July 8, 2014 by Mark Borkowski
July 8, 2014 – In the business of investment banking, there are all kinds of difficult situations that business owners can face. Sometimes a client’s need for financing is driven by an unexpected business or sector slowdown; other times it is for acquisition or growth purposes. But more often than you might think, a need for capital will arise as a result of a breakdown of existing credit facilities through no real fault of the borrower.
I spoke to one of my colleagues in the financing arena — Barry O’Neill with Zed Financial Partners — and he had this advice to share: “Some of the most disheartening circumstances we’ve seen have involved management becoming blindsided by their traditional financial partners. A business owner can have a long-standing relationship (along with shining credit rating and excellent margins) with a traditional lender and still find their loan called, or ‘no-brainer’ requests for further capital declined. Changing market conditions, concerns around exposure to industry sectors and risk management strategies can change a traditional lender’s interest in a client, and the effects can be devastating.”
But there are steps that business owners can take to go on the offensive and secure the liquidity they need to grow outside of traditional financing sources. Business owners and managers must learn to become as creative and versed in options for financing their businesses as they are in other facets of operations.
Sometimes it is a matter of looking for another financial institution that better understands the business. Other times it requires re-examining the assets of a company from a different perspective. Alternative or non-traditional financing options can help to facilitate and allow for the execution of business plans.
Often, access to the appropriate financing may solve liquidity problems or even present hidden and creative opportunities for freeing up cash flow. Several unique structures may be employed to ensure a successful transaction and to maximize the availability of funds. Knowing where to find the different types of financing is crucial.
O’Neill suggested some options.
THE U.S. OPTION: An increasingly viable option for Canadian businesses is U.S. private equity and private debt lenders. In Canada, there are a limited number of such sources of capital available, but in the United States, there are hundreds of different institutions that are actively seeking opportunities in Canada. Because of the vast amounts of money available south of the border and a limited number of transactions, many of these financial institutions are looking for opportunities outside the United States.
Because of the size and specialization of the U.S. financing market, there are numerous funds that specialize in specific industries. Understanding industries allows them to better assess the risks and rewards associated with the financing, resulting in a better financial partner. As a result, there is growing demand for more creative financial structuring to solve liquidity issues. Companies seeking U.S. funding should work with financiers who understand the industry sector and business, so they can work with the company as it changes and grows.
Regardless of whether the source of capital is domestic or foreign, the key to securing capital is presenting value where others don’t, and then translating that value into a workable solution for a lender. There are many ways to put financing together. It’s a matter of being creative and knowing where the money is. Some examples of different vehicles for creative financing through non-traditional sources include:
EQUITY OR QUASI-EQUITY PARTNERS: A well-suited, strategic financial partner who understands the business and industry can provide the appropriate financial structure to take the company forward. These partners typically bring cash injections to relieve immediate problems and supply sufficient liquidity to take the company forward, and often times are critical to the future viability of a company. Private equity partners can be important tools in situations where owners want to retire or semi-retire and transition the company to family or a management group, but wish to extract some wealth from the business.
REFINANCING OF SUBORDINATED DEBT: Subordinated debt may need to be restructured or refinanced to alleviate liquidity concerns. Strategies for accomplishing this objective include: purchasing the debt at a discount; converting debt to equity; exchanging the debt for future royalty payments tied to revenue or cash flow; moving the debt off-balance sheet.
CASH FLOW MANAGEMENT: In many cases, there is significant capital being tied up in working capital. Various operational specialists can help to assess cash flow restrictions and assist companies to unlock liquidity by putting in proper controls and systems.
SECURING FUTURE CASH FLOW STREAMS: Cash flow streams that are associated with long-term contracts and a high degree of certainty may be sold to a third party.
SALE LEASEBACK: Land and/or buildings can be sold to certain lenders at market value or greater using long-term sale leaseback agreements. In this case, the financier relies on the company’s business plan and future cash flows to support future payments.
REFINANCING “DEPRECIATED” ASSETS: Specific machinery and equipment within a company may have little or no collateral value to traditional lenders. Other lenders, such as appraisal or auction companies, may attach value to these assets that allow other financiers to loan against them regardless of whether they have been fully depreciated.
INTANGIBLE ASSETS: Many companies find that intangible assets (i.e., patents and trademarks) carry little or no collateral value to traditional lenders. However, some non-traditional lenders will lend against such assets. In fact, there are firms that will attach a value to intangible assets and guarantee that value to lenders.
TAX STRUCTURES: Off-balance sheet structures may generate additional liquidity. For example, intellectual property may be sold into a separate company, which reverts back to the parent company after a period of time.
The bottom line
One of the most important advantages in maximizing a company’s access to capital is finding the most beneficial source of capital from the most ideal financial partner.
In many cases for Canadian businesses, banks and traditional sources of funding are the ideal financial partners. The convenience and the efficiency of the commercial branch suits most situations effectively, and commercial bankers work hard to service their clients. However, for businesses in periods of transition, whether caused by distress, explosive growth or the potential for a change in ownership, the traditional lenders can be impediments and obstacles. There are numerous other options available to Canadian businesses. With a little research, business owners and managers can unlock a realm of new possibilities to suit their situation and best serve their needs.
There are countless ways to improve business liquidity, and it makes sense to review options regularly before additional liquidity is necessary. With the many creative alternative options for financing one’s business, sometimes a “no” from your traditional lender results in a better financial partner.
Mark Borkowski is president of Mercantile Mergers & Acquisitions Corporation.