THERE ARE EFFECTIVE WAYS TO ENHANCE YOUR FINANCIAL FLEXIBILITY OR RESTRUCTURE A FEW TERMS OF YOUR EXISTING AGREEMENTS TO INCREASE YOUR CASH AVAILABILITY, AND THAT COULD BE JUST THE TICKET YOU NEED.
For example, if your receivables aren’t turning fast enough, you might find that you are not able to capitalize on opportunities for expansion because cash flow is pinched. The climate for middle market financing has become one that is extremely advantageous to the borrower since an abundance of lenders are competing vigorously for new business. We know these lenders and are experts in working with them to achieve the best results for our clients.
In deciding which type of debt financing is most advantageous to you, it’s helpful to understand the different types of financing structures and their basic definitions.
CASH FLOW LOANS:
These loans are underwritten based on expected cash flows. A lender generally has a senior security position covering all the assets of the borrower. However, there is very little underwriting emphasis on the collateral value of the assets securing these loans. Instead they are based on the maintenance of financial covenants on an ongoing basis. These covenants include stipulations such as minimum EBITDA requirements, leverage
restrictions and fixed charge coverage ratios. These types of loans are not generally well-suited for lower middle market and small companies due to the ongoing challenges that many smaller companies face in meeting the covenants due to more erratic operating results as these entities move up the growth curve.
ASSET-BASED LOANS (ABL):
When it’s difficult for companies to meet the covenant requirements of cash flow loans, ABL loans can be more appealing and unlock funding based upon the value of accounts receivable and inventory. Covenants for these loans are typically limited to maintaining a minimum level of borrowing availability. These loans are secured by collateral representing all the assets of the borrower. Assets include inventory, accounts receivables, property, plant & equipment. These loans typically require frequent reporting on the composition of assets securing the loan in the form of a borrowing base calculation, which monitors collateral levels and borrowing availability.
This form of debt is generally unsecured, ranks behind every other debt provider in a company’s capital structure and is only ahead of equity capital when determining the order of a borrower’s repayment obligations. It’s generally used to finance the expansion of a company during a significant period of growth. Subordinated debt can incorporate a mix of debt and equity financing and gives senior lenders comfort that there are investors that rank below them in a company’s capital structure. This form of debt is generally the most expensive type of borrowing and can result in the dilution of existing equity investors if there is an equity component in the transaction and specific milestones are achieved by the company during the term of the loan, such as revenue growth and profitability measures, or conversely, in the event of a loan default.
SECOND LIEN LOANS:
These loans are a form of secured financing where the lender holds a secondary security position in the collateral of a senior lender who maintains a first security position in all the assets of a borrower. There is still an expectation of timely repayment, however, in the case of default, the security position of a second
lien lender ranks behind the senior lender’s interest in the collateral. Their right to enforce against the collateral is often restricted by an inter-creditor agreement. These loans are generally offered by finance companies desiring higher yields with some perceived level of protection from the collateral. These loans are more expensive than senior secured loans, although, due to the security provided by the second lien, they tend to have a lower cost than subordinated debt or equity financing.
There are other forms of financing for middle market companies in addition to the structures described above, including equipment leasing, project finance, factoring, and purchase order financing.
In order to best evaluate the needs of your company given your current financial condition and projected operating plans, it’s prudent to consult with an expert in these matters that has YOUR best interests in mind.
Consider scheduling a complimentary consultation with one of our debt advisory professionals at Hardesty, where we specialize in evaluating your debt financing needs and finding the right funding solution for your company.