When looking to purchase debt portfolios, evaluating potential capital providers is a crucial step in the process. There are generally four types of capital providers in the debt buying market: high net worth investors, commercial banks, private equity and hedge funds, and specialty finance. Each of these providers has its own unique set of terms and structures, and it's important to understand the depth of the relationship and the value that each source provides.
When evaluating potential capital providers, it's important to consider the firm's industry experience, flexibility, ease of doing business, value adds, collateral requirements, guarantees, fees, penalties, effective advance rates, and effective interest rates. Additionally, non-financial attributes like trust, reliability, and timeliness should also be taken into account. By evaluating all of these factors, a debt buyer can truly determine the value of the capital for their organization.
It's important to note that the "cost of capital" is not the same as the imputed interest rate. Interest rates only apply to the amount borrowed and do not take into consideration the value of the equity contribution. For example, a company could secure financing to buy a portfolio at a 75% advance rate with a 10% interest rate or finance the same portfolio at a 90% advance rate with a 12% interest rate. Which option is better depends on the needs of the buyer and the cost of their equity.
Another consideration is the repayment structure. Is the structure pari passu, which enables the debt buyer to get their investment back at the same time as the lender, or is the structure senior/junior, in which the debt buyer must wait until the senior capital gets paid off before they are able to get their capital returned?
Using an intermediary or M&A advisor can be money well spent if the debt buyer lacks experience. These advisors are paid on a contingency basis and can save time and negotiate a better deal than the debt buyer can alone. They can also help to avoid mistakes that can harm the competitive advantage and enable the debt buyer to purchase debt portfolios in a way that balances the need to mitigate risk while also enabling them to purchase debt portfolios competitively.
In conclusion, when evaluating potential capital providers for debt purchases, it's important to have a complete understanding of the depth of the relationship, structure, and terms that each source provides. By evaluating all aspects of the process and final terms, debt buyers can make informed decisions that balance the need to mitigate risk while also enabling them to purchase debt portfolios competitively.