Banks vs Private Credit for GovCons
Tony Gray and Matthew Gillman compare banks and private credit on what actually decides which one fits: cost measured in dollars rather than rate, speed of approval, how each treats growth, fees, and whether the lender knows your industry.
Why does every government contractor need a bank?
Tony Gray: To win prime contracts you register in SAM.gov, and it asks for three things: a company registered with a state, with its legal name, date and state of incorporation; a taxpayer identification number from the IRS; and bank account details for electronic funds transfer. Whatever you decide about financing, you need a bank account.
What are the other names for banks and private credit?
Tony Gray: A bank may be called a depository lender, a deposit-funded lender, a traditional lender, a regulated depository institution, or a commercial or retail bank. Private credit may be called a non-bank or non-depository lender, an institutionally funded lender, an alternative lender, a private credit fund or a direct lender. Do not let the terms confuse you.
Why does private credit cost more than a bank?
Tony Gray: A bank is typically your lowest cost of capital. Private credit offers more flexibility and faster speed, and you pay a somewhat higher rate for both.
Matthew Gillman: Think about your own business. A staffing company earns a margin on people. Private credit is the same, except the inventory is money. A bank has the lowest cost of goods. A private credit lender like us borrows from a bank, marks that money up, and has to earn the difference with service, creativity, flexibility and speed.
Tony Gray: In GovCon terms, the private credit lender is the prime and the bank is the sub, with a pass-through rate on top.
Is a bank always cheaper than private credit?
Tony Gray: Not always. Smaller SBA loans are seen as riskier, so the bank adds a larger spread over the prime rate, and that can push the rate up to or above what some private credit providers charge.
How should I compare the cost of a bank line and private credit?
Matthew Gillman: Turn the rate into dollars. Say a private credit line costs four percentage points more than a bank line. On $200,000 drawn for a year, that difference is $8,000. That is real money, and on an identical offer there would be no reason to choose the alternative lender. So the alternative lender has to offer something the bank does not.
If the bank offers $200,000 and the alternative lender offers $500,000, the question becomes whether the extra capital lets you win, say, an extra $2 million of revenue at a 35% margin. Look past the cost of capital to the opportunity cost of not being properly capitalized.
Is subcontracting work cheaper than financing it?
Tony Gray: It is the same choice a prime makes: perform alone, or bring on partners and grow faster.
Matthew Gillman: People are trained to look at the cost of funds. But a contractor who subs out 50% of the work to avoid carrying payroll might make half the margin on it. Subcontractors on net 30 or net 45 terms carry the payroll expense, and you pay for that in margin. Add it up, and a couple of extra points of interest to take the work in house can earn you far more.
How fast does a bank approve a loan compared with private credit?
Tony Gray: There is no hard and fast rule, but a bank generally takes about four to six weeks, and the bigger the bank, the slower. The banker is the front end; credit analysts and underwriters sit in separate departments by design. Private credit is generally faster.
Matthew Gillman: Banks offer a great product for the right company at the right time. If you want to move fast on a steep growth trajectory, you need less bureaucracy and direct access to the decision makers. And banks make money many different ways. A non-bank lender makes money only by putting capital to work, so providing capital is the lifeblood of the business.
Tony Gray: You still need a bank, for deposits, treasury management and wires. It is not one or the other. It is one and the other.
Why won’t a bank fund fast growth?
Matthew Gillman: A bank wants to see that your history supports the line you want. That is great for a stable company growing 5% a year. But in government contracting you can go from zero to a hundred very fast: your history shows zero and your future shows a hundred. The answer to that is not a bank line. It is a lender who understands government and can look at what you will bill in the coming months.
Tony Gray: Banks look backward; private credit can look forward. Some banks even treat rapid growth as a risk factor.
Matthew Gillman: And it is one. Companies do not only go out of business, they grow out of business. They take on too much work without the non-billable people to support invoicing, HR and operations. So we look at whether the company can perform, and when it can, we help fuel the growth. Many banks will just say it does not fit their box.
What fees should I expect from a bank versus private credit?
Matthew Gillman: Size plays a big role. The biggest difference is usually the one-time legal expense to close. We have no legal expense; our documents are already in form. Many banks use boilerplate documents up to a certain size, and above it legal gets involved and you pay both the bank’s legal costs and your own. With a bank you also usually have more ongoing statement and transaction fees, but the upfront fees make the bigger difference.
Tony Gray: Ask every lender for its full list of fees up front.
Why does industry expertise matter in a lender?
Matthew Gillman: Start with people who know your industry. When a lender has to learn your business before it can solve for it, the relationship is harder for both sides. Some banks have specialty government divisions and know the business well; the question is whether you are the right size for them. We consider a small government contractor to be $1 million to $20 million in revenue. Many banks consider small to be $25 million to $100 million.
Ask your banker whether they have other customers like you. A lender that only dabbles in an industry can decide to leave it, and when the one person with the expertise leaves, the expertise goes too. You can tell real expertise by the questions they ask you.
Tony Gray: Ask whether the government contracting team includes people with operating experience at contractors, not just lending experience.
What should I ask a lender about the future?
Matthew Gillman: Ask about the future, not just today. If a bank gives you a $100,000 signature line, that might solve today. Ask whether they have a group that does $500,000, $1 million, $2 million and $5 million lines, so you can graduate within the bank instead of having to leave it.
Read more on this
- Government contractor loans, compared
- National banks with government contracting teams
- Contract line of credit
This is an edited version of the conversation: spoken repetition is removed and each answer leads with its point. Every figure and example is as said in the episode. For financing specific to your business, talk to us.
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