Special Series: Securing Equity Capital

November 26th, 2013 by DWM Magazine

Most door and window dealers are not large enough to secure equity capital from traditional channels, such as private equity funds, family offices or pension funds, says Michael Collins, partner, Building Industry Advisors. There are, however, often overlooked sources of equity available to smaller businesses. In the next few weeks, DWM will explore with Collins the opportunities available and ways to secure capital.

First, Collins says companies may look to friends, family and business associates; non-competing companies engaged in the industry (suppliers); local high net-worth individuals (beware of lookers with no intention of making an investment); and successful business owners in allied professions, such as home building and real estate development.

Collins explains the benefits of a merger of two companies. “A true merger is similar to an acquisition in certain ways,” he says. “It provides a platform for two companies to operate together. It also affords the merged companies opportunities for selling synergies and cost reduction synergies.”

In a typical merger, companies exchange stock with one another, creating a single merged company, he adds. If structured properly, this transaction will be tax-free. “Mergers probably work best when one owner is ready to step back from the business,” he says. “The ideal merger of a door and window dealer would be between two companies with contiguous, but not overlapping, territories.”

Another way to secure capital is through placement of senior debt. Collins offers the following advice in this area:

—Cash flow-based loans are difficult to secure.

—For most building products companies, asset-based loans (ABLs) are more likely.

—Typical advance rates vary by asset type, such as accounts receivable 75-85 percent, and inventory and finished goods 50 percent.

—The typical maximum amount of senior debt leverage in the current market is 3.0X EBITDA.

—Typical pricing right now is LIBOR + 2-4 percent, depending on size and credit quality.

Requirements of Asset Based Loans (ABLs)

—ABLs typically feature less financial performance or other covenants than cash flow loans. “Lenders are expecting to be made whole by the value of assets if the loan defaults,” says Collins.

—Cheapest rates are available to companies that are profitable. “Certain aggressive lenders will loan even into troubled companies if the asset coverage is seen as sufficient,” he says.

—Cash flow usually must be two times fixed charges.

—Customer deposits must be sent to a lockbox that defrays the balance of the loan. “Customers access additional needed capital as often as daily as the loan balance fluctuates,” says Collins.

Small Business Administration (SBA) Loans

—Banks, savings and loans, credit unions and other specialized lenders participate in the SBA program. “Full or partial government backing on the loan encourages lenders to loan to small businesses,” says Collins.

—The 7(a) program is the most common small-business loan.

—Another important program created is the Small Business Investment Company (SBIC). “These groups may look like private equity funds,” says Collins. “They typically bolster their own capital with low-cost federal funding, allowing them to invest in small companies. At year-end 2012, the government had extended $1.9 billion in capital to SBICs. The government shutdowns may interfere with the processing of such capital placements.”

Real Estate Sale-Leaseback

—A sale-leaseback is completed through the simultaneous sale of a property to an investment group who leases it back to the seller.

—There are few if any restrictions on the uses to which the capital generated may be put; for example to pay off debt or invest in machinery and equipment.

—The lease payments are a tax deductible expense.

—While institutional investors may have $3-5 million minimum investments, a good local corporate real estate agent may be in touch with local investors willing to undertake smaller deals.

Non-Bank Finance Companies

—Such sources of capital are willing to loan in situations where their payback is less guaranteed.

—They are rewarded for this additional risk through higher interest rates and numerous fees.

—Structured finance companies. “These are non-bank lenders with looser loan requirements and higher expenses,” says Collins.

—Accounts receivable factoring companies. “These pay you upfront for your A/R, minus a healthy fee,” he says. “This capital can save a troubled company but it can also become a debt treadmill. Companies should not use A/R factoring a moment longer than necessary.”

Look to future DWM e-newsletters for more on this topic, including preparing for conversations with capital providers and mistakes and misconceptions to avoid when going through the lending process, as well as ways to improve your company’s capital position.

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