Capital Is Not A Commodity

Michael Flock Managing Capital Leave a Comment

Capital Is Not A CommodityAccessing capital is complex.

The crash of 2008 radically changed the structure of the capital markets in the debt buying industry. Prior to the Great Recession, dozens of hedge funds and commercial banks provided portfolio financing to medium and large debt buyers on a regular basis. Warehouse lines of credit were common and readily accessible. Pricing and returns were at an all time high. Debt buyers spent up to 13 cents for fresh paper. Gross collections were projected to average 2.5 to 3 times the investment over five years.

All that changed overnight

The implosion in both the employment and housing markets has had a devastating effect on portfolio liquidation rates and therefore, the debt buyers’ returns. Many debt buyers were forced to take impairments on their inventory, restructure their loan facilities, and in certain situations, were forced to close their business.

Consequently, the financial markets for debt buyers have tightened dramatically. Only a handful of funds now will finance debt buyers, and no longer will they provide “blank checks” or blank lines of credit. Typically, funds lending to this space require their own level of underwriting and approval for individual portfolio acquisitions. Due diligence is deep and rigorous on each transaction.

Making matters worse is the tight supply of paper being sold. Due to a steady decline of new credit card originations since 2008, the supply of charged off credit card debt for sale is at an all time low. What’s a debt buyer to do? No paper. No financing. The drought is deadly and threatens the livelihood of middle market debt buyers who haven’t diversified out of credit cards or found a niche that they can exploit.

Some new sources of financing have emerged. There are large industry buyers who have created their own funds. But their due diligence and underwriting standards and processes can be onerous. Friends and families remain a trusted source as always, but can be fickle and not a source for sustained large amounts of capital. Commercial banks have exited the market entirely, except for a few very large banks who supply very large debt buyers, and almost always with guarantees.

We are now in an era when capital is no longer a commodity. It is scarce. But that doesn’t mean a debt buyer or collection agency should not be selective about what kind of capital they want and what kind of capital provider source they want to partner with.

How to find and select the right kind of capital

First, hire an investment banker or broker to help find capital sources.

Finding capital, especially on attractive terms, can be a full time job and your already have a full time job running your business. Investment bankers have much bigger networks than most agencies and debt buyers, and are mostly compensated by success fees. So if they don’t find capital, they don’t get paid. On the surface, the fees may appear high, but the structure and terms of the deal will far surpass anything you can do on your own, not to mention the time and distraction from running your business they will save you.

Just running a professional capital raising process will create more alternatives for you. Those alternatives will create competition and pressure for the capital sources to propose the best deals for you in a timely fashion. A professionally run capital raise process will generate serious proposals at optimal terms.

Second, be sure to have a sound business strategy, a story that differentiates you from the masses.

Find a niche or segment in which you specialize or enjoy special relationships that enable you to buy debt outside of large auctions. Be sure to present a solid track record and pipeline that reflects a successful past and a bright future.

Third, be sure to have a sound financial strategy.

What is the best capital mix for the kind of debt you are raising? What cost of capital can you afford for the kind of debt you are buying? Will the structure of the capital enable you to buy the right kind of debt and provide you the cash flow and equity you need to maximize debt buying volumes?

Fourth, develop and leverage the depth and breadth of your management.

Show how the leaders of your business have a full complement of skills and experiences, analytical processes and technologies to scale the business with the capital.

Select your capital source based not only on cost, but on value

Lastly, interview and do due diligence on the capital sources that interest you. The best lenders are like investors. They want to help you grow so they can grow with you. They will provide added value. They prefer long term relationships with years of recurring revenues over immediate or short term gains, especially in segments that are less competitive, on roads less traveled.

That is certainly the practice of Falcon Funding, which was developed by Flock Advisors to meet the specific needs of the middle market. At Flock Advisors, we are “more than a transaction,” meaning we provide value beyond just capital. We help you navigate the complexities of the new economic environment.

This is accomplished by offering new relationships to debt buyers, communities of debt buyers with whom one can partner to reduce competition and improve decision making through additional data points that are provided by our systems and processes, And, we provide risk management expertise and information from our experience in financing more than 80 portfolios, bringing deep intelligence to the debt buying process.

So, capital is not a commodity. Different kinds of capital have much different values to the debt buyer. The right capital partner can be an invaluable resource that brings power and intelligence to the debt buying process in a way that generates long term profits and cashflow for you, as well as certainty for investors at a time when other markets are not profitable and cashflow is uncertain.

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