Working Together: How Factors and Non-Bank Lenders Can Capitalize on Credit Retrenchment from Banks
Opportunities for factors and non-bank lenders will continue to increase as banks tighten their credit standards in the face of economic tumult. Pulling inspiration from an unlikely source, Bryan Ballowe of TradeCap Partners provides a detailed explanation of how forming relationships with other financing providers will help non-bank lenders and factors when it comes to creating a competitive advantage, minimizing risk and, most importantly, winning business.
BY BRYAN BALLOWE, MANAGING PARTNER, TRADECAP PARTNERS
I’ve never been one to watch a lot of television. There’s simply not enough time in the day between my wife, my two-year-old daughter (with another on the way) and owning a company. However, my schedule was recently turned upside down when my wife introduced me to the drama series Suits.
For those of you that have been living under the same rock that I have for the past decade and don’t know anything about this TV nirvana, Suits is an American legal drama with an intense storyline surrounding the never-ending energy of a high-profile New York law firm, made up of money driven, manipulative and narcissistic personalities.
Harvey Specter (played by Gabriel Macht) is one of the main characters of the series and has an amazing ability to navigate his way, and the law firm he works for, through a maze of legal issues while maintaining a cool, sometimes calm and collected demeaner, while delivering great one-liners. He’s able to do so based on his ability to strategically utilize his network of legal, political and celebrity relationships who willingly respond to his beckoning calls.
As my addiction to this show has grown over the past several weeks, I’ve realized that Specter’s adept ability to use his relationships to navigate big corporate mine fields to his benefit can provide invaluable lessons to non-bank lenders and service providers as they navigate the current state of the lending environment.
All signs point to banks growing more cautious and restrictive about extending credit as they respond to elevated inflation and insecurity brought on by recent bank failures. While banks are still holding on to assets with the sole objective to maintain deposits, the wave of companies that will be asked to find a new lender, as well as companies that have been turned down by banks altogether, is growing by the day. While the risk appetite of banks is growing scarce, non-bank lenders and factors are starving for new deals to build up portfolios and increase funds employed. Competition among these players is intensifying, and non-bank lenders are positioning themselves strategically to be able to execute once new opportunities hit the market. How non-bank lenders and service providers distinguish themselves from their competition in order to win new relationships, as well as keep valued ones, will be critical.
What tools do non-bank lenders, factors and service providers have in order to stand apart and successfully execute going forward? Some have established a strategy as a one-stop shop in order to offer all things to everyone. Others have taken a different approach and focused more on being “best in class” related to a single product offering in hopes that prospective clients will be able to discern the difference.
Regardless of the strategy, the strength of relationships that non-bank lenders, factors and service providers have with each other and the ability they have to identify when to utilize those relationships will prove to be a key differentiator as it relates to referrals, deal execution and client retention.
Besides being jealous of Specter’s spot-on suit game and witty one-liners (several of which are meaningful for purposes of this article and cited below), he has reminded me of how critical it is now for lenders, factors and service providers to establish strategic relationships with one another to create, strengthen and maintain valuable customer relationships.
“I don’t pave the way for people…people pave the way for me.” - Harvey Specter
The commercial finance world is made up of traditional banks, non-bank asset-based lenders, factors, equipment finance companies, niche funding companies (such as standalone inventory and purchase order funding companies) and service providers, including appraisers, liquidators and consultants. This list is not meant to be comprehensive, but it shows the number of different funding solutions and service providers that exist, with each having their own risk appetite and skill set.
Part of being successful is not only knowing your strengths and weaknesses but also having a complementary relationship in place that can help augment both. For example, purchase order funding is a complementary funding solution to asset-based lenders and factors that enables existing borrowers to fulfill large orders and contracts for the sale of tangible goods over and above what their balance sheet, existing cash flow and/or terms with suppliers can support. Purchase order funding is a unique discipline in that it is transactional and highly structured due to the execution risk involved. Most asset-based lenders and factors are not willing or able to provide such a solution for various reasons; however, all asset-based lenders and factors, as well as their clients, can benefit greatly from utilizing such a funding tool.
