Securing Capital to Grow and Innovate

Fueled by advances in materials, automation, robotics and connectivity, American manufacturing has entered an era of opportunity. Innovative tools and technology capable of improving efficiency, cutting costs and enhancing the performance of factories have the potential to revolutionize processes and productivity. At the same time, a business-friendly administration in Washington and greater economic optimism broadly are opