Small Business

Financing: There's no such thing as bad debt

Written by Eleanor Beaton

Four years ago, entrepreneur Chris Walker was on the brink of his first debt-purchasing deal — a move that would initiate the transformation of his fledgling collection agency into one of Canada’s Fastest-Growing Companies.

There was just one problem: the CEO of Newmarket, Ont.-based Collect Canada Ltd. lacked the funds to make the landmark move — and no banks wanted to lend good money to a company that purchased bad debt from the banks themselves.

A lack of capital is one of the surest growth curbs for promising new companies, especially those in emerging industries. But as the Collect Canada case illustrates, one investor’s loss is frequently another’s gain. Seeking out distant sources of specialized financing is one way cash-hungry companies can transcend lender and investor doubt and get on with the business of growth.

In the mid-2000s, Canada’s debt-purchasing industry was in its infancy. For years, banks and other financial institutions had been clawing back the commissions paid to collection agencies, from a high in the early 1990s of roughly 30% to less than 20% a decade later. “I began to see where my industry was headed,” says Walker. “Financial institutions wanted to get out of collections altogether.” Rather than pay another company to recoup defaulted loans, Walker recalls, banks found they could wipe the debt off their books by selling it to a third-party collector.

Collect Canada had been collecting bad debt on behalf of financial institutions for a 15% commission on any amounts salvaged — meaning some jobs paid nothing. Walker thought he’d be better off owning those debts himself. Why throw good money after seemingly bad? Because Walker could purchase the debts at a discount on the dollar and keep 100% of the monies collected. By his calculations, gross margins would double despite the added risk.

But switching from debt collector to debtholder was no simple feat: Walker would have to put up several hundred thousand dollars to as much as $1 million at a time to purchase a typical debt portfolio. (Walker pays anywhere from 2¢ to 50¢ on the dollar for bad debt, depending on its age, how many collections agencies it has been through and the type of credit product it is — e.g., credit card, store card, etc.)

Beginning in 2003, Walker began pitching his business case to financial institutions — including some of his existing clients — with the assumption that they’d be open to the idea. “Here I was, asking to borrow money to buy their five-year-old bad debt,” he says. “I saw a lot of closed doors.” In the banks’ view, the model was far too risky.

It didn’t help that the practice of debt purchasing wasn’t well understood by Canada’s commercial lenders. But if debt purchasing was then just a glimmer in Canada’s financial eye, it was already well established south of the border, complete with its own industry association.

In 2004, Walker travelled to a Debt Buyers Association meeting in the U.S. While networking, he met several U.S.-based private investors who expressed an interest in developing the Canadian market. Among them was Collect America, an experienced debt purchaser with capital to invest. Within a year, Walker and Collect America had negotiated a breakthrough deal that saw the U.S. firm extend to Collect Canada $25 million in financing — as well as critical industry-specific advice — in exchange for an equity stake in Walker’s company. “I wanted an experienced management team with expertise to go along with the money,” he says.

In 2005, Collect Canada acquired its first debt portfolio, generating half of its revenue from collecting purchased debt. Over the next three years, it bought another $15 million worth of bad debt; today, purchased debt accounts for 90% of Collect Canada’s total revenue. Walker says the move from collector to acquirer drove Collect Canada’s revenue from $752,000 in 2003 to $4.7 million last year — giving the firm 146th spot on PROFIT’s 2009 list of Canada’s Fastest-Growing Companies.

It’s fair to say that with $10 million of capital to play with and rising default rates, Walker’s mantra that there’s no such thing as bad debt is now more believable than ever.

Success strategy

Scouting foreign private-equity investment: Entrepreneurs looking for private investment would do well to look beyond cash, says Walker. Seeking investors with a background in your particular business gives you access to a panel of specialists who bring connections and expertise to your boardroom table. When it comes to tracking down foreign private investors, Walker recommends attending international trade shows, which attract experienced players in search of new investment opportunities.

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