Financing in a Financially Unfriendly world
January 30 2009 by Jennifer Pellet
In less than six months, Wall Street saw six top-tier banks and financial institutions perish or merge and the consolidation of several more. While credit markets show some easing since the height of the squeeze, it is clear that all but very large companies face continued uncertainties, liquidity problems and access to capital with amenable terms.
“It’s tough out there for the banks and, therefore, the banks are making it very tough for organizations,” panelist Lyndon Faulkner, CEO of Pelican Products, told CEOs gathered for a discussion on how business leaders can cope with the tighter capital markets. “If people can work within their own cash flows and invest in managing their [accounts receivables] and [accounts payables] better, this is the time to be doing that and to be really watching your balance sheet.”
Companies with debt in place must be particularly vigilant, added Faulkner, who points out that banks are likely to take a hard line with those who run afoul of loan restrictions. Violations of loan covenants often give financial institutions the opportunity to invoke penalties that raise interest rates or alter loan terms— opportunities likely to be exercised to the utmost in a tighter capital market. “Those of us using debt for growth capital must be very, very aware,” noted Faulkner, who has recently been investing in growth in emerging markets through acquisitions. “You’ll pay a lot of money in penalties for breaking technical bank covenants, let alone debt-ratio requirements. Personally, I’ve never spent more time with a CFO in my life than at this moment, trying to make sure we’re not doing anything in running our business that will come back to bite us.”
Companies that need to not only manage existing debt but access additional capital face an even greater challenge, added Ed Kopko, chairman and CEO of Butler International, a global provider of technical and technology services. “If you go down the usual menu of choices—lines of credit, mezzanine debt, various forms of equity and so on—there are challenges everywhere you look in terms of trying to get access to money right now,” he says. “Banks’ number one need right now is to improve their capital positions, so I think they’ll be feeding very aggressively on their clients and take every opportunity they can to charge fees and improve profitability.”
Kopko recounted a conversation with a private equity investor about the investor’s attempt to finance the growth of a portfolio company that had won a new contract. The company—which was profitable—needed cash to fulfill the additional orders, but its bank not only refused to extend its credit line, but also wouldn’t permit the private equity firm to invest new capital. “He was told, ‘Any funds that you get from the outside must go toward paying down our loans, you can’t use them to run your business,’” said Kopko. “In the end his only option was to pay the bank a large fee to waive the requirement that all the funds be applied to existing loans. He had to pay for the right to invest his own money in his company.”
What’s a business in need of growth capital to do in such an environment? Bob Darbee, president of Omni Capital, advised CEOs to make investor relations even more of a priority than ever. “Already, a CEO’s job is twofold: One part is running the company and the other is the care and feeding of the investor community,” noted Darbee, whose boutique firm specializes in financing and investor relations for development- stage companies. “Talking to investors and keeping their confidence is important to keeping the cost of capital under reasonable control, even for established companies. And obtaining and footing the cost of capital is increasingly difficult as you move down the spectrum in size.”
Darbee pointed to rollups and asset-based lending as avenues that may remain open to the small and mid-size companies that typically struggle most in tight markets. While rollups are often considered exit vehicles for business owners looking to retire, they can also be a source of capital. “Instead of an exit strategy, a rollup can be a way for existing management to stay on and run the company, but with a financial cushion in place in exchange for an equity interest,” explained Darbee.
Similarly, asset-based lending is typically thought of as lending against receivables or physical assets. “But in this environment, lending against shares of stock makes sense and works on two levels,” said Darbee. “One is on a corporate basis, providing a credit line against shares the company has issued and thereby avoids its having to sell at present market levels. On a secondary basis, itinvolves working with executives who have substantial share positions but don’t want to sell at these levels, but may need to monetize shares without having to sell them and get involved in a reportable transaction.”But even companies able to find financing through these or other methods will need to manage their finances with greater vigilance in the current environment, warned Kopko. “We’re all going to have to get back to financing our businesses the old fashioned way—which is out of retained earnings, cost-cutting, selling assets and other mechanisms to improve liquidity,” he said. “That’s not necessarily all bad news. It will put a discipline into all of our companies that will make us better companies and CEOs going forward.”