Increasingly, traditional banks lack the appetite – or freedom – to lend to SMEs without the backing of real estate assets.
5 essentials for guiding clients into private credit
Accountancy practices in the privileged position of advising dynamic growth companies with various funding needs would be hard pressed not to have heard about private credit alternatives to traditional bank business lending.
The private credit sector in Australia is booming, yet the public focus of this sector has typically targeted one side of the credit equation: the benefits to investors.
For savvy accounting practices, private credit opens the opportunity to support their business clients to understand flexible funding options that could help transform their business and drive value for their shareholders. This transformation could take the form of investment in property, plant and equipment, an acquisition or increasing marketing spend to target new customers or new market segments.
Many accounting firms enjoy strong relationships with Australia’s “middle market”. These are companies with revenues in the range of $10 million to $50 million and which typically seek capital from $5 million to $50 million. These businesses are often ignored by large banks because they do not neatly fit cookie-cutter loan assessments and often do not have substantial real estate assets. Business owners are also uncomfortable providing personal guarantees to access debt for expansion.
Just as the accountant brings a deeper understanding of these types of businesses, their growth dynamics and future opportunities, a quality private credit provider can also partner with the business for transformational outcomes.
Where should an accountancy practice begin when looking at the available funding options on behalf of a client, and how does private credit stack up against traditional bank offerings?
Here are five things accountants should understand about private credit:
- Australia’s private credit market is nascent, but catching up.
The rise of private credit as a percentage of the total credit market will continue as Australia and New Zealand plays catch up to the US and Europe, where private credit represents a significant majority of the credit issued (a much larger share of the market than the banks).
The primary factor driving this private credit growth across the world correlates to the significant increase in banking regulation post the global financial crisis, coupled with wealthy investors (family offices and high net worth investors) wanting access to private credit for their investment portfolios.
2: Banks have funding constraints.
Due to changes in regulation, most banks today require large scale and highly liquid investments (ie: investment-grade debt and residential mortgages). It has become increasingly difficult for your friendly bank manager to continue to provide the same level of credit to small, medium and new businesses to allow them to grow and transform.
Even when the banks have given debt capital to these businesses, the decision factors considered are skewed to the value of the real estate that the business owner has pledged – assets such as industrial land, factories and even the family home. Furthermore, banks will not lend to businesses which have had any recent adverse credit events, even when this is clearly behind the business.
3: Look deeper into the balance sheet.
While banks typically prefer to lend to business customers with property to underwrite the loan (because real estate assets are relatively easy for institutions to value), a quality private credit provider will work with the accountant and business owner to better understand the nuances and operating performance of the business – taking into account cash flow, value of non-real estate assets, risks and opportunities. Increasing shareholder and regulatory pressure on the banking sector suggests that the banks do not have the same historical freedom or appetite to lend into these business opportunities without the hard asset backing of real estate, for example. Banks will also almost always require personal guarantees from business owners.
4: Not all private credit is the same, nor transformational for the business.
On the face of it, all non-bank debt provided to companies or projects could be considered private credit. However, a large portion of the private credit market relates to LBO debt (leverage buy out). A large global credit fund providing leverage buy out debt to another large global private equity fund is not what we might call transformational. Yes, it allows the deal to occur, but does it really help the businesses transform and become more productive? Likely not. What it does do is potentially enhance the returns of the private equity fund if everything goes to plan.
In the property world we have seen the emergence of two types of private credit: construction debt and leverage against properties where borrowers cannot get bank debt (residential and commercial). Both are turning out to be essential in a world where banks are pulling back. This debt is allowing new projects to be built and giving property owners a second chance.
5: Due diligence and a commercial mindset are critical.
Accountants can fundamentally support their business client with their mission-critical lending needs by guiding them through the due diligence phase. A quality private credit provider with a commercial mindset would need to dig deep into your client company’s financials and market history, business planning and service contracts, for example. Lending to a business where banks will not or cannot often require the private credit provider to be flexible, nimble and pragmatic through the life of a loan. The due diligence and management of these loans can be more akin to a private equity investment.
The accountant, as the trusted business adviser to a growth business, has the potential to act as an important lynchpin in the relationship between borrower and funder, particularly where time-sensitive access to key financial and business projection information is required.
Gavin Solsky is the co-founder of GCI.
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