Calling all entrepreneurs and business leaders-opportunity is knocking on the door. The timing has never been better to seriously consider building the next great new lending business.
Why would 2018 be the time to consider this? An unusual convergence of market factors during the past few years has created opportunity. Independent finance companies have been slowly and quietly disappearing, many cashing in with lucrative sales at attractive valuations. The ones remaining will have to consider if now is the time as the valuations are extremely tempting. The once mighty independents are now parts of banks, with more restrictive approaches to credit and structures they can pursue.
While private equity firms such as Warburg Pincus and Fortress have acquired top 100 equipment finance platforms in the past few years, and PE, in general, has been all over the space, the new variable entering the fray is the return of banks as aggressive purchasers. Due to more onerous regulatory requirements, growing banks without a distinct lending platform have been on the sidelines in the acquisition of equipment finance companies. These banks have now come back, in force, as players who need and want to grow in equipment and asset-backed lending.
They are being noticed as active bidders and winners on current sale processes for this past year. One investment banker reported to us that it is typical to see 25-30 banks providing bids on quality platforms that are for sale, and their pricing is now exceeding what the PE firms will pay.
However, only 19 of the top 100 ranked leasing and finance companies are considered independents, and of these, only half might be in the category of entrepreneurial independents who may be open to monetizing their businesses. We would venture to guess that at least another half a dozen will be taken out by banks in 2018, creating a further scarcity of independents in the space. This week alone, Navitas was the first announcement of 2018, with their news of being acquiring by United Community Banks for $130 million.
Knowing that a true shortage of platforms will exist, now may be the time to build the next great independent, and be ready to take advantage of the market factors that will exist in a few years.
Factors Impacting the Opportunity
The finech lending sector has been the talk of the town the past few years, but this past year, the bloom is off the rose. Fintech business lending concepts like OnDeck Capital, Kabbage and AdvanceMe were the darlings of Wall Street, attracting hundreds of millions of dollars of equity investment with algorithmic lending solutions that would surely beat old-fashioned underwriting. But, something strange happened on the way to creating a lending unicorn. Losses exceeded the algorithm’s projections and the real costs to originate customers surged much higher than the MBA modelers had projected. The net result was plenty of loan originations but significant net losses driven by high customer acquisition costs that were not sustainable and predictably to some, credit defaults that exceeded the wisdom of the new and improved algorithms.
This has guided many savvy investors and buyers back to appreciating the traditional and boring aspects of equipment finance and secured lending, where portfolios actually perform and companies truly make money, concepts that seem to be eluding the majority of the fintech lending platforms that were once the darlings of the investment community. This has made good, solid platforms with experienced leadership even more valuable.
A New Generation of Entrepreneurs has Simply Not Risen Up? Why?
Why are there so few independents today and even fewer founded the past few years? What happened to create this shortage of true independents? The answer is capital. After the financial crisis of 2008, to fund a finance business required a sizable balance sheet, access to lines of credit and funding via securitizations and conduits. This required significant capital to invest, and without serious equity, you could only toil as a broker and not progress further to credit decisioning and funding, keys to creating value. Those who had access to capital flourished and those who could not tap institutional funds were left with little options but continue to grow at a very slow pace.
It is interesting to look at the nature of a few successful entrepreneurs and independents that have been able to achieve a life-changing exit valuation these past few years. We found an interesting trend as we looked back. It was not first-time entrepreneurs growing and cashing in, it was often the second or third act of the leadership team or founder that was able to realize a meaningful exit.
One of the highest valuation exits for founders of an independent was the sale of Direct Capital to CIT. A decade plus before this, the founders had sold a majority interest in their small ticket leasing and finance company to private equity firm, Allied Capital. The financial crisis of 2008 led to a unique opportunity for the founders to repurchase the business at a steep discount from the private equity firm who had their own issues at that time. After repurchasing, the founders achieved new momentum through the positive business cycle taking Direct Capital to new heights and ultimately, a landmark sale to CIT. The founders had raised money with private equity, bought the business back and then ultimately sold it again.
Ascentium Capital is another story of founder persistence and the willingness to reinvent the model to fit the times. Founder Tom Depping, after successfully selling Sierra Cities/First Sierra to American Express in 2000, decided to approach the industry as a bank. He purchased a small, two branch bank in Humble, Texas, called Main Street Bank and used the low cost of capital to build a nice lending business. However, as the business grew, Tom found that dealing with the costs of bank regulation and their constant oversight did not fit the business model and creatively spun out the business from the bank with the support of several significant private equity sponsors. The timing was right as securitization had returned with low cost of capital. Ascentium significantly grew from a startup as Main Street Bank to over a billion dollars in assets booked in 2017 alone. They recently sold the firm to one of the world's biggest private equity firms, Warburg Pincus, to continue the growth story and most likely providing some serious personal liquidity to the management team.
Navitas Finance, a Jacksonville, Florida, lessor was the second chapter for CEO Gary Shivers. After co-founding Marlin Leasing, and later exiting successfully through the personal stock sale as Marlin was a public firm, Gary waited out his non-compete and went back to the capital markets with a plan. He was able to again secure seed capital to supplement internal resources from a PE Firm he had previously successfully worked with, and today, Navitas has grown from a start-up to one of the top-100 companies in equipment finance with originations exceeding $750 million to date and serious year-over-year growth. The sale to United Community Bank will now allow Navitas to continue to grow with lower cost of capital while providing liquidity to the founder, shareholders and investors.
