Hedge funds and other large institutions can deploy sizable amounts of capital for the right opportunity. Unlike family offices, venture funds, and private equity funds, institutional lenders are not necessarily focused on growth.
As fiduciaries, the main concern for institutional lenders is having little to no chance of losing principal. They tend to look for low risk investments, even if the returns are lower as well.
As a result, institutions tend to focus on companies with:
Stable Cash Flows
Stable cash flows are a necessity to providing a hedge fund the confidence to invest. Cash flow stability can come in the form of long term contracts with buyers, proprietary products or services, long term pricing advantages, high switching costs for clients/customers, etc.
Hard Assets
If a company’s performance is not as expected and the company goes out of business, a lender can liquidate the company’s assets to recoup their losses.
Having substantial hard assets provides an additional level of security on top of the company’s stable cash flow.
Upside Potential
Although substantial upside potential is not a necessity, it can help entice an institutional lender. Upside can be provided in the form of an equity kicker, warrants, revenue share, or convertible debt structure.
Low Customer Concentration
If a company has high customer concentration, where they are primarily selling to one or a very small group of customers, institutional lenders will worry about the potential for large losses if that customer chooses another vendor or goes out of business.
This is not a deal-breaker for most lenders, especially if the customer is a well established company.
Strong Team
At the end of the day, unless a lender is receiving substantial control over the company for their investment, they are betting on the management team to lead the company to success.
The company should have a management team with extensive domain expertise and experience. The company should also have strong corporate governance and controls in place.
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