Investing in the Small Business Funding Gap

Small businesses have struggled to find capital in the years since the financial crisis. Sources of funding have dried up as new limits and regulations have been imposed on lenders, including the traditional financier of small enterprises, the local bank.

To fill the void, many entrepreneurs have been turning to alternative small business finance (ASBF) companies. To that end, private equity firms have been seeking out ASBF companies to invest in. In September 2014, Pine Brook managing director Robert Glanville led a deal to buy one such company, Strategic Funding Source, Inc. In a conversation with Privcap, Glanville says he expects that acquiring ASBF companies and adding growth equity to them will continue to be a part of Pine Brook’s business plan in the future.

Privcap: Why do ASBF companies need capital?

Any time a specialty banker or lender issues a loan, it needs equity capital to support it, and demand for such loans is strong. If

you look at month-over-month growth, you will see substantial capital needed in this sector. You have all these small businesses that are the engine of growth in America. They are businesses like your local pizza place, landscaper, and dry cleaner, and it’s now harder than ever for them to access a loan.

How is private capital helping to fill this void?

Institutional capital that understands how to grow high-growth financial-services businesses is welcome. ASBF companies need quality investors that can exercise a level of discipline to make sure the investments make sense from a regulatory point of view. That’s why only the experienced private equity firms that invest in financial services will be attracted to this niche.

Why are banks not meeting the demand for loans to small businesses?

There used to be plenty of $250M community banks that could make character-based loans. However, these banks are being consolidated pretty aggressively, because they can’t make money in today’s regulatory environment. This leaves small business owners with fewer options to borrow capital.

Are the loans to the small business considered risky loans?

The borrowers generally don’t have perfect credit, so they can be risky loans. The lender has to be proactive to understand how risky the loan will be and how to monitor and underwrite the loan appropriately so it makes economic sense to make the loan. The lenders have to assess who they are lending to.

Do you expect many private equity firms to invest in ASBF companies?

You really need to understand commercial lending, asset-based lending, and wholesale-based lending to invest in this space. You have to also understand the nitty-gritty associated with how funds transfer and how loans are underwritten.

Are there many opportunities like the one you found with your buyout of Strategic Funding Source?

In 2014 there were 5.7M small businesses in the U.S., and ASBF completed $4B of funding for them. That’s up from $1B in 2010.

Are you expecting new ASBF companies to start popping up?

When you start from scratch, you have a learning curve, but there are good returns in the space, and that will attract money to flow into the sector. It was really a cottage industry, but we are at an inflection point where it’s turning into a sector that’s structured and regulated.