The debt market has changed massively over past decade. It’s now more fragmented than ever before and navigating this dynamic market is tricky.
Debt is cheaper than ever before. Rates have barely been above 1% for the past decade, but this does not reflect the longer term average. Prior to the 1980’s rates typically averaged around 5%, however, this increased dramatically during the 1980’s, coming back down over the following 20 years. The financial markets have also been through some significant changes during the past 20 year. So given current pricing, is this the best time to refinance your business? However, navigating a market that has become highly fragmented to find the best deal is not straight forward.
Following the financial crisis of 2008, the lending market principally consisted of the main High Street lenders; Barclays, HSBC, Lloyds Banking Group and RBS. In addition to these four, Santander and Clydesdale Bank entered the High Street banking market. Well over 50 other lenders have also entered the market, but rather than competing on price and leverage, they have sought to focus on specific markets and differentiated offerings.
According to the Bank of England over 20 challenger banks have been created since 2010. To be categorised as a bank, they need to offer retail deposits as well as lending. Challenger banks use new technology platforms and do not have the legacy property or technology platforms of the High Street banks. Brands such as Metro, Virgin Money, Starling and OakNorth are becoming more familiar.
Asset based lenders
Asset Based Lending (ABL) is common in the US and becoming increasingly common in the UK too. ABL’s lend against fixed and current assets, so it is well suited to businesses that are capital heavy, and many low margin businesses find they can borrow more when compared to cash flow loans. I have arranged ABL facilities for food processing and construction sectors clients as well as for high growth businesses, where the increase in working capital is soaking up the cash generated from profits.
Contrary to some out dated views of factoring, ABL facilities have become far more sophisticated and easier to use, offering facilities against most asset categories and some specialists will lend against assets that have previously been difficult to fund, such as contractor billing. Some also provide an additional cash flow lend.
Whilst some ABL’s such as PNC, Aldemore, Shawbrook and Bibby have established positions, many ABL’s will be unfamiliar to Finance Directors, such as Aurelius, Nucleus, White Oak and Secure Corporate Finance.
There is a vast array of other lenders ranging from direct lenders and asset managers to providers of unitranche and mezzanine finance. Examples include Five Arrows, Beechbrook, Crescent, Pemberton, Cererus, BlueBay and Ares. In a crowded market they can be segmented by size, structure and the lending situation.
The more equity-like in nature the more expensive the debt. The debt market has been competitive and we’ve seen some very attractive rates offered at senior debt levels. Whilst Growth Capital at 13%+ might seem expensive, it enables greater equity retention and thus cheaper than an equity investment in most situations.
Securing the right debt funding
With finances in many businesses becoming stretched as a result of COVID-19 and increased market uncertainty, getting the right debt package that is flexible will be key. The debt market has become a lot more complex, there is a vast array of providers offering different debt solutions. What they are looking for, and offering, is dynamic and varies frequently. Below we have outlined five steps to securing the right debt package:
1. Have a clear understanding of your funding need
It seems obvious, but having a clear understanding of your funding requirement is essential. We are frequently presented with gut feels which is subsequently found to be over or under estimated.
Your business plan and financial forecasts need to include full details of income and expenditure and capital requirements, both longer terms fixed asset investment and short term working capital. A base case forecast should represent what you believe will realistically happen, not an over estimated sales pitch, or over cautious view, these options can be run as sensitivities scenarios to check the impact on funding.
2. Consider the funding options
Having identified the funding requirement and causes, you can assess what funding solutions are best suited to the situation. Key to this initial assessment is:
- Historic and forecast cash generation and the business’s ability to meet debt repayments (capital and interest);
- Assets currently held, both fixed assets and working capital;
- Growth and the investment in assets required to achieve it;
- Seasonality and other variations in working capital cycles; and
- Managements’/shareholders’ appetite for debt and third party equity.
3. Testing the market
Given the number and diversity of lenders, there will be many options available. Approaching all lenders would be a time consuming and exhausting process. However, a focused approach to a handful would provide different options to choose from.
Ahead of approaching lender a business plan that includes detailed financial forecasts needs to be prepared. Whilst there are many lenders and good availability of cash, lenders will be more cautious in the current market and ensuring that there is a well-constructed business case is key. The plan needs to sell the opportunity and why you represent a great prospect for them.
Lenders like cash and assets, so the business plan needs to demonstrate an ability to do deliver either or both of these. If you need cash to fund losses or to develop intellectual property then an equity provider is most likely to be the best option.
No doubt many questions will follow with requests for further information. Make sure you have the time and resources to handle these efficiently. Raising capital can be a time consuming process.
4. Selecting your funder
After courting any number of lenders you need to decide which one is best suited to your business and it’s needs. The lenders will provide an indicative term sheet that will set out key information about the loan, including:
- Amount – for an ABL facility, the headline number might be much higher than your current needs;
- Structure – amortising term loan, non-amortising revolving credit facility, overdraft, stock loan, Confidential Invoice Discounting (CID) facility, letters of credit;
- Period – typically three to five years;
- Pricing – interest margin over base rate/LIBOR, annual/monitoring fees, advance fees; and
- Covenants – typically quarterly tests to report to the bank on, to check the business is on track. For more information you can watch our video on managing banking covenants.
There will be room to negotiate some of the above terms, but rather than trying to get the best deal, select a lender that you feel most comfortable with. This will be a long term relationship and it may not always be straight forward.
5. Securing funds
Prior to completing the deal the lender will want to undertake some due diligence on the business and your business plan. The complexity and length of this process will depend on the type of facility and size of lend. For example they may require an audit of your debtor book and credit processes, accountants to undertake a detailed review of your plan and forecasts, or may have their own analysis and questionnaire to complete. This process should be confirmatory, so be upfront with difficult/problematic areas and don’t leave them to the last minute.
The bank’s legal documentation will be long and complex. Invest in a lawyer that has good banking experience. They will ensure the funding is correctly documented and be able to explain matters that more complicated.
Given current challenges, it is likely that there will be wave of businesses that will be looking to raise additional funds or refinance. Making sure that your business is one that stands out will be key to securing your preferred choice. If you need support through this process please contact Phil Sharpe using the form below.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.
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