The relationship between lender and lower-middle-market CEO is a critical factor in the success of ETA deals, say veterans of the Entrepreneurship-Through-Acquisition strategy. This episode of Search Party is about how to get the most from your lender over the lifecycle of an ETA investment, with expert commentary from ⁠Castle Capital ⁠Managing Partner and ETA veteran Chandos Mahon, Conor Tidgwell of ⁠Avidbank⁠ and Anthony Walker of ⁠Next Coast Legacy. ⁠

Central to the conversation is the story of the relationship between Avidbank's Tidgwell and Mahon, who as an ETA acquired, ran and ultimately sold a recycling business called Castle Tire. Under Mahon's leadership, the lower-middle-market company did a total of ten add-on acquisitions financed by Avidbank, plus a facility financing. Along the way, Castle Tire's debt structure changed again and again, with close and transparent coordination between borrower and lender.

Among the key takeaways from the engaging and lively conversation:

Treat your lender as a strategic partner, not just a source of capital. In an ETA deal, the lender often provides the largest slice of the capital stack, making frequent, transparent communication a key to long-term success. “Your lender is your largest investor. Avidbank was my largest partner in this deal," notes Mahon.

"Radical transparency" enables flexibility and prevents surprises. Lenders are more likely to support growth or navigate tough times if they’re looped in early and often. According to Avidbank's Tidgwell, “If we get caught with a surprise and we’re in a reactive mode, that’s typically when lenders are less flexible.”

Financing tuck-in acquisitions requires confidence in cash flow and covenant wiggle room. Lenders are open to supporting add-on acquisitions, but only when the platform business has proven stability and enough covenant cushion to absorb uncertainty. “We’re looking for probably a half turn, at least, of cushion on these covenants. We want to make sure it’s an add-on that makes sense for the business, but I think you always start with the numbers, to make sure there’s adequate cushion out of the gate," says Tidgwell

Covenants can - and should be - adjusted to support growth. If a company's expansion plan makes strategic sense, lenders are often willing to rework covenants to accommodate short-term trade-offs for long-term gains. Walker described a Next Coast portfolio company meeting in which “the lender kind of raised their hand and said, ‘Hey, why are we talking about constraints here? What does the business need? Isn’t the right decision to relax the covenants in the interest of pursuing that growth?’”

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