If you are seeking capital to grow your private lending firm, keep these strategies in mind.

As the private lending industry starts to face headwinds, including higher interest rates, more small- and midsized lenders are focused on growing quickly to compete. They know their larger competitors are receiving a better price when they sell loans. The small- and midsized lenders understand the biggest firms have better financing, more stable and reliable loan buyers, economies of scale, and equity capital to aggressively invest in marketing and personnel.

Lenders’ strategies for growing fast include remaining independent, raising equity, or selling the business. Let’s look at each option.

Remaining Independent

If you stay independent, you have complete control. There are advantages to that. But will you be able to grow fast enough? Do you have enough capital? For example, can you triple your marketing budget and hire 15 people—and still have sufficient capital to close a lot more loans? Are you willing to risk your capital? It’s easier to spend someone else’s money than it is to spend your own. Do you have all the advantages, resources, and expertise you need? Do you have the right IT?

Consider these questions as you decide whether outside equity is right for you:

1. Can you fulfill a partner’s requirements? This includes monthly detailed financial and production reporting packages, board meetings (which generally take several days to prepare for), extensive risk analysis, and a detailed budget process.
2. Are you giving up more control than you are comfortable with? Will you be fine if your partner requires their approval on loans that don’t fit guidelines? Are you OK if your partner insists on approving major expenditures?
3. Are you OK giving up some of your vendor relationships, including loan buyers, warehouse lenders, inspection companies, IT providers, and CPAs? Your partner is likely to require you to use some of their relationships, especially if they offer lower prices or other benefits that your current vendors don’t.

Partners could expect you to attend daily or quarterly meetings. Some partners will allow you to approve your loans; some will require they approve loans that don’t fit guidelines or are more than $1 million. Some partners will require all loan approvals go through them.

Likewise, a partner could require complete control over your expenditures, or they may be fine with giving you control—or a level anywhere between the two extremes. They could also say you can make purchasing decisions as long as you are within budget.

Pursuing Outside Capital

If you consider bringing in outside capital, you need to choose between raising equity (for a portion of the business) or selling the whole company.

Considerations include how long and hard you want to work, whether you want to maximize your proceeds now or have greater upside in the future, and whether you think it’s a good or bad time to sell given the market cycle. Buyers likely will be less aggressive in terms of what they will pay for a private lender, but that prediction is worth what you are paying for it. Even if you decide to sell 100% now, deals can be structured so you retain a lot of incentives and benefits.

Whether you sell a portion of your company or all of it, you could choose a partner that invests capital but is not in the private lending business. Or, you could partner with a firm that is in private lending. Most likely, partners that are not in private lending will be less involved in your business. Partners that are in private lending will be more involved.

Any partner you choose should bring experience and benefits, including economies of scale, better pricing, additional loan products, better financing, IT, relationships, and back-office support. This infrastructure allows you to spend more of your time growing your business.

If you decide to bring in a partner, consider these questions to determine the right partner for you:

1. How involved will the buyer be? How much control will I give up? How often do we meet? What type of financial and risk reporting is required?
2. Who approves the loans? Who approves the budget? How much capital and resources will they provide to grow the business? How much capital do they have? The latter is more important, given recent market volatility.
3. Who decides whether to hire or terminate employees? A partner could be very involved in personnel decisions, they could give you authority if you are within budget, or they could give you more control.
4. Do you have to sell loans to your partner? What percentage? This could range from zero to 100%. Is their primary focus buying loans, or are they focused on investing equity and resources to grow your business? If your priority is growing and maximizing the business, and your partner’s priority is buying loans, you may not be aligned. Alignment is important.
5. Does the partner give you the actual price they receive on loans, or do they keep a profit margin? Again, this is important. If you have to sell them loans, how are you guaranteed you will always have the best price and products? These types of arrangements require extensive negotiation and expertise.
6. What happens if your partner does not want some of your loans? Are you still allowed to originate them if you can sell them? Some partners will allow this; some won’t. Some will say you can close the loan only if you table fund it (use the loan buyer’s capital). Does the partner have attractive loan products you currently don’t have?
7. Does the partner have experience buying and operating similar companies? Both are important. A lot of firms have one or the other, but not both. If the partner has not bought a company, how do you know if your deal will work out?
8. What is the potential partner’s track record? How did they respond when COVID hit and during the recent spike in rates? Their performance during those challenging times may indicate how they will react to future market disruptions.
9. Is there a good cultural fit? The key people need to spend time together to ask questions and visit each other’s offices. Importantly, they must talk about the values of each company to ensure everyone will enjoy working together. This is critical.
10. What is your risk going forward? Do you have to contribute capital going forward, or does the partner put all the money in?
11. How much upside do you have? Are your incentives completely aligned with those of your partner? Is your equity treated the same as their equity? Will your partner let you benefit when they sell the company at a higher price in the future? For example, if the partner sells the business for a high multiple of earnings, can you sell at the same price?

How will a buyer value my company? The answer is complex. Generally, buyers look at a multiple of your pretax earnings. Deals can range from 1-10 times net income. You may need to negotiate whether to use prior year or current year earnings to determine the price. If profit margins go down due to market conditions, most buyers will pay less. Most buyers also factor in a percentage of your origination volume. Buyers have paid anywhere from 2%-8% of annual origination volume. They may look at the price compared to your book value, which could bring down the price.

Typically, sellers receive a substantial portion of the sale price after the sale, based on metrics the buyer and seller agree upon. Most likely, the metrics will include future profitability and, possibly, volume. Anywhere from 20%‑80% of the total purchase price could be paid based on these metrics. That will be a major point in negotiations.

As mentioned, the earnings multiples buyers will pay varies. There is no simple formula, but keep the following in mind:

• Larger companies sell for much higher multiples than small companies
• Whether your business is “institutional”
• Whether your volume comes from a large group of productive loan officers, or just a small number
• Loan performance
• Market timing
• How fast senior management can grow volume and profits