Factors to Consider When Choosing a Lender

Beyond the Four CornersThe four corners of the credit agreement will contain all of the important contractual terms and conditions to which a lender and borrower have agreed to be bound. The language will dictate what is required of each party in both the affirmative and negative. While the loan documents ultimately control the specifics of the relationship, language can be rigid and does not always anticipate or reflect the realities of human nature and complex relationships.

Due to the importance of the human element, borrowers should consider factors which cannot be captured through legal documents but will nonetheless affect the long-term working relationship. The importance of the terms crystalized in legal documents should not be minimized, but the other factors discussed herein can be just as impactful to producing optimal outcomes for all parties involved.

To frame the significance of non-contractual considerations, it is important to remember that both parties are entering into a partnership that could span upwards of 5+ years. Moreover, the trajectory of early-stage companies is rarely a straight line up and to the right, which means periods of adversity should be expected. The ability for the parties to collaboratively work through inevitable challenges can be fruitful both from a value creation and an interpersonal relationship perspective.

The foundation for achieving a successful long-term partnership is rooted in the trust and rapport that is built and nurtured from day one. We find that candor, particularly when discussing sensitive topics, is the most crucial ingredient to quickly building said trust and rapport. The entire underwriting process typically takes no longer than one month, so the parties must quickly evaluate whether a good working chemistry is developing and likely to persist for several years hence.

Prior to signing any dotted lines, borrowers should consider a potential lender’s reputation, which can often be difficult to ascertain. Many borrowers hire investment bankers which can be an invaluable resource while advising the company through the capital raise process. Experienced bankers will have worked with a host of lenders and can provide insights into their interactions with a specific lender as well as that lender’s reputation. Borrowers can also conduct reference checks with management teams from the lender’s portfolio companies. A reputable lender will not hesitate to provide contact information for references. Lenders will naturally provide references that are willing to provide highly complimentary recommendations, but the discerning borrower should carefully formulate and pose questions that will elicit valuable feedback.

Discussions with references will help elucidate how a lender approaches their business and whether they have a history of being fair, collaborative, and amicable. When evaluating lenders, borrowers should endeavor to answer, amongst other questions, whether the lender is known for employing a loan-to-own strategy; whether the firm is known for offering a lower headline cost of capital at underwriting only to enhance their returns through punitive fees and wholesale changes to the economics of the loan at the slightest hiccup; or, whether the lender is known for having sharp elbows and a less than collaborative approach to resolving issues.

Furthermore, borrowers should strongly consider whether the lender they are partnering with has domain expertise in the borrower’s industry. An experienced lender with deep industry knowledge will better understand the borrower’s business. Industry experience not only makes for a smoother working relationship, but an adept lender can be an invaluable partner. Lenders that are not versed in a borrower’s industry can be more easily spooked and inclined to take drastic measures at the earliest signs of turbulence. An inexpert lender with a happy trigger finger can be prone to enacting draconian measures that lead to suboptimal outcomes for all parties.

Beyond having a steadier hand during times of adversity, industry expertise can be a valuable asset that management teams can leverage. Similar to a seasoned board of directors, SWK often acts as a sounding board for borrowers that are seeking input and guidance. We also often provide useful industry contacts, whether that be for potential hires, customers, service providers, board members, or funding sources.

Borrowers should also consider whether a lender has experience in venture debt and working with earlier-stage companies. If you are an earlier-stage borrower seeking to raise $15mm+ in growth capital, the good news is that you have opened yourself up to a larger pool of potential lenders, which may result in a lower cost of capital for your business. The bad news is that this next tier of direct lenders may be accustomed to lending to more established middle-market companies that have already navigated the growing pains that your business will inevitably experience.

Venture focused lenders are accustomed to dealing with earlier-stage companies and are therefore more attuned to their specific needs and challenges inherent to growing a business. This keen understanding of where a business is in its evolution should lead to a better working relationship and better outcomes for all parties. Additionally, size-wise, a $15mm loan from a venture lender may put a borrower in the lender’s top quartile of portfolio companies, whereas a $15mm loan from a middle-market direct lender would place it into their bottom quartile. Loan size relative to the lender’s total portfolio value tends to closely correlate with importance, and the relative significance of your loan to the lender may have meaningful consequences for the relationship post-close.

Finally, borrowers should consider the size of the firm with which they plan to partner and the potential implications for the relationship. Larger firms tend to have a greater number of portfolio companies and employees, which means more layers of management between the investment professionals that originated the loan and key decision makers on the investment/credit committee. The further a borrower’s main point of contact sits from key decision makers, the less direct influence they may have while internally advocating for the borrower. At SWK, we take pride in our small team and our borrowers typically have the opportunity to interact with all of our investment professionals both during the underwriting process and throughout the relationship post-close.