IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities. Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Louie Jachim of Fremont Capital (www.fremont-capital.com):
Obtaining Financing for Your Business: When Does Engaging a Loan Broker Make Sense?
There are numerous challenges of running a business that keep business owners awake at night. To name a few of the most common:
- procuring new customer/vendor relationships
- making payroll
- hiring new employees and retaining talent
- effective marketing
- expanding while maintaining adequate cash flow
- managing investor expectations
- complying with taxation, licensing, and industry regulations
One of the most daunting tasks, however, that frequently surprises owners with its level of complexity, is applying for commercial financing. Even more challenging is establishing a sustainable banking relationship. Relative to their own operations, business owners call the shots and execute a business plan in a well-defined space, whereas with external financing, they are playing an away game on someone else’s home turf – the bankers’.
This metaphor is certainly not used to evoke a notion of borrower vs. lender. In fact, a strong banking relationship is readily achievable, and one of the most important attributes of a successful business. Rather, “bankers’ turf” highlights the fact that most business owners, while financially savvy, do not have technical banking experience and vernacular, which naturally results in the lender establishing the rules of engagement.
Much like real estate, travel, and insurance, the owner has two options when it comes to obtaining financing; call the source directly and try to structure the deal they want, or hire a knowledgeable third party to do so on their behalf. This article is intended to highlight the pros and cons of working with a commercial loan broker in obtaining business financing.
- Market Knowledge
- In a rapidly changing credit environment, due to the volume of lenders that brokers engage with, they have their “finger on the pulse” of lenders’ appetites for certain industries, leverage profiles, underwriting requirements, and management experience. Engaging a broker with a high degree of market awareness is to the owner’s advantage, as it will provide them with financing insights that would otherwise be unavailable.
- Negotiation Skills
- Loan brokers are highly attuned to which elements of loans are negotiable, and where they can “push back” with lenders. Oftentimes, a borrower is not able to identify which elements of the deal are negotiable, or more commonly, does not know what leverage they have to push back or when they should accept the deal as is. Brokers will navigate the negotiation while tactfully questioning aspects such as price, term, guaranty/collateral, and miscellaneous requirements. Put simply, a broker knows what is “nice to have” versus “need to have” for lenders.
- Broad Access To Capital and Professional Services
- Because of their pre-existing network, brokers unlock a myriad of lending and bank options for borrowers immediately upon application. Conversely, borrowers who apply directly may not know where to begin, or become fatigued after contacting a few lenders.
- Significant Time and Energy Savings
- Commercial loans often take six or more months to close, particularly large real estate projects, M&A transactions, and complex C&I deals. Engaging a loan broker has the potential to save business owners and/or their finance executives a significant amount of time on initial communications, applications, and negotiations with banks. Specifically, brokers will handle one of the most time-consuming aspects of the finance application which is the exchange of financial, entity, and legal materials and answering questions regarding those documents.
- Brokers Know How to Effectively Present Transactions
- The crux of a broker’s job is to present effective executive summaries and requests for financing proposals to solicit competitive term sheets. If the broker has many years of experience, or has previously worked in investment or commercial banking, they will undoubtedly have a competitive advantage and the specialized skillset to write a cohesive debt request narrative that will appeal to best-fitting commercial lenders. This is far more valuable than a standalone “financial package” that owners are requested to provide to lenders. Brokers will take the financial package and create a compelling narrative that has a cohesive and polished feel.
- Source and Structure Loans When the Company Can’t
- One of the primary reasons to utilize a broker is when the company has tried numerous banks or lenders, but cannot obtain the financing it needs and is fatigued with the process. Whether this is due to financial challenges of the business, or a misalignment between credit request and the lender’s appetite, a broker will find a lender who will do the deal.
- Opportunity for a Trusted Advisor
- Finding the right broker not only saves time and headaches on a loan application, but provides a knowledgeable industry professional who can serve as a financial advisor for your business. While this reality exists with a strong banking relationship as well, one of the key differences is that a broker maintains the ability to work with any lender (public and private) in order to ensure the financing you receive is continually the most market-competitive and appropriately structured.
