Obtaining Financing for a Collection Agency in Today's Market

We get calls regularly from owners of agencies seeking growth capital to purchase new technology, hire additional staff, upgrade their operational infrastructure, and so on. Neighborhood banks and other lending institutions have curtailed their lending activity, particularly for cash flow/people intensive businesses such as collection agencies, because agencies live and breathe month-to-month on 30 day performance-based and easily-terminated contracts with few exceptions.

Historically, many collection agencies were initially self-funded by owner/founder investments or from family and friends, and growth was financed through cash flows generated from the business. As the business expanded, the owner would establish a small working line of credit with a local bank that would grow over time with the company. Bank financing is a lot less available today, so if you are in need of capital to grow, here are some alternate financing sources to consider:

Mezzanine Lenders – These are non-traditional lenders who provide debt based on cash flows of a business. They generally require companies to be profitable and producing at least $1 million in EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), and are more expensive than senior lenders because they charge a higher interest rate and in some cases require a warrant position, but they are also willing to accept greater risk than senior lenders.

Small Business Administration (SBA) Loan (www.sba.gov) – Currently capped at up to $3 million, this option requires an agency owner to apply through a commercial bank that offers SBA qualified loans. Your best bet is to start with the financial institution that you bank with to see if they offer an SBA program. Having an established credit line in place with your local bank, where you have demonstrated your credit worthiness, will only help your case when you try to obtain SBA financing. Typically, these loans are used to start or buy a company, but they can also be used for working capital needs if certain conditions are met. They tend to be somewhat restrictive in terms of repayment options (e.g., ten-year term loans at prime + 1-2.5% with inability to make additional principal payments in the first few years without incurring a pre-payment penalty). The SBA has detailed underwriting requirements to receive financing, but if you have your financials in order, it can typically only take a few weeks to be approved.

Angel Investors – These include high net-worth individuals who have previous experience and/or interest in the debt collection industry. There are a number of previous agency owners/executives who have cashed out of their former businesses and are in the process of getting back into the industry once their non-competes have expired. While this option may seem interesting due to the fact that these types of investors bring more to the table than just cash in terms of industry and operating expertise, their money tends to be expensive because they require it to be an equity investment or a convertible debt instrument with an option to convert to an equity position. Angel investors tend to latch on to industry executives they know or have had a relationship with while in the industry. If you interested in locating an Angel investor, I suggest flipping through your rolodex of industry contacts and letting them know you are looking for financing. More often than not, your connections will either express an interest or know of someone for you to talk to. Most Angels will require some form of a business or financial plan before considering an investment.

Venture Capital – These are typically early-stage investment firms that provide growth capital to early and mid-stage businesses experiencing or poised for significant growth. Some VC firms are willing to invest as little as $1 to $2 million, and they expect their investment to be used predominantly for working capital and growth needs, not to be distributed to shareholders. Because these investors take a preferred equity position, this option can be deemed expensive; however, certain firms may also be able to provide additional support in terms of helping companies to develop a near-shore or offshore capability, improve operational performance, locate additional executive and management level personnel, establish new business relationships, etc. A VC firm will require a detailed business plan that explains your business model, your competitive advantages, management experience, and your financial plan to grow the company with the VC’s help, with a basis for your growth assumptions.

Have you been able to obtain financing? Under what terms? How difficult was it to obtain? I look forward to hearing your thoughts/commentary.

Michael Lamm advises owners on their growth and exit strategies for Kaulkin Ginsberg’s Strategic Advisory Group. Michael can be reached at 240-499-3808 or by email.