Banks Won’t Touch a $5M EBITDA Company. He Will.
Michael Sarner / President & CEO, Capital Southwest (NASDAQ: CSWC)
About this episode
Banks will not lend against $5 million of EBITDA. They take capital charges, they want hard assets, and they will not underwrite cash flow that small. Michael Sarner’s firm lends there on purpose, at two and a half to three and a half turns against six to eight up market.
Ryan Harper sits down with Michael Sarner, President and CEO of Capital Southwest, for the side of the deal that almost never gets explained on camera: the debt. Capital Southwest is an internally managed, publicly traded BDC lending to lower middle market companies, with roughly 2 billion dollars invested and nearly all of it in first lien senior secured loans.
Sarner walks the machine end to end. How a deal reaches his desk, what earns an automatic no, how leverage actually gets set, what he requires from a founder before he will fund the check, and the exact sequence that runs when a buyout starts to break.
Inside this episode
- The funnel in his own numbers: about 1,500 deals seen a year, and 20 to 25 new platform companies out of it
- Why AI is now the hardest question in the room, and the deals it has taken off the table
- Two and a half to three and a half turns of leverage down here, six to eight up market, and what that does to recoveries
- The one litmus test every deal has to pass, modeled peak to trough against the financial crisis
- Country club money, and why he will not fund a founder who refuses to roll equity
- What a PIK holiday is, and what a first lien lender does before it takes the keys
Chapters
- 0:00Cold open
- 0:52What is private equity?
- 1:52Private equity versus venture capital comes down to cash flow
- 3:21Why 90% of all M&A lives in the lower middle market
- 4:21Three turns of leverage here, six to eight up market
- 5:42Why recoveries are higher down here even when defaults are not
- 6:40What a lender needs from a sponsor when things go sideways
- 7:45Why banks will not lend to a 5 million dollar EBITDA company
- 12:33Diligence: two weeks up market, 90 to 120 days down here
- 13:37One hundred SIMs, sixty in the waste basket
- 14:42The question in every deal now: will this exist in five years?
- 15:43Are you the AI, or the company AI is about to replace?
- 16:16The deals AI has taken off the table
- 17:53No government contracting deal in two years, and why
- 18:59The litmus test: downside modeling against the crisis
- 21:04The thrift shop with the same EBITDA for ten years
- 23:31The deal he killed over a thirty year old background check
- 24:28The automatic no: customer and supplier concentration
- 25:13Building products, and a decade of passing on every deal
- 26:07Stroke of the pen risk
- 30:24Fad risk, SKU count, and the supplements company
- 32:44The gasket in your iPhone, made by a company you never heard of
- 35:07How the debt and equity split actually gets set
- 37:35Warrants, and asking for 20% of the business
- 38:56Crushing the equity and taking the company
- 40:04Half a billion in dry powder, and the ATM program
- 42:11Check size: 20 million at origination, 50 at the top
- 45:25Bidding to lose, and breaking into a sponsor's rotation
- 47:23When the founder walks away at the closing table
- 49:49Country club money
- 50:31Why he requires rollover equity
- 51:32The deal he lost because the owner would not roll a dollar
- 52:28Earnouts, and the EBITDA he does not believe yet
- 53:07Add backs: the yacht club and the family on payroll
- 56:17What actually happens when a deal goes bad
- 58:12PIK holidays explained
- 1:00:07What people get wrong about private credit
- 1:02:21IBM at SOFR plus 250 versus lending here at 12%
- 1:03:22Where Capital Southwest ranked among BDCs at the spin, and now
- 1:07:24Carlyle's one pager went from two weeks to five hours
From the taping
This interview is for informational and educational purposes only and is not investment, legal, or tax advice. Nothing here is an offer or solicitation to buy or sell any security. Private market investments are illiquid and carry risk of loss, including loss of principal, and are generally available only to accredited investors. Views expressed are those of the speakers. Figures cited by guests are their own and have not been independently verified. Do your own due diligence and consult your own advisors.