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516 - 551 - 5285 /
631 - 338 - 2438 |
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Facsimile: |
631 - 206- 9165 |
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| The first question that must be answered prior to obtaining funds from
another party is: Why do you need the money? There are many reasons why
companies
seek outside financing. This section covers the most common reasons.
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Growth Financing |
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The most common use of
financing is to fund a
company's growth. Many
companies reach a point
in their growth at which
they need outside
financing to expand so
as to meet their
potential. In such a
case, we assume that the
current owners of the
business are not seeking
to liquidate some or all
of their
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stake in the
business. Rather they are looking for financing to augment the cash flow of
the
company during a period of anticipated rapid growth. This growth can result
from
an expansion of the company's physical plant or through sales growth that
requires
additional working capital.
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Physical Expansion |
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Physical expansion can be the easiest form of growth for a company to
finance
through outside sources. The company is normally increasing its asset base
and
therefore its borrowing capacity. Expansion scenarios can be located on a
spectrum. At one end of the spectrum is the project in which all of the
costs are
associated with the purchase of fixed assets. The most obvious example is
the
purchase of a new vehicle used in the core business of the company. These
projects are good candidates for low-cost financing -- asset-backed senior
debt
being but one possibility. The rise of lease financing as a tool for
businesses
provides another low-cost, off-balance-sheet source of capital that in
certain
situations may enable the company to finance 100% of the cost of the asset.
Even
if lease financing is not available, the company may be able to use some of
its own
excess borrowing capacity to collateralize that portion.
At the other end of this spectrum are projects in which a substantial
portion of
proceeds will be spent on soft costs, generating little in the way of fixed
assets to
collateralize the loan. If the company has little or no debt on its books,
it may be
able to use its borrowing base to fund the soft costs. If the company has
borrowed
against those assets for its own purposes and additional asset based loans
are
unavailable, the companies must turn to junior capital (equity and/or
subordinated
debt.) to fill the gap.
Somewhere in the middle lie those situations in which the collateral values
are, too,
low to secure asset-backed financing for the entire transaction. That is to
say that
if historic cash flows of the business are sufficient or the likelihood
that
the
expansion effort will succeed are so great, a senior lender will make what
is termed
a cash flow loan. This loan, often structured with accelerated amortization
and a
cash flow sweep provision, is also referred to as an "air ball". The lender
holds his
or her breath for the period of time this loan is outstanding, hoping that
those cash
flows hold up and the loan is repaid. Cash flow loans are always more
expensive
than asset-backed, or secured loans, and are generally available from
larger, more
sophisticated banks and financial institutions.
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Working Capital for Growth |
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In some situations, a company can grow without purchasing additional assets
or expanding its physical
plant. Often this growth requires additional working capital to finance
inventory purchases and accounts
receivable that may grow faster than payables, thus putting the company in
a
tight cash position.
Provided this growth follows historic patterns and is built on business
relationships with customers
roughly similar to the company's current customer base, an existing
revolving line of credit can generally
be expanded to accommodate the new credit needs of the business.
In situations where the company is branching out into uncharted territory,
or is contemplating growth
that does not necessarily create a larger current asset base against which
to borrow, the company may
find itself in need of subordinated debt or equity. In those situations,
the
analysis the company will be
subject to is identical to situations where they require subordinated debt
and equity financing. The risks
of the business as it is, combined with the risks that the growth efforts
will fail, are weighed by a lender
or investor relying on continued cash flows and equity growth to realize an
appropriate return.
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Refinancing to Replace Restrictive Lenders |
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There are situations when a company is poised for growth and is held back
by
a reluctant financial
partner, most often but not exclusively a conservative bank unwilling to
bear the risks of growth. Banks
are often in the position of curbing growth if only because they generally
do not price their loans to
account for the risks associated with change. In some cases, the company
will require both additional
senior debt from the institution in question, as well as, junior capital
which will complicate the
company's balance sheet and introduce a new party into the lending
relationship, In the event that such a
situation may occur, the bank may elect to exit the loan.
The most important insight an entrepreneur can take into a refinancing
situation is that the same amount
of senior debt can look very different depending on the other elements of
the balance sheet, even
without any changes in the company's base business.
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Acquisition Financing |
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The opportunity to complete a strategic acquisition is one of the best ways
to enhance the value of a
company, since an acquisition may enable you to leap frog competitors, open
new markets, develop
new product lines, etc. However, a poorly executed acquisition can weaken a
company's balance sheet
and distract key management without providing the anticipated value.
All acquisitions have unique characteristics and, therefore, unique
financing requirements. Much
depends on the company being acquired (the "target") and the acquirer's
strategy. Below we have
highlighted the three basic types of financing and their respective pros
and
cons. Depending on the
financial health of both the target and the acquirer, the financial
structure can be any combination of (I)
debt, (II) equity and (III) the acquirer's stock. Three primary issues to
address when structuring the
acquisition are:
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the amount of debt which should be raised |
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creating a capital structure that is appropriate for the combined Company's future |
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the cost of funds |
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Debt Financing |
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Debt is the cheapest method of financing an acquisition bid and can take
many forms. The amount of
debt that can finance an acquisition depends on the projected cash flows of
the combined company.
This will depend on the financial health of both the target and the
acquirer.
If your company is interested in a leveraged buyout, it may be able to
finance all or most of the
purchase price with debt. Under this structure, the assets and cash flows
of
the target collateralize the
debt. This transaction is very similar to a home mortgage, in which the
underlying asset backs the loan.
