Partnership Between Lenders
The participation agreement is a standard form between the senior lender and
the over-advance capital provider and allows a lender to expand an over-advance
financing program across many clients. The ordinary course risk to the over-advance capital provider is stand-still risk and therein lies the technical and
practical beauty of this partnership.
With a daily debit loan, when something goes wrong, there is no real mechanism to get a modification. All of these firms would have that loan classified as
bad debt at best and, at worst, would raid the borrower’s bank account, as some
of the these firms actually employ a “confession of judgement” – a written agreement signed by the borrower that accepts the liability and amount of damages
that were agreed on, enabling the lender to circumvent normal court proceedings.
The partnership aspect is the key to the success of these arrangements as the
capital provider entrusts management and administration of the over-advance
to the senior lender and is paid by the senior lender. Each deal is unique, but
there is a tacit understanding of the risk and a relationship in place to deal with
the likely occurrence of having to modify a decrease in availability or planned
amortization as part of working out of the over-advance.
The over-advance capital product can offset a tidal wave of fintech firms, who
are not concerned if their borrowers have existing loans. Their primary underwriting methodology is a bank statement analysis to determine how much to
lend. This methodology (plus a look at the FICO score) has proven to be effective
when it comes to mom-and-pop businesses borrowing $50,000, but does not
work well when it comes to bigger businesses with cash cycles that do not fit an
indiscriminate daily payback.
The commercial finance industry is entering a new era of borrower sophistication and technology, giving borrowers more options to obtain small amounts of
capital in a matter of hours. We are in the first inning of a long ball game as the
fintech industry is only going to grow.
Fintech loans were never designed for subordinated working capital issues
due to the indiscriminate nature of the repayment with no flexibility to provide
a structured solution. The move upmarket and to subordinated financings is a
result of too much competition and market saturation from several hundred daily
debit providers. This industry has the potential to act as a double edge sword for
ABL and commercial lending clients because an indiscriminate daily debit loan
cannot possibly take into account the cash need or cycle of most businesses.
To combat the rise of daily repayment loans, asset-based lenders would
be wise to partner with over-advance capital providers that understand the
senior lenders are the ones best positioned to provide, manage and monitor an
CHARLIE PERER is head of Originations, Credit Committee Member, Super G Capital.
He can be reached at Charlie@SuperGCapital.com.
Based on significant experience and research, new
products are being developed that can resolve the over-advance issue without sending the borrower to a SBL
fintech for a quick fix.
One new product is a fund formed specifically to finance
over-advances up to $500,000 and enable the senior
lender to manage everything from soup-to-nuts. The
senior lender would administer and manage an over-advance, but a third-party fund would finance the loan.
Having the senior lender manage this process is a game-changing way to provide more capital and better control
a risky situation. This method offers a more flexible
amortization schedule based on the needs of the respective businesses rather than a bank statement analysis
or algorithm. Too often the interest rate becomes the
focus rather than the real issue affecting the cost of the
loan — daily amortization. By resolving the amortization paradigm, companies are more effectively able to
put the over-advance capital to work and stand a better
chance of returning to formula.
Most borrowers clearly do not know this is an option
because the product is not marketed directly. A client
typically goes to its senior lender first to ask for over-advance before pursuing other alternatives, including
SBL firms. The senior lender now has a viable alternative to provide additional capital instead of either going
out of formula or saying “no.” This product offers clients
a viable alternative to get much needed capital rather
than forcing it to go online and search for quick cash
that might not be tailored to its actual cash needs.
The borrower, in these cases, may be unaware that
there is a third party fund financing the over-advance.
The economics for the over-advance would be expensive, but the amortization would be significantly less
aggressive (monthly versus daily) and the senior lender
would administer the loan. The key is crafting a partnership with the senior lenders as they are best equipped
to provide additional availability and monitor collateral.
The partnership enables the lender to provide a quick
over-advance when the need arises with scalability
across a portfolio of companies.
The FILO (First In Last Out) structure is not new,
but applying it to lower middle-market lending structures certainly is. Debt funds like Super G have come
up with a bespoke mechanism that enables asset-based
and other secured lenders to fund an over-advance on
their own loan paper and then enter into a relationship
with Super G (or other capital sources) whereby it would
purchase or finance the over-advance on the senior
lender’s paper so the senior lender is within formula.
The combination of using a participation agreement that
can easily be replicated across many deals and allowing
the senior lender to administer, manage and remit funds
to the participant enables a scalable solution.
The commercial finance industry is entering a new era of borrower
sophistication and technology, giving borrowers more options to obtain
small amounts of capital in a matter of hours. We are in the first inning
of a long ball game as the fintech industry is only going to grow.