Barf: “I’m a mog: half man, half dog. I’m my own best friend! “– quote from Mel Brooks Spaceballs :The Movie
I continue to experience some confusion by owners as to the nature of their financing agreements. When I ask what form of financing they have, I get responses which remind me of this line by Barf. I realize it can be complex and bankers, lawyers and even accountants seem to revel in throwing around terms like springing liens, clean up period and covenants and I am sure for most owners, this just serves to make their hair hurt. They wonder if their advisors and bankers are talking about some strange animal, their son’s bedroom (which never has a cleanup – period) or the Old Testament. So, let’s spend a few minutes describing three basic types of financing. By design, I am leaving out equity and more complex instruments like commercial paper, subordinated notes and convertible debt in an attempt to keep the suicide rate down. Let’s stick to basic loans from financing (legitimate) sources.
The first is a cash flow loan sometimes called an unsecured loan. The banker or financing source looks to historical and projected cash flows and determines the amount they will lend, the period of the agreement and how and when they will get paid back. This is true borrowing off the cash flow of the business and usually has the most favorable rate. While personal guarantees are less prevalent now, they come and go based upon the overall economy. These loans also usually have covenants – financial benchmarks you will need to meet to prove you are still worthy of this type of loan. This loan is the most common instrument for providing working capital to a profitable business.
Next is a secured loan. It is modeled similar to a cash flow loan but you may not be as credit worthy so the financial institution will take a security interest in (put a lien on) your assets – principally receivables, inventory and fixed assets. Many of the concepts under cash flow loans apply here and the rate is usually a bit higher.
Finally, there are asset based loans or ABL’s. This type of loan is for those struggling a bit where the financing source wants to monitor the overall level of debt. It is also a secured loan as the security interest is present but it is more formulaic – the company prepares a periodic borrowing base certificate containing eligible assets and negotiates a formula – usually a certain percent on receivables and inventory with exclusions for aging, concentration and foreign accounts. The result is the amount of borrowings the financial institution will allow. As you can tell, it is a bit more complex but it does force a discipline which keeps your borrowings within a range your assets can support. This type of financing can be costly as it limits overall availability and there are a number of fees (in addition to a higher interest rate) to cover. I would not suggest getting into this type of arrangement without some internal or external qualified financial personnel. Dealing with an ABL can be a bit overwhelming.
While every loan does not fall directly into one of these categories the vast majority do, so as an owner, an awareness of the basics should make you more knowledgeable as to your alternatives and also provide you (based upon the type of loan you obtain) with a view as to how the outside financing world perceives your business.
“Patience hell; let’s kill something” – quote from famous image of two hungry vultures
At times, I think we live to repeat history over and over again. Unfortunately, many of us only see with hindsight and not what is happening in the present. How many of us today look back to the 2007 – 2008 time and admit that we should have taken all of our money and invested in stocks (remember GE at $7) and been part of the remarkable gains since then? As usual, we realize it now when the best is perhaps behind us.
Many discussions I have with clients and prospects these days have a slightly different spin… “Had I only pulled the trigger and acquired that target – I would be so much better off today.” Well, I have news for you – I think there is still a chance to do a successful deal. Here is my gut reaction as to why.
First, I don’t know about you but if I have another conversation about the “new normal” I think I am going to vomit. It is tough to take anemic growth rates that are so low, an extra workday this month versus the same month last year accounts for all of your growth. How painful is it trying to assess progress that is so small, the tools we have can’t even measure it? What about being congratulated because your break even results are an improvement over past performance? All of this is wearing on the patience of many entrepreneurs and this pent up frustration is leading them to think like these two vultures.
There is no doubt that your competitor or that target is probably sensing the same malaise. And, while there is a good chance that the cost to acquire them may be higher than it was a few years ago, back then most felt their financial performance was at an all-time low so there was no motivation to even consider a transaction. Well, most are now through that soft period and many are singing the famous Peggy Lee song “is that all there is?” This, my good friends, can lead to the motivation to do something or what we refer to as a burning platform.
There is also a major factor working in your favor… the lending environment. Interest rates have never been lower, the cash available at banks and investment funds are at record levels and with such strong competition for good deals, terms are as “borrower friendly” as we have seen for a long time. We are seeing transactions close in reasonable time frames and robust activity is being reported especially in the lower end of the middle market.
So, if expansion and growth are in your strategic plan and you find yourself wondering if the time is right, I would encourage you to go after that deal and execute the transaction that will take your company to the next level. And, please remember to get the right professionals to help along the way.
Quote: from High Anxiety by Mel Brooks (my favorite)
Brophy: I got it, I got it, I got it [thump]
Brophy: I ain’t got it.
Sometimes, when I talk to entrepreneurs about their “plan” to sell their business, I begin to think of this scene from High Anxiety. They start with some high-level thoughts as to how they will complete the sale only to drop the ball when you ask the first question about execution. Most soon realize, like everything else in the world, this is a process. In fact, we have been through it so many times that we have a registered mark for it called TransactReady®. The purpose of this blog is not to take you through the entire process, but to focus on some preliminary thoughts to help you get started.
One major assumption we will make is that there is no one to leave the business to (so, a succession plan is not an option) and you have decided to sell (if not, see my blog “Am I Ready to Sell My Business?”) So, here are some focus points for the entrepreneur:
- Know what your business is worth – Get a solid understanding of what the business is worth. Next to seller’s remorse, an unrealistic expectation as to value is a second major reason why a sale of a business fails. Use brokers and other professionals to help you gauge what you should expect. It is rare that someone comes along and offers a price substantially above what the professionals think is fair.
- Do a SWOT analysis – Do a thorough assessment of your strengths, weaknesses, opportunities and threats. Big checks for your company are usually accompanied by significant due diligence, so it is best to know where you stand (warts and all) before a potential purchaser does.
- Make sure you will realize enough from the deal to meet your needs – Engage a professional to assess those needs. While you may think you know what it takes to maintain your current lifestyle, an objective view by an accountant or a financial adviser can be eye opening when it comes to making sure that your financial objectives will be met.
- Understand how you want your business to look after the deal. – We often hear an entrepreneur say they want to sell all (or a good part) of their business, get a good price and stay in control. Our standard response to this is “you probably can stop looking; you are not ready to sell.” However, that is not to say that you may not have options depending on your strong preferences. If you want to keep your management intact, you probably want to consider a sale to a financial sponsor, including management or funding a sale yourself. If maximizing sales proceeds is your preference, then sale to a strategic buyer may be the best route.
- Think long and hard before doing this yourself. – Unless you have been through this process before, doing it yourself is not for the faint of heart. You probably would not sell your home or building without a professional broker, so why choose that route for perhaps the transaction of your lifetime?
There are plenty of very qualified professionals to help you through this process. You can still control it but trust me, you do not want to do it on your own. Get the right help and you will not be sorry.