Hard numbers and tangible assets often dominate decision-making when it comes to asset-based lending. But one critical but often overlooked factor can make all the difference: character.
Of the classical ‘C’s of credit – capacity, capital, conditions, collateral, and character – character is the most overlooked. Yet, in the experience of seasoned capital providers, both public and private, character holds equal if not more weight in the determination of extending credit.
Lenders have learned that the proper evaluation of a company’s management is as essential as evaluating its collateral when determining its worthiness for financing. This kind of due diligence is particularly important for non-bank lenders, which make up an increasingly large share of credit providers.
Arif Bhalwani, CEO and co-founder of Toronto-based alternative capital provider Third Eye Capital has said that no matter how promising a business model may appear or how attractive an asset may seem, the quality of management can determine the success or failure of an investment.
Bhalwani has emphasized in the past that the success or failure of a business often hinges on the decisions made by its leadership during times of adversity. By placing a premium on character, firms like Third Eye Capital have successfully steered their lending portfolio through various market cycles, often outperforming traditional lenders who solely rely on financial metrics.
For non-bank lenders, the stakes are higher, and the risks are often greater. Unlike traditional banks, these lenders typically take on more complex, unconventional lending opportunities, which means they often encounter situations where a company’s financials may be less predictable.
Bhalwani has said, “The interaction between collateral and character is what ultimately determines the success of the loan. A strong collateral base can mitigate some risks, but it cannot substitute for poor management. Conversely, a management team of high character and competence can sometimes compensate for weaker collateral, using their skills to enhance asset value over time.”
Lenders have observed time and again that leaders who lack integrity are more likely to engage in practices that are harmful to the business and its stakeholders. These practices can range from financial mismanagement and fraud to unethical business dealings and poor corporate governance. This creates an environment of mistrust that can be fatal, especially in situations where a company is undergoing change, challenge, or complexity.
Empirical evidence backs up these observations: a 2024 study that builds a machine-learning “managerial integrity index” from thousands of firms’ MD&A disclosures finds that each one-standard-deviation increase in measured integrity lowers the average loan spread a company pays (Yang, Meng & Li, 2024).
This doesn’t mean that asset providers should disregard traditional lending metrics. A thorough understanding of a company’s assets is necessary in order to gain a more complete and accurate picture of the business. By combining rigorous financial analysis with deep insights into the character of company leaders, alternative lending firms can consistently deliver strong returns to investors, even in turbulent times like Third Eye Capital has done.
Even the best leaders and the most well-run companies can encounter difficulties. Challenges are a part of business, and mistakes are a part of being human. What matters is how those challenges and mistakes are handled – and this is where character plays its most vital role.
This emphasis on character doesn’t just apply to those on the lending side of the equation. Entrepreneurs seeking financing should also be mindful of how they present themselves and their values to potential lenders. Along with business plans and projections, they should showcase their leadership qualities. Lenders and investors want to know who they’re getting into business with, and examples of resilience and strong leadership through turbulent times will certainly stand out.
In an industry where hard assets and tangible metrics often take center stage, asset-based lending firms are demonstrating that thorough diligence pays off for their investors, especially amid rising insolvencies and increased debt costs. By championing the importance of character in their lending decisions, they prioritize the human element, which ultimately drives value, stability, and growth.
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