Trends Watch: Investing in Small Business Loans

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.   

This week, Elana talks with Karl Douglas, Chief Investment Strategist, Covenant Venture Capital.  

What is your outlook for investing in small business loans? 

The outlook for investing in small business loans remains highly compelling. The recent high-interest rate environment and tighter credit conditions have significantly reduced the number of lending options, driving up the risk premium for the small business private credit (SBPC) asset class and delivering higher returns for investors. However, there are important considerations: Investors should target recession-resistant sectors, and SBPC loan portfolios must be highly diversified, with no more than 1% to 2% exposure to any single borrower. 

Where do you see the greatest opportunities and why? 

The most dynamic sector in private credit is short-term private business loans with maturities under one year. This segment delivers net yields and Sharpe ratios that far surpass other private credit classes, largely due to its status as an underserved area within the market. 

What are the greatest challenges you face and why? 

While the net yield in SBPC is highly attractive from a performance standpoint, underwriting costs can become inefficient without economies of scale. Underwriting SBPC loans demands the same level of diligence as middle-market private credit, involving three-to-five-year term loans ranging from $10 million to over $100 million. This cost structure can significantly erode the superior net yield that SBPC offers. To mitigate this, we participate in a loan syndicate to manage and control costs effectively. 

What keeps you up at night? 

In the post-COVID environment, we remain acutely aware of the potential for unforeseen 'black swan' events. One of the key advantages of investing in small business private credit is the access to highly granular business data, which serves as an early indicator, enabling us to detect shifts in economic conditions with heightened sensitivity. 

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.