Despite a professed “stabilization” of the lending environment, lower-middle market banks continue to exhibit inconsistencies that that can only be described as schizophrenic.

I recently had experience with a company with strong credit and a history of double-digit operating results (albeit slightly declining during the recent downturn), a recurring revenue “core” business with Fortune 1,000 clients and an emerging proprietary product with blue-chip, referenceabe customers.  While the business has few fixed assets (i.e. property, equipment, etc.), its receivables provide a substantial borrowing base.

We presented an acquisition structure with total senior credit availability slightly less than our proposed equity investment.  Proposed total senior leverage was just under 2.0x trailing twelve-month earnings before interest, taxes, depreciation and amortization (“EBITDA”).  The non-secured (“stretch”) portion of the proposed financing was 0.6x EBITDA.

Six banks were selected based upon sales calls from business development professionals and introductory discussions describing the opportunity.  Three of the six banks immediately declined due to sector concerns (no appetite for technology or asset-less service businesses).  The other three were highly confident regarding the ability to fund the transaction as proposed and submitted initial indications of interest.

We commenced initial due diligence with these three, hoping to receive comparative term sheets on an expedited timetable . . . then the fun began.  Repetitive positive assurances—after several weeks of needing “more time”—gave way to “mea culpas.”  Interestingly, none of the banks cited credit concerns in these conversations.  Instead, it was a general unease at the credit committee level regarding acquisition transactions, despite the assurance provided by an equity investor at the bottom of the capital structure.  Two of the banks declined the stretch portion of the financing all together, and the final bank downsized the term from what was originally requested.

In our world, certainty of close is absolutely critical.  In the face of inconsistent lender response, we mutli-tracked the process, expending diligence dollars in an effort to make sure we had a structure we could close.   In addition, we leveraged relationships and contacts at higher levels within the banks in an effort to assure that our transaction maintained visibility.

What did we learn from this experience?  In the world of lower-middle market lending, take the indications from business development professionals with a grain of salt.  Insist on preliminary credit approval in order to obtain early indications and sign-off from key credit decision makers.  Multi-track processes, while expensive, can increase certainty of close. And lastly, lower-middle market lending is as schizophrenic as ever.

CRAIG DUPPER is a partner and leads the San Diego office of Solis Capital Partners, a private equity firm headquartered in Newport Beach, CA. Solis focuses on disciplined investment in lower-middle market companies. Mr. Dupper was previously vice president in the Investment Banking Division of Goldman Sachs & Co. and an associate with Bear Stearns. He earned an MBA degree from Yale University.