Credit has 5 C’s. Deal Making has 6.

Where Deals Are Made (courtesy of: Pexels.com)

When you look back, at deals that were made and blew up spectacularly, we often find ourselves asking “how on earth could they have thought that was going to be a good idea?”.

It’s easy to say this when we look back - hindsight is always in perfect vision - but in the moment, at the deal table, everything likely looked great. A good investment sponsor, solid cash flows, favorable market conditions.

But it still imploded.

The deal didn’t lack good numbers. It likely didn’t lack strong analysis. Models upon models, numbers upon numbers.

What it did lack was Commerciality, or just simple common sense.

It's in the Numbers Bro

I won’t go through a full recap of the 5 C’s of credit - you’ve all been exposed to it in the past; as a quick refresher the 5 C’s of credit are: Character, Capacity, Capital, Collateral, Conditions.

These 5 C’s are extremely important, they were developed and refined for a reason. A potential investment that does not meet the 5 C’s should be questioned thoroughly or potentially turned down.

However the problem with the 5 C’s is that they have become more of a tick-box exercise: able to process 100’s of loan applications, standardize decision metrics and be easily taught to the myriad of new hires that will inevitably pass through the banks office corridors.

But tick-box thinking gives way to a robotic style of decision making, and eventually loses the art and skill behind real deal making.

Commerciality is not a checklist. It’s the application of judgement. This makes it much harder to teach and learn, but is unquestionably the more important element. Commerciality is not judged by the fact that there may be one extremely strong element (or C) present in the deal, it’s actually about how all of these elements work together.

A deal may have an investment sponsor with a great reputation: decades of success, and good choices. But the remainder of the deal only shows average metrics. Commerciality would put the entire deal into question. But tick-box thinking may lead to a situation where the reputation of the sponsor precedes all other elements.

Here are two examples that show how a lack of Commerciality led to the collapse of what looked like really promising investments.

(1) Greensill Capital (2021): Greensill was considered a FinTech darling company based in the UK, focused on providing supply chain finance to small and medium businesses. The firm had secured USD 1.5 Billion financing from SoftBank’s Vision Fund in 2019, which valued the company at USD 3.5 Billion. But 18 months later filed for bankruptcy.

There were several reasons for the collapse of Greensill, but one of the more alarming reasons found was that the company had concentrated more than half of its entire loan book to a single client: The Gupta Family Group. The German Financial Authority, BaFin, had issued a notice to Bremen-based Greensill bank to reduce its exposure to its single largest client, to which the founder is quoted as saying …”was going to be impossible for us to comply with.” [1][2][3]

(2) Toys R Us (2005): Im sure this transaction needs no real introduction; KKR, Bain Capital and Tornado to the retail giant private in a USD 6.6 Billion transaction, which was majority financed by debt (USD 5.3 Billion of debt). The interest bill alone was estimated at around USD 400 Million a year. Toys R Us was still a great company, it was still profitable. But it was facing increased competition from growing players like Amazon.com and Walmart. In the end, with its capital stack made up 80% of debt, sales softening and the competitive landscape changing fast, the company had almost zero safety buffer to get it through this period. Put another way: the deal worked, but only if nothing ever went wrong.Strategies for Effective Transaction Structuring.[1][2][3]

There are countless more examples, and even ones I see daily (but cannot talk about for obvious reasons).

What we learn from this is that a lack of Commercial thinking isn’t reserved for small firms only, it can exist in firms whose own reputations precede them.

The 5 C’s are a fantastic set of parameters on which to collect and scrutinize data, but they are inevitably static; based on data that has already occurred. Commerciality is forward looking; it requires creative thinking and perhaps even inferred thinking.

It's not only about asking "Whats in it for me?", but more often than not its about asking "Whats in it for them?".

Experience is the only true teacher.

However, the people behind the examples Ive brought forward, were by no means idiots. In those deal rooms sat some of the smartest people in finance - perhaps, wizards even. But there is a very real gap between being able to build the financial models - run mathematical equations, the quantitative analysis, all the checklists - and being able to determine if the entirety of the models are capturing the whole picture.

Popular and modern finance qualifications are rigorous, and teach in-depth the technical skills to work in finance. But Commerciality is not a syllabus that can be learned in books or courses.

It has to be learned through exposure.

The graduate that has only ever seen a deal on a spreadsheet has a limited reference point for what a Commercial deal looks like in the real world. The person who has sat in the credit committees, worked through restructurings or had to deal with a “watertight” covenant go bad, inevitably has something that no qualification can give: a mental library of what generally goes wrong and why.

This is also why the tick-box mentality we discussed earlier is so persistent. It isn't laziness; it's what the system is built to produce. Finance education, by necessity, optimizes for what can be taught at scale and tested reliably: frameworks, checklists, the 5 C's.

None of this means formal training is wasted, or that experience alone is sufficient without it. The 5 C's still matter — they're the vocabulary. But vocabulary isn't judgment, and no amount of additional technical training substitutes for the thing that actually builds commerciality: time spent close to deals that didn't go the way the model said they would.

But not everyone is lucky enough to be sitting at the deal table. So what can you do?

If the deal room is truly where you want to be, shadow, at every opportunity. Whether this be interning in the summer, or spending your lunch break shadowing credit committee presentations, or working with some of the deal makers in your firm; the more exposure you can get the better.

Additionally, use resources like deal autopsies, and learn where the blind spots were.

In parting: technical skills is always going to be extremely important, but it’s important to understand that critical thinking and experienced judgement are the real key ingredients in determining a good deal from a bad egg.