What to Look for When Evaluating Capital for Debt Purchases

On April 15, 2021, at The Receivables Management Association’s flagship event in Las Vegas, NV, Michael Flock participated in a panel session and discussed the different types of capital currently available to debt buyers in today’s economy. Michael shared his thoughts on what to look for when evaluating capital for debt purchases. He specifically discussed structures, terms and advantages and disadvantages of each type of provider. Below is a summary of his perspectives.

There are generally four types of capital providers in the debt buying market: 1) high net worth investors, 2) commercial banks, 3) private equity and hedge funds, and 4) specialty finance.

When evaluating potential capital providers, it is critical for the debt buyer to have a complete understanding of the depth of the relationship, structure, and the terms that each source provides. It is much more than looking at an interest rate.

Some of the factors that should be considered in your selection process are the firm’s industry experience, flexibility, ease of doing business, value adds, collateral requirements, guarantees, fees, penalties, effective advance rates, and effective interest rates.  In today’s competitive marketplace, I think it is valuable to look at important non-financial attributes, like the trust, reliability, and timeliness of the capital provider. Thru this evaluation process, you will be able to truly determine the value of the capital for your organization. As an example, a common misnomer is the concept that “the cost of capital” is the same as the imputed interest rate. What many borrowers forget is that interest rates only apply to the amount borrowed, it does not take into consideration the value of your equity contribution. For example, a company could secure financing to buy a portfolio at a 75% advance rate with a 10% interest rate or finance the same portfolio at a 90% advance rate with a 12% interest rate. Which is better? It really depends on the needs of the buyer and the cost of their equity. Another consideration is the repayment structure. Is the structure pari passu which enables the debt buyer to get their investment back at the same time as the lender or is the structure a senior/junior, in which the debt buyer must wait until the senior capital gets paid off before he/she is able to get their capital returned.

Since capital is the most critical resource of a debt buyer, it is essential to analyze all aspects of the process and final terms. Using an intermediary or M&A advisor can be money well spent if the debt buyer lacks experience. These advisors are paid on a contingency basis and can save you time and negotiate a better deal than the debt buyer can alone. And these advisors help you avoid mistakes that can harm your competitive advantage and enable you to purchase debt portfolios in a way that balances your need to mitigate risk while also enabling you to purchase debt portfolios competitively.