The New Environment

COVID-19 has been financially devastating for millions of business owners large and small.  Before the pandemic, many experienced strong sales, a growing customer base and were executing pursuant to a defined and successful business plan.  Following the global economic shut down, all companies are faced with objectively reviewing their operations, strategic plan and financing needed to pivot and succeed going forward.

To best react to this difficult environment, we believe it is important to understand how financing sources themselves are affected and what approaches owners should make to best position their companies for capital access.

Financing Sources are Pivoting

Allegiance Capital has long standing relationships with all categories of financing companies including the legal, accounting and economic data providers underlying the broad financial sector.  Since March, we have been holding conversations with dozens of these companies to gauge their outlook, how they pivoted and their expected process going forward.

Similar to any other business, providers of capital are actively evaluating their own operating plans to refine or redirect where they wish to deploy capital.  Although each institution is making their own modifications, below are some common themes we are hearing at each provider type:

Insights: Commercial Banks

Strongly risk-adverse providers of credit.  In this environment, banks have substantially tightened loan requirements and many have specifically established which companies, sectors and transactions they wish to fund going forward – likely to the exclusion of thousands of middle market companies nationwide.

Currently, banks are working through a comprehensive review of their entire loan portfolio

  • This review is to segment which clients and sectors they wish to support and those which they will cap exposure or seek to downsize over time
  • When banks anticipate credit issues within a particular sector, they will immediately seek to limit exposure and move problem loans to their workout group – unfortunately, banks often view sectors similarly and challenged companies may be shut out from most of them concurrently
  • Banks have been active in fulfilling obligations under the government PPP programs – often to the exclusion of pursuing new clients – this is now ending and banks are again actively pursuing new opportunities in sectors they support
  • Terms and covenants will be lender friendly in the near term; banks expect significant loan losses across several industries and will not be stretching on amount or terms

Covenant Breaches:  Downturns inevitably trip covenants for even top clients

  • Banks have wide discretion on how to approach troubled clients
  • You cannot predict whether a bank will work with you or exercise their rights to liquidate and protect their loan – be prepared
  • In general, banks do not want to foreclose and liquidate – it is costly to them as well
  • To avoid liquidation, companies can threaten bankruptcy – lenders lose control post-filing
  • We understand your rights and options and can assist to seamlessly exit to a new commercial bank or non-bank lender

Insights: Non-Bank Lenders

Private lender funds are established to provide non-dilutive capital in excess of what is available from commercial banks and/or to out-of-favor sectors.  Loans take the form of senior secured and/or second lien loans.  Often their solutions offer an excellent middle ground to obtain growth capital, without impactful dilution.

In the current environment, non-bank lenders are seeing a substantially increased amount of deal flow including companies being asked to exit their commercial bank and those seeking incremental capital to advance growth now:

  • Unlike commercial banks, these lenders do not borrow from the Federal Reserve Bank and as such have a higher cost of capital and lend at higher rates
  • Senior Loan Alternative:
    • Lender replaces commercial bank loan with a single loan providing proceeds above the bank, up to 4x EBITDA
    • 8-10% cost of capital: To offset their higher cost, they are often flexible, offering limited amortization (e.g., 5%/year) and lighter covenants
    • Importantly, they also allow a commercial bank to remain in place to provide treasury services (checking, ACH, etc.) so daily operations are not impacted
  • Second Lien/Mezzanine Option:
    • Lender provides additional (2nd lien/unsecured) debt of 1-2x EBITDA
    • Unsecured position infers higher rates (12-14%), although blended rates (Senior + Second) often remain below 9%
    • Structure typically offered to larger, more established companies ($10M+ EBITDA) where the second lien lender feels more comfortable in their unsecured position

Insights:  Private Equity Firms

Private equity funds are specifically established to provide owner liquidity and/or growth capital to quality companies with clever management.  Today, private equity firms continue to review transactions but valuation and forward expectations are clouded given the uncertainty:

  • Industry sitting on $1.5 trillion of dry powder – firms are actively seeking to put capital to work
  • There are 10x+ more equity investors who prefer control vs. those who will invest in a minority position
  • Valuation and multiples will be down in the near term but funds are absolutely closing on transactions where they have a supportive angle
  • Many firms are seeking troubled situations where their expertise can meet better pricing

Insights:  Family Offices

Family Offices are pools of family (and often other outside) wealth founded and run by a small team of investment professionals to source and invest in attractive opportunities.  As a portion of their strategy, many offices pursue private company investments across the capital structure (debt, preferred stock, minority and majority equity) and typically with longer time horizons.

Materially impacted by the recent stock market volatility, many offices are tightening their investment reigns and choosing to focus on companies/sectors with which they have direct experience.  Below are key characteristics that make these family offices a must-pursue capital provider when seeking financing:

  • Investment horizon is generally open ended with a focus on cash flow generation and in segments they know and understand well
  • Valuation and structure can be superior to private equity and leverage utilized generally more conservative
  • Time to close can be quicker than private equity with closing terms and conditions also less cumbersome

Next Steps:  Objectively Evaluate your Situation

Companies and owners are facing long term changes to the status-quo, evaluating the varied types of financing available will ensure your company is well positioned to compete.

If you are facing any of the following scenarios, you deserve an experienced advisor to collaboratively evaluate and address your options:

  • Scenario 1: Existing commercial bank not willing to expand its relationship, provide supportive capital or you are at risk for a covenant breach
  • Scenario 2: Growth capital is needed for working capital, an acquisition or corporate expansion
  • Scenario 3: You would like to realize a modest liquidity event without ceding control
  • Scenario 4: You would like to evaluate options regarding a majority sale of your business

Raising Capital:  Preparation Checklist

Successfully raising capital is a process not an event.  We work with your team to create a confidential investment package that provides the lender or investor with all information necessary to engage in discussions.  We then partner with you every step of the way, evaluating competing options and closing on the proper amount, terms and conditions for you.

Closing a financing typically requires 60 days from start to finish while an equity investment may take substantially longer.  As such, determining your needs and implementing an actionable plan now will allow your company to be fully funded well before year end and in advance of the economic upturn.  Below are key checklist items which should be included as part of the process:

  • Updated business plan – ability to succinctly describe your customers, back-log and differentiating characteristics with a clear snapshot of how COVID-19 affected your business and processes set in place to return to normalcy
  • 2018 & 2019 financial statements
  • Revised projection model

Thank you for your time, we trust that our insights and overview were helpful to your planning process.  As next step, please click link to be connected with me