Turbulence is everywhere. Trump leads in the polls. The GOP is shattering. The Dow dropped thousands of points a couple months ago, and then bounced back over 17,000. Oil falls below $40 a barrel. Interest rates remain near zero. Apple has the highest market capitalization ever replacing Exxon. Who would have thought?
In the receivables industry, credit card debt volumes are still at the lowest in years, while both auto and student loan debt volumes reach record highs. The CFPB continues to attack established lending and collection practices of big banks, credit card companies, debt buyers and collection agencies. Resales of debt portfolios are either banned or severely restricted. Rumors abound that the CFPB will push to launch a proposal to manage amortization schedules for consumer revolving loans, which could threaten the existence of subprime lenders including many online lenders.
Then there are the changes in consumer borrowing behavior. At the recent DBA International Annual Conference, Bill Kolz of Kolz Associates stated: “Millennials have become heavy users of alternative financial services, primarily payday lenders and pawn shops. A joint study from PwC and George Washington University found that 28% of college-educated millennials (ages 23-35) have tapped short-term financing from pawn shops and payday lenders in the last five years. These consumers are moving from using credit cards to alternative lenders.”
Despite these massive changes, many debt buyers and collection agencies will survive, although consolidation continues with mergers and acquisitions of smaller players. Attendance at industry conferences is slightly down. However, conversations with owners reveal that operators are adapting, learning how to comply, getting certified through trade association programs and other sources. Some are even turning compliance into a competitive advantage.
So, survival is real and our industry isn’t dead. It’s just different. Trish Baxter, newly installed DBA International President, Compliance Officer for Recovery Management Systems Corporation, and a stage-four cancer survivor, recently stated in an interview with our Capital Club internet radio show: “We can’t control what happens to us, but we can control our choices.” This profound advice could also apply to debt buyers and collection agency owners.
To thrive, companies in the ARM/Debt Buying/Distressed debt markets must reinvent themselves and rethink how they deploy capital and its structure—the scaffolding of a business. Many companies are exploring new emerging segments like online lending, healthcare, and litigation funding, among others.
But reinventing your business requires money to enter new markets and to develop products and solutions for those markets. Either you will have to build the business from scratch, buy into the market through acquisition, or create a joint venture with an experienced partner with a track record and expertise you can leverage.
Kolz further stated, “As traditional product availability shrinks the middle market, mid to small size debt buyers will have to rethink their business plans. Alternative asset classes will have higher purchase prices, lower returns but less risk of underperforming.”
At the same DBA Presentation, Peter Waldstein of Javlin Capital stated, “Debt buyers have expertise in traditional asset classes but have to develop the proficiencies needed for new asset classes. Expertise and risk of loss have to be aligned for co-investors. A debt buyer has to demonstrate both the ability and expertise to 1) determine the right price to pay and 2) collect what has been projected.” Waldstein continued by stating, “Capital providers assess the risk of loss. How should risk be allocated between the capital partner and debt buyer? Perhaps a 90/10 split is right for traditional asset classes, but for new asset classes, perhaps the split should be 80/20, 70/30 or, maybe 60/40. As traditional debt buyers venture into new asset classes, the willingness of capital partners to co-invest diminishes.”
Traditional financing sources can be simple and straightforward, although sometimes burdened with lots of fees and convoluted collateral requirements which can affect control. Sacrificing control means sacrificing creativity and therefore competitive advantage, the lifeblood of entrepreneurship. So look for a finance partner who understands this and who is aligned with your interests.
Traditional types of capital are still available: senior debt, subordinated debt or mezzanine debt, and equity. These types of capital can be obtained from banks, hedge funds, and some specialty finance companies. On the opposite page is a table that summarizes the features and benefits of these kinds of capital.
While some of these types of capital can be “cheaper”, they often come with a price dearer than interest rates: giving up some equity or control. In other words, frequently the collateral requirements demand that other assets be tied up, or more equity be invested because of lower advance rates. Giving up equity and surrendering assets for collateral can be a hefty price to pay, particularly in turbulent times when traditional businesses are in jeopardy because of the current storm of regulation and reduced volumes. Just when entrepreneurs need war chests of capital to survive, those funds could be tied up due to the constraints associated with traditional capital sources which appear “cheaper”. Business owners have to be careful, but remain creative to survive.
We remain enthusiastic about the joint venture (JV) types of capital solutions available, although owners do have to share the “back end” residuals or profits from portfolio cash. Most JV structures allow freedom and flexibility because of the structure which doesn’t sap capital strength from the company itself at a time when the company is most vulnerable, like many are today in this world of uncertainty. Owners need the freedom to control their resources, including people and payroll, which are vital to winning in today’s tough markets.
Above is a chart that outlines and compares the features and benefits of traditional types of capital and JV types of structures.
Any one of these scenarios will require capital, most likely some form of equity. At a minimum, you will probably need a financing partner who will advance most of the capital, preferably with flexibility so you can maintain as much control over your business as possible.
So, when talking with financing sources, don’t just ask “what is your cost of capital?” Ask, what is your structure? How do you collateralize? What is your payment schedule? Are we equal partners? Are we aligned?
In these challenging times, the only thing that is certain is uncertainty. As Trish Baxter said: “You can’t control what happens to you, but you can control your choices.” We would simply add: “Make Capital Choices Carefully and Creatively.”
About the Author
Michael Flock has been involved in the credit, collections, debt buying, and outsourcing businesses for over 20 years beginning with being President of Dun & Bradstreet’s Receivables Management Services. In 2007, he founded Flock Advisors, an M&A and capital provider to these industries. In a move to provide capital and expertise to more industries underserved by traditional financial services, this company changed to FLOCK Specialty Finance in 2013. Michael earned his BA from the University of Virginia and received an MBA in finance from Fordham University.
About FLOCK Specialty Finance:
FLOCK Specialty Finance is dedicated to alternative funding in a variety of specialty finance segments. FLOCK’s mission is to provide clients with capital and expertise for the purchase of both charged off debt portfolios as well as for the financing of subprime consumer obligations. FLOCK has funded over 600 portfolios since 2013.
FLOCK believes its funding is “More Than a Transaction”. FLOCK’s proprietary financing structure provides growth-minded clients with a competitive advantage in multiple asset classes. Founded in 2007, FLOCK is headquartered in Atlanta, GA. For additional information, please call: 770-644-0850 or contact us today.