When the world lost famed Harvard Business School professor Clayton Christensen in late January to a long battle with leukemia, it lost one of the most respected and prolific authors of the past three decades. Christensen, age 67, had written extensively about innovation and disruption in the business world. His 1997 book, The Innovator’s Dilemma, was one of the best business books I’ve ever read and is considered by some to be the most influential business book of the last 25 years.
In a final interview before his death, with Karen Dillon of the MIT Sloan Management Review, Christensen discussed what he labeled the “prosperity paradox,” which he described as three types of innovation. “Sustaining innovations, the process of making good products better; efficiency
innovation, when a company tries to do more with less; and market-creating innovations, build a new market for new customers.” Christensen believed that the latter form of innovation was the most important, while he sensed that businesses were investing far too much in efficiency and sustaining innovations.
The Mothers of Innovation
What does this have to do with equipment finance and leasing? The Monitor editorial board suggested that I write about the interdependence of the independent lessor in the equipment leasing and finance ecosystem. The idea was to look at the equipment finance industry as an ecosystem and discuss the roles that independents play in that space as the test tube for innovative business models or for adopting new technology.
Dictionary.com defines “interdependence” as: noun: a reciprocal relation between interdependent entities, objects, individuals or groups.
I believe that the independent lessors are the only participants who bring market-
creating innovations to bear in our industry. They are willing to take risks that their bigger bank brethren shy away from. Many say that necessity is the mother of invention, but independents are the mother of innovation in the equipment leasing and finance industry.
Over the course of the past three decades, we have seen the critical role that independent finance companies have served in the commercial finance ecosystem. Start-up companies like Innovation Finance USA, founded by Bill Verhelle, former head of First American Equipment Finance, demonstrate how differently an independent can operate in today’s technology driven environment. A primary focus of the company is to leverage technology to provide the greatest possible customer experience. Increased profitability, streamlined processes and improved efficiency are byproducts created by the heavy reliance on technology. But the optimal customer experience is the primary goal. Do you think that concept was ever explored at GE Capital? I doubt it.
Nimbleness
“Independents don’t have low cost deposit bases to rely upon, so we need to differentiate in other ways,” says Kyin Lok, president and CEO of Dext Capital, an independent lessor with financial backing from Sightway Capital, a Two Sigma company focused on private equity investments. “Nimbleness and ease of doing business can be huge differentiators. Who today, even the largest of companies, wouldn’t pay a little more to work with a partner who understands their business, has the freedom to craft solutions that best fit their needs and will save them much needed time and avoid frustration because they can move quickly and smartly? Independents can deliver this far better when they don’t have to broker their deals and they’re truly in charge of the decision making by having access to a strong financial sponsor and efficient debt.”
Independent lessors have a way of finding solutions for businesses small and large that banks aren’t always able to fulfill. How many times have we heard a credit analyst proclaim, “it’s a good deal, but it doesn’t fit our credit policy”?
I asked Lok how he thinks an independent lessor can justify approving “story credits” after bank-owned lessors have declined those transactions. He says: “Did it have a temporary hiccup in the financials and now it is no longer a bankable credit? Was the structure a bit too creative? Does the company need the financing fast or the customer not want to take a month for an approval that may or may not happen? Is the company private equity owned and have more leverage than policy allows? Maybe the company is too new and needs to show a longer track record of success before they qualify for bank financing? Or does someone in the chain of command simply have a bias toward a certain industry or lack a deep understanding of the nuances of an industry? All of these reasons, plus many more, are why independents like Dext Capital exist.”
Larger financial institutions may have deep pockets, yet it costs them many times what a smaller independent would require for innovation due to the burden of their legacy systems and the bureaucracy that oftentimes bogs down innovation. “Less than 10 years ago, the industry was largely reliant on peer-to-peer phone and email references and comparable credit to make credit decisions,” Lok says. “Today, data is abundant and can be mined through data science to make better, faster decisions. Dext Capital aspires to make sense of complex data to make better, faster decisions and feed the data back to the customer or partner in a form that can easily be consumed and help them improve their business.”
In its January publication, “2020 Predictions for Equipment Finance,” The Alta Group made a prediction about banks and innovation. Under the heading of Regulatory Issues, the authors made a presumption that banks are under regulatory strain and as a result, they will focus on better quality traditional markets and avoid innovation and the incumbent risk of being investigated by the regulators. The prediction states, “They [banks] are reluctant to innovate because doing so might trigger a reaction from regulators concerning how they conduct business. There are opportunities for independents and captive lessors to step into the breech or form partnerships, and for technology providers to help banks manage impacts on processes, procedures and infrastructure expenses.” The banks cannot or will not risk the regulatory oversight. So instead, the independents fill the void and bring the new and innovative products to market.
Later in the Industry Structure section of the same publication, The Alta Group speculates that independent lessors will gain ground. “Independents play an important role in the industry — historically the innovators. Free of regulatory and parent pressures, they are attractive M&A targets. Expect the launch of fresh independents and renaissance of existing ones in the short term because traditional bank financing and institutional funding will be tight for innovations and market entrants.” There has never been a better time to be an independent lessor.
True-Blue
I asked Tony Golobic, CEO and chairman of GreatAmerica Financial Services, what he sees as the greatest benefit of being an independent lessor. “Of the many important benefits we gain from being independent, I think the one that might stand out the most for me is how we’ve been able to stay true to our principles and focus on our customers,” he says. “We’ve been able to adhere to our long-term vision without having to make short-term sacrifices that would otherwise have happened in a parent or bank-owned situation. We are unencumbered in this sense, and it has helped us stay true to our course.” Golobic’s response shows why independents revel in their independence.
Interconnection
Most independent lessors insist on keeping control of customer touch points such as sales, credit adjudication, collections and customer service. When it makes sense, they rely on external partners to whom they outsource certain tasks where a partner brings specific expertise. Dave Fate, president and CEO at Stonebriar Commercial Finance, shared a complex description of how SCF relies on a network of strategic partners who serve the needs of his company. He also explained how the company relies on internal sources for areas deemed to be core competencies.
“We have two full-time asset managers in house in our General Equipment platform and another in our Aviation Capital platform,” Fate says. “The vast majority of our asset work is done in-house. We are a large-ticket leasing company. Over 65% of our $2.7 billion portfolio are leases. On the occasions where SCF engages the services of an outside inspection or appraisal company, we typically have had a longstanding trusted relationship with those firms.”
Certain areas of the business are behind the scenes, allowing SCF to outsource such disciplines to third-party providers. Fate described those situations: “We rely on outside sources or ‘strategic partners’ to run our business. Sales and credit are very valuable to our origination, credit and documentation functions. SCF relies on technology service providers such as Salesforce and Capital IQ. With respect to operations, we began outsourcing all of our back-office functions when we started the AIG business in 2004 [a predecessor to SCF]. I went from having an operations manager and eight or more high turnover headcount to a combination of IDS/JDR. It has been a home run! Very efficient and accurate work product.”
Fate has also outsourced information technology, financing and legal disciplines. Fate notes that SCF has ranked second among independent lessors for the past three years. He draws comparison to Ascentium Capital, the top-ranked independent, which employs approximately 460 people, in contrast to 46 employed by SCF. Outsourcing non-critical disciplines is a key reason SCF can stay so lean and competitive.
Independents serve as the innovators who push the industry to create better ways to do business. The pioneers who address areas of the market that are underserved or poorly served. And the champions of small and large businesses who need capital but don’t fit the traditional box. They drive innovation, stretch limitations and develop talent along the way. Independent lessors are crucial members of the equipment leasing and finance ecosystem. They are here to stay.