- Additional Costs
- Loan brokers can be expensive, especially if the amount of intended borrowings is large. Typical broker fees range from 0.50% to 1.50% of the amount of loan commitments, earned and payable at closing. Many brokers will also require an engagement fee, and/or additional compensation for time spent negotiating and packaging a loan. These costs can add up quickly and are a significant factor for the business owner to consider as part of overall transaction costs. Additionally, many banks and lenders will not pay broker fees directly, meaning that if the fees are not able to financed as part of loan proceeds, this is a direct out of pocket expense for the company.
- A second implication of broker costs is that once you have a primary banking relationship established, it may not be necessary to utilize a broker to obtain and structure subsequent loans, despite an expectation of the same. It is recommended to discuss upon engagement with the broker the nature of involvement with subsequent financings, particularly if the bank the broker initially places the debt with becomes the company’s primary bank.
- Foregoing Experience of Negotiating Loan Terms
- While challenging and time consuming, structuring and negotiating loans is a vital skill for business owners and their CFOs or financing executives. Utilizing a broker, despite being convenient and perhaps most appropriate given capacity, eliminates the opportunity for experience in working directly with lenders to discuss loan terms from the outset, potentially resulting in an ongoing need for the business to engage a third party to source debt capital.
- May Be Less Sustainable and/or Transactional
- While fortunately not common, like any industry, there are brokers whose primary motivation is quantity over quality, meaning they are incented solely by closing commissions and not on the sustainability of the borrowers’ relationship with the lender they place them with. In most cases (the exception being one-off or private transactions) it is advisable to ensure the broker you engage has a broader intention of sourcing and establishing a sustainable banking or lender relationship. As a general rule, if the broker leads with their fee structure and does not ask strategic questions about the company’s long term growth goals and lender relationship, the borrower should be wary.
- “All Talk, No Walk”
- With commercial loan brokering, oftentimes who the broker knows is more effective than what they know. To explain further, if a broker has the ability to compile an acceptable RFP/executive summary, simply tapping into their extensive network of lenders will be enough to “find one that sticks.” For this reason, many brokered deals have a reputation in commercial banking of being lower quality underlying transactions. While this is not always the case, if a company intends to engage a debt broker, the broker should have either direct experience in commercial or investment banking, have taken certified brokering courses, and/or have several years of experience and a successful track record. It is incumbent upon the client to understand the broker’s qualifications prior to engaging, and vital that the broker has a thorough understanding of commercial finance in order to be able to communicate with lenders effectively.
- Banks Want to Work With Management
- While utilizing a broker can be extremely effective for sourcing a lender who is able to provide credit, invariably, the lender will want and need to meet with the owner or management directly to discuss many aspects of the transaction. Specifically, after the initial phases of the loan application, bankers need to meet with management to assess character, guarantor wherewithal, and most importantly to familiarize with the actual legal signers. Even the most talented and knowledgeable loan broker is not the one who signs the loan documents, and companies should be aware that if the primary intent is to save time and avoid negotiating directly, there are some elements of the deal they still need to work with the bank directly on.
For newer businesses with inexperienced financial teams, those who have had difficulty sourcing financing, or those with limited time for extensive financing searches and loan negotiations, engaging a broker is advisable. In these circumstances, the cost of the broker is less than the cost of time and potential negative impact on operations by way of focus spent on applying for financing. However, if the business has a sound management and finance team in place, has an existing banking relationship, or wants direct control over communication with lenders, engaging a broker does not make sense. In these cases, the additional cost of a broker does not provide value that outweighs the internal cost of time and effort to procure financing.
Loan brokers play an integral role in the commercial financing market by bridging the gap between well-qualified borrowers who need credit but can’t find it, and well-capitalized lenders who need help sourcing earning assets. The effect is a net positive value to the economy by stimulating overall lending activity, and further defining pricing, terms and structures that “make the market.”
Louie Jachim is the principal of Fremont Capital, LLC, a Pacific Northwest-based commercial loan brokerage and debt consultancy helping clients effectively source and structure optimal financing at the most competitive terms. Previously, Louie worked in commercial banking for seven years as a Commercial Relationship Manager, and currently works as a Credit Officer for a private lender providing small-ticket equipment and working capital loans in the western United States. For more information or to connect directly, visit www.fremont-capital.com , call (425) 577-8871, or email Louie at firstname.lastname@example.org.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.