What is common about these stories? Each of the founders and management teams were able to secure Private Equity investment to drive growth that opened up low cost of funding and dollars to invest in expansion. Each of the founders were veterans at the game as well in their second and third acts.
Can Management Teams Today Secure Capital for a Startup?
You might surmise that the barrier to entry for a budding lending entrepreneur with an idea is access to capital. It has been the case where if you successfully have raised capital before, you could do it again, with ease, but what if you had not yet done this? There is some good news for the aspiring entrepreneur in the markets. New trends are emerging that are opening the doors for strong leaders to take their place on the stage of growth and wealth creation as entrepreneurs.
This past year, ZRG Partners, in our retained recruiting and growth consulting work, has worked with several hedge funds and private equity firms who now want to invest with management teams who might not have done it before but can with capital. First timers to the entrepreneurial game now have a new way to do it. These types of investors are interested in backing experienced management teams and leaders who have a few common characteristics:
- A solid management team that includes sales, risk and general management team members who would join a new business;
- A clear route to generating originations that is quick and opportunistic so ramp up is clear;
- An ability to generate loans and leases at above bank rates where the private equity model can work taking risks in areas of credit, deal and vendor structure, documentation or residual risk to drive above market rate returns;
- A professional plan that is well thought out and detailed.
If you and your team check these boxes, now may be the time to act. Why are private equity firms and hedge funds viewing this market as opportunistic? There are several factors. The gap between banks and traditional independents is wide. Banks are clearly staying in their credit lanes, delivering 4-6% yields with low risk while there exists a band of opportunity for deals one level out of banks' sweet spots. Deals that make sense but hurt a bank's head. The second reason is scarcity. These investors believe that there is a shortage of independents today and there will be even fewer in 12 and 24 months. To fill the gap, they are willing to invest and build a platform looking five to seven years out when there will be even fewer independents and the ability to sell a successful platform at a large premium.
Kiran Kapur with 36th Street Capital proved this was possible for a first-time entrepreneur. Armed with a great corporate resume and a solid business plan, Kiran secured a funding and equity commitment for his business, 36th Street Capital with Tennebaum Capital Partners, a PE firm that has invested in excess of $15.5 billion in over 400 portfolio companies. After their first year in business, the success of the venture has been strong and the future is bright for this new entrant into the game.
What About a Startup in a Bank or an Existing Platform?
There is another way to build a business and create shareholder value for today’s aspiring entrepreneur to consider. It is the “Intrapreneur” route, which is growing in popularity and demand today. In equipment finance and lending jargon, it is a leader who builds a business from scratch with a parent who might have funding capacity and advantage, but not a specific niche lending business they may want to enter.
There have been several highly successful examples of this approach. The first is Signature Financial, a division within Signature Bank in New York, which entered the equipment finance space through a management lift-out from Capital One. This business went from zero to billions in originated assets in a few short years for Walter Rabin and the Signature management team — which had been together for decades as a unified team. Surely, this is one of the top startup successes in the history of equipment finance.
Another relevant example of this is Fred Van Etten. Fred joined Scottrade a few years back when they had excess cash from overnight deposits on trading that could be deployed for higher returns. He presented a plan to build a full-service lending platform and successfully turned this into a top 100 platform calling on many of his old colleagues from his days at Banco Popular to join him in the new chapter. This startup went from concept to billions in assets originated by the team. With the announced Scottrade now to TD Ameritrade, it was announced this week that Fred is now onto a new chapter of intrapreneurial growth with Midlands State Bank, one of the many new bank players with a desire to growing equipment lending to keep up with core asset growth and to diversify lending lines.
Bob Neagle former business unit leader of First Data’s leasing business had a plan and an idea to take advantage of the gap that existed in financing merchant processing equipment. The market only had 2-3 competitors due to unique risk and system issues. Bob knew where the opportunities resided, but he needed a partner with deep pockets for equity, funding deals as well as a firm with strong systems capabilities. He ultimately joined Ascentium Capital, opening up an entirely new line of business for Tom Depping to help fuel continued double-digit growth. This plan was better suited in a platform than in a startup under a PE model.
How Are These Deals Working?
The start-up model is usually much more than an employee compensation model. Today’s leaders, who are doing startups or lift outs, are able to structure deals with significant equity upsides, similar to what might be realized in an independent, but with slightly less personal risk. Today’s structures often include equity pools and divisional profit share models that incentivize and reward high performance with millions of dollars of upside and formulaic agreements to how profits and value creation will be shared.
Banks are Hungry to Build New Lending Lines
As we enter 2018, ZRG Partners is engaged with multiple clients who now want to create “new divisions” or “new business lines” via the startup model and it is taking creative structures to attract the right leaders to these opportunities, but it is happening. Many successful leaders don’t need new jobs, but they are interested in significant opportunities. If banks can’t buy an independent, they may very well decide to do a greenfield and build it or are now willing to think differently about sharing the upsides. Executives with drive can now be part of doing something that is their own.
Conclusion
Equipment Finance and Leasing was started by entrepreneurs who founded independents that served niche markets in ways the banks could not. While the markets have evolved and become clearly more mature and competitive, we can’t forget this industry has been built through the creativity of entrepreneurs who found ways to do things differently. While many of today’s leaders have concluded the business is merely a commodity and a bank-driven industry, for the creative, hardworking and the resourceful entrepreneur or budding intrapreneur, now may be the time to dust off the business plan and think about creating the next great independent.