The benefits of purchase order funding to an asset-based lender and/or factor include the following:
Increased accounts receivable and inventory, resulting in a larger borrowing base and increased funds employed
A stronger borrower as a direct result of increased sales and profitability
The ability to keep a borrower happy by providing additional access to funds without taking on additional risks, thereby eliminating the fear of losing a client to a competitor.
Purchase order funding is just one example of a complementary lending product, as asset-based lenders and factors as well as their clients can also benefit from standalone inventory lenders, turnaround consultants and other service providers for many other reasons. From the other perspective, purchase order funding companies, standalone inventory providers and other service providers also can benefit from strategic relationships with asset-based lenders and factors. For instance, standalone purchase order funding companies lean on asset-based lenders and factors for credit enhancement, customer collections and, most importantly, repayment once goods that have been financed have been shipped and invoiced. Standalone inventory finance companies also look to asset-based lenders and factors as a repayment enhancement.
Strategic relationships among various non-bank lenders and service providers are also accretive in that those relationships provide a conduit for continual referrals that benefit all parties. Maintaining strategic relationships with complementary lenders and service providers decreases the need to compromise core competencies while simultaneously decreasing risk and allowing all parties to provide the “best-in-class” service clients demand. While Specter’s quote at the top of this section may come across as self-serving and arrogant, it is all too true and meaningful in context of how various lenders and service providers can benefit from strategic relationships with one another.
“I don’t play the odds; I play the man.” - Harvey Specter
In most instances, playing the odds means taking a rational approach to dealing with decisions and problem solving. However, sometimes making the most rational decisions based solely on the odds doesn’t always end up with the most favorable outcome when other variables aren’t closely considered.
Poker is a perfect example. How many times does a player with an inferior hand defeat another by reading the competitor and knowing what their strengths and weaknesses are? While bluffing in poker goes against conventional odds, it can work since no one in the game has complete visibility to all available information (unless you can count cards). The same can be said for business decisions. Knowing what’s most important to the client — and who your competition is — can provide valuable insight in order to align with a strategic partner that will augment your perceived value. In fact, aligning with a complementary lender or service provider helps strengthen the odds and significantly levels the playing field against competitors that might be superior on a standalone basis.
The concept is further illustrated in the economic principle of comparative advantage that was introduced by economist David Ricardo in 1817. This theory explains how two entities can benefit from specializing in the production of goods or services in which one has a lower opportunity cost than the other. Case in point, non-bank lenders and service providers will specialize in providing a particular solution if that solution can be provided at a lower cost in terms of resources, access to talent, expertise and risk mitigation compared to other solutions and to other non-bank lenders or service providers that can provide that same solution.
When two lenders that both possess a comparative advantage in relation to their product offering align, the whole can become greater than the sum of its parts. While I don’t think Specter was thinking specifically about comparative advantage when he made the statement at the beginning of this section, he was on to something. Strategic relationships among lenders and service providers augment product offerings and overall customer satisfaction while simultaneously minimizing risk. Identifying what the competition is offering and what their strengths and weaknesses are will allow lenders and service providers the opportunity to initiate specific relationships with others that will result in a comparative advantage and a higher probability for success. Odds become irrelevant when you they are stacked in your favor.
“It’s going to happen because I’m going to make it happen.” - Havery Specter
The power of will to accomplish goals is a remarkable and influential force that resides within each individual. Motivation, perseverance and adaptability are some key aspects that make up the power of will need to accomplish goals. As flawed and narcissistic as Specter’s character is, his will is his most powerful trait and far and away exceeds that of his partners, clients and adversaries.
Utilizing the power of will to build business relationships is a complex and dynamic process that involves elements of communication, trust, mutual respect and shared experiences. It takes time, patience and perseverance. It also requires a forward-thinking mindset built on hard work and tireless networking to build a reputation. However, once those business relationships are established, building and fostering those relationships is equally as important. It’s a continuous process that takes effort from both parties. Utilizing strategic relationships in order to successfully compete and win business first requires the ability to identify a situation to partner with another lender or service provider as it arises. This requires the ability to know not only when the opportunity requires another lender or service provider but also the willingness to work with another party. Do you know and trust the lender or service provider well enough to work alongside them and at the same time put them in front of your prospect or existing client? What will the prospect or existing client think when bringing on another lender or service provider? Will that be seen as a sign of weakness or a sign of providing the client a “best-in-class” solution? The decision that you make to bring on a complementary lender or service provider will not only determine the outcome of winning a client and/or keeping a client happy, it will also be a direct reflection of how the client or prospect sees you.
Determining when to partner with a complementary lender or service provider, as well as who that partner will be, is half the battle. Establishing and memorializing the relationship from a legal perspective is critical in order to protect everyone’s interests. Lenders can enter into various types of agreements to coordinate their interests, establish their rights and manage risks when dealing with a common client. These agreements help lenders work together effectively, especially when multiple layers of debt exist. Here are some common types of agreements between lenders:
Intercreditor Agreement: An agreement between multiple lenders who have provided financial accommodations to the same borrower. It outlines the hierarchy of debt, the order of repayment and the distribution of collateral in case of default or bankruptcy.
Subordination Agreement: A specific kind of intercreditor agreement in which one lender agrees to subordinate its rights in certain assets of a borrower to another lender’s rights.
Participation Agreement: An agreement that allows one lender to sell or transfer a portion of its lending relationship to another lender. The participating lender becomes entitled to a share of the borrower’s payments and has an interest in the loan on the same terms as the original lender.
Negotiating these agreements requires careful consideration, effective communication and a focus on achieving mutually beneficial outcomes. Some key considerations for successful negotiations include open and transparent communication between lenders, clearly defined objectives and priorities, the identification of common interests, flexibility, a willingness to compromise, and a focus on the long-term relationship with the other lender as well as the mutual client. Strong relationships with other lenders and service providers will enable the negotiation of these critical agreements to be done with respect and professionalism.
“The thing about smart people is that they seem crazy to dumb people.” - Harvey Specter
I would be remiss not to mention the dynamics and role that artificial intelligence will play in the world of commercial finance and how it will impact relationships lenders and service providers establish. Is AI a shapeshifter for the reality of human intelligence? No. However, it is a powerful tool that enables machines to process and analyze vast amounts of data, recognize patterns and make predictions and decisions with exponentially greater speed and precision than humans. AI is expected to have a significant impact on lenders across various aspects of their operations and decision-making processes by improving efficiency and automation, enhancing credit risk assessment, detecting and preventing fraud, as well as providing efficiencies in underwriting and portfolio management.
Despite its numerous benefits, the adoption of AI in commercial lending also raises certain challenges and concerns related to data privacy, ethics and potential job displacement. It is essential that lenders strike a balance between leveraging the benefits of AI and addressing these challenges responsibly.
As AI continues to evolve, lenders will need to adapt and embrace innovation in order to stay competitive in a rapidly changing financial landscape. This makes it even more essential that lenders establish strategic relationships with other lenders and service providers. As AI is implemented systemically across the industry, the ultimate distinguishing factor will be the strength of the relationships lenders and service providers establish.
“The only time success comes before work is in the dictionary.” - Harvey Specter
The last several years of loose credit from banks means their retrenchment in the marketplace will lead to the tsunami of opportunities to flood non-bank lenders and other financing providers. While the number of cash-starved borrowers looking for new homes will significantly increase, the competition among non-bank lenders to capitalize on these opportunities will be fierce. How non-bank lenders and service providers are positioning themselves to execute on those opportunities and manage the associated risks is paramount to their success. Relationships are critical and are time-tested; however, they require hard work to establish and constant attention to develop and grow. Strategic relationships among non-bank lenders and service providers are accretive in many different ways, and they also provide a strong barrier to entry to competition. They can level the competitive landscape by allowing lenders to utilize their comparative advantage to not only win business but also minimize risk. As I find myself quickly approaching the final episode of Suits, I have a feeling I will be incorporating several Specter one-liners more often. Please don’t judge.
“I win. That’s what I do.”- Harvey Specter