services more valuable than revenues they generate off of loans.
Interest rate swaps are another way to galvanize interest in your deal, says Bjonerud. These bank products are available on loans of $1 million or more. Borrowers and banks can enter an agreement where the bank “swaps” your variable interest rate for a fixed rate on the derivatives market.
Borrowers that express a willingness to explore interest rate swaps and use other bank services early in their discussions with lenders will increase their chances of getting lenders to reduce their overall interest rates and fees. However, this is only effective with commercial bank lenders. Non-bank lenders are often looking at loan fees and rates as the primary lever to increasing their interest in the loan request.
5. Offer up equity
While not a common practice for bank lenders, many non-bank lenders are open and receptive to equity offers in addition to debt repayment. This won’t apply for asset-based lenders. But for cash flow lenders, you can offer warrants, or rights to purchase stock shares or common membership units in your business at a specific price and by a specific date to make your loan package more attractive. This option is best for growth companies that do not have assets to use as collateral.
An equity-kicker sweetens the deal as it lets the non-bank lender benefit in the upside of your company’s future success. Lenders are also more willing to relax covenants and raise loan amounts for additional capital if they anticipate your valuation will increase.
While equity can be a positive indication of finding a long-term lending partner, companies should still consider the downside of warrants, which is equity dilution. However, most borrowers are okay to move forward even though the warrants represent some dilution because it is almost always far less dilution compared to raising equity.
Consult with your accountant, though, as issuing warrants, in some cases, may mean your lender will be considered a partner in your company for tax purposes.
These five pointers will put you on the right path to get lenders interested in your deal request. Once you get interest from the lender marketplace and create competition, then you can ask for more capital—as long as you can show how you’ll put it to good use, reasonably and profitably.
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