At Rotunda, we have been investing in specialty finance companies for over fifteen years. We have closed five different deals for commercial finance, small ticket leasing and consumer finance firms. What are we looking for? Return on Assets or “ROA”. We define ROA as After Tax Net Income / Assets.
Why ROA? Finance companies can typically be differentiated by only three basic means. Done well and consistently over time, this approach will drive long term equity value. It is rare to find a specialty finance firm that does even two well so find your point of differentiation and drive it!
- 1. Originations Approach – Do you go to market in a truly different manner? Is it easily replicated? Is your sales prospecting data “live” – ie: are you changing the approach based on market data? Do you feed sales leads dynamically to your sales team to improve their efficacy? How are you using social media? Are customers finding you on the internet? Are you overly reliant on one sales method such as direct sales, a technology based interface or outbound calling? Are you using some combination of push and pull approaches?
- 2. Underwriting – Are you using YOUR data to make decisions? We see so many new specialty finance firms claiming their back-tested credit algorithm is better than the next guys. Nothing beats actual experience for how your customers really performed when times are tough. How easy is it to scale collections? Are you using manual underwriting or trying to credit score? Are you an asset specialist (know your collateral) or a generalist small ticket underwriter? How strong is your fraud detection? It is late in the cycle and fraud is rising. How is it evolving as on-line fraud is increasing?
- 3. Portfolio Management – How well do you service and collect your assets? Please tell me you service your accounts yourself – outsourced servicing is never better and can be fatal. If this is your core strength – are you the master of your asset values and how does that influence your underwriting? (ie: LTV versus OLV). Is your collection team a source of differentiation? Are you using cradle to grave or step-stage? In one deal we switched the head of underwriting and the head of collections – it led to an amazing result as both sides saw the value of their organizational counterpart.
So what’s the point? Done well – one of these there aspects can truly set your firm apart. What do we look for? A ROA of 2-5% (after tax) or greater once the business is at scale. Why? In our opinion, 2% means you have found a way to sustainably differentiate yourself from the masses. 2%-5% will give you room for credit cycles and allows you the ability to take lower leverage while driving strong ROE of 13-18%. As a private equity firm, we look for total annual returns of 20-25%. The delta between the ROE from the assets must come from building a valuable, scalable and differentiated platform. In essence, we invest at book value and sell for a premium to book.
We love to “chat” specialty finance – business models, plans, market approaches, lenders etc. We geek out when discuss static loss curves and gross to net loss ratios. Please call us to talk about your firm and how we can help you build a better business!
Next up: DON’T LET THE DATA FOOL YOU!