When looking for capital for their business operations or opportunities, business owners and managers will try to determine if who they are working with to source money is a direct or indirect lender.
The basic premise is that its better to work with a direct lender than an intermediary such as some form of broker.
But while this can appear to be logical on the surface, the term direct lender can be very misleading.
The truth of the matter is that all lenders, outside of private mortgage lenders, are utilizing someone else’s money to help fund their deals.
Business financing is about leverage for all those involved and many of the wholesale financing strategies that fuel larger transactions are far beyond the scope of this discussion.
Its not uncommon for any particular debt lender to have several different funding options to consider to fund the deals they are putting out to small and medium sized business owners. But are they lending all their own money? Again, unless they are a private mortgage lender or a certain type of equity investor, not a chance.
This is where people get confused.
The goal many business owners have is to work directly with someone who is lending out all their own money, but virtually no one is doing that.
And there’s a good reason why. If you look at your own expected return on capital for the money you hold, are you prepared to give it to someone else for a three or four percent return that may be secured, but hardly guaranteed?
The answer in most cases is absolutely not.
So why would lending organizations be prepared to do that on a very large scale when they could get a better return doing something else with their money?
The answer is they don’t.
When pressed on this issue by a client, I asked them to name me someone they considered to be a direct lender. After the client provided a name of a well know international lender, I went online and accessed their balance sheet as the company was publicaly traded.
The balance sheet showed total assets of over $500 billion and equity of slightly more than $50 billion, leaving the difference of $450 billion as debt financing, clearly showing that they were lending out someone else’s money, just like most everyone else.
Private mortgage lenders provide financing at higher rates, which reflects their desired cost of capital as the money they’re lending out is their money.
For lower cost sources of capital, the lender is providing a combination of equity and debt, with the debt portion getting above 90% in some cases.
Even the largest of the large may employ several different forms of financing for the deals they do. They may have their own pre-approved lines of credit they can draw against, provided the deal to be funded fits the underwriting requirements of the lending source, they may syndicate deals with other lenders to share the overall risk, they may outsource the deal to a strategic partner who has a funding source more closely aligned with the deal requirements. There are other potential funding methods and practices as well.
The key point is that the lower the cost of financing, the less likely you’re actually going to be working with someone sticking 100% of their own money into the deal.