Banks usually provide the cheapest and most common form of debt: senior
debt. However, there are
many other providers of senior debt who employ different methodologies for
structuring loans.
Subordinated debt lenders are more aggressive in the amount of debt they
provide. Accordingly, these
lenders charge higher interest rates and often require a piece of the
equity
of the combined company.
While debt is cheaper than equity, the interest and amortization
requirements as well as possible
financial covenants can limit a company's flexibility. Large amounts of
debt
are more appropriate for
mature companies with stable cash flows which will not require much capital
for growth. Companies
that foresee rapid growth, require substantial capital expenditures and
compete in turbulent markets are
often better off financing acquisitions with more equity than debt.
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Equity Financing |
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Equity is a more expensive form of capital than debt. This is because it
carries the most risk since it has
no claim to the company's assets. Acquisitions that have unstable cash
flows
require capital for growth
and compete in turbulent industries often require a greater amount of
equity. Equity provides more
financial flexibility because it does not require scheduled payments.
Financing an acquisition with equity requires relinquishing some amount of
ownership in the combined
company. The equity investors will often assume some amount of
representation on the Board of
Directors. Equity investors can take the form of leveraged buyout funds,
venture capital funds or
corporations.
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Turnarounds |
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Turnaround financing involves providing capital to companies that are
performing poorly but that are
expected to turn around and perform much better in the future. Often this
kind of financing occurs in
the context of a transaction or purchase of the company by a new owner and
often a new management
team is hired at the same time. Turnaround financing can include senior
debt, subordinated debt and
equity.
There are very few sources of turnaround financing. Turnarounds involve
companies that for one
reason or another (or a combination of reasons, more often) have fallen on
hard times. Someone sees
value in the business beyond what is obvious from the current and recent
performance and takes on the
challenge of turning the business around. These opportunities are fraught
with risk; typically, if the
company continues on its present course, it will not be able to remain a
going concern. This is all the
more true if the transaction that starts the turnaround involves debt
financing. Against that backdrop -
that the current state of affairs will lead to disaster - are the twin
challenges of
(a) accurately diagnosing
what is wrong with the business and
(b) quickly developing and implementing
a turnaround plan that
addresses those problems.
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Management Buyouts |
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Managers often team up with private equity investors to purchase businesses
or subsidiaries, divisions or
product lines of corporations, using a combination of debt and equity
financing. This is one of the most
powerful methods for enriching the entrepreneurial spirit of professional
managers.
Management buyouts represent the opportunity of a lifetime. After playing a
critical role in building their
company, managers often consider buying their company as the natural next
step in the progression of
the company's ownership. For most managers, a company buyout is the
fulfillment of their dreams.
However, successfully pursuing and implementing a management buyout is one
of the most difficult
jobs a manager will ever tackle.
Managers are experts at running their companies, but most managers have
little experience making an
acquisition. Management buyouts generally occur in a short time frame and
require substantial and
multiple sources of capital, as well as, legal, accounting, environmental
and other professional support.
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Employee Buyouts |
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Employee buyouts are one of the most fascinating developments in the world
of corporate finance.
They had their beginnings in the early 1970s after Employee Stock Ownership
Plan (ESOP) regulations
were codified in the law as part of the ERISA legislation in 1974. An
employee buyout involves owners
of a company selling a majority of their stock to its employees through an
ESOP structured corporate
transaction.
Employee buyouts can turn around failing companies, increase the cash flows
of good companies,
motivate employees to outperform their competition, reduce or eliminate
corporate taxes for years, and
provide a tax-advantaged investment for employees. In the highest of
capitalist traditions, employee
buyouts can also transfer wealth in a free market transaction to the
employees who have spent their
careers building the company.
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ESOP Financing |
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Countless studies have shown that employee ownership motivates employees to
improve their
productivity, the quality of their work and the competitiveness of their
company. ESOP financing
provides a whole series of benefits to the owners of a company, to the
company itself and to the
employees.
Leveraged ESOP financing can allow an owner to sell all or a portion of his
or her stock to the
employees and indefinitely defer capital gains taxes. This has the added
impact of reducing the
company's taxes while it provides employees with tax sheltered ownership of
the company's stock.
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Internet Financing |
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Every company that deploys a product or service through a large and
expensive distribution system will
be confronted over the next ten years with a major distribution dilemma.
Should the company continue
to market through its existing distribution system or should it
dramatically
reduce costs by turning
instead to the Internet to distribute and market its product or service? A
direct market distribution
strategy will require significant investment in expertise, structures and
systems that many executives
today cannot fathom. Additional funding may be required to make the
business
transition.
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Recapitalizations |
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There are many situations in which a company may need to be recapitalized.
As the word implies, a
recapitalization involves an infusion of capital and, potentially, certain
parties taking money out of the
company. This occurs when a shareholder sells his or her stake in the
company or when existing debt
providers are being replaced. In any recapitalization, the company must
perform many of the same tasks
as it would have in an acquisition or buyout.
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Rollups |
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A rollup is a strategy of buying several companies at once, or in rapid
succession, in one industry to gain
a variety of corporate benefits, such as economies of scale, broader
product
line, cheaper financing,
greater diversity of customer base, etc. Rollups are very complicated
transactions that should be
implemented by a highly experienced team of professionals. Experienced
sources of capital are critical to
implement a rollup on the timetable necessary to achieve success. However,
rollups can be considered
to consist of a number of the above discussed transactions (or combinations
thereof) executed within a
narrow time horizon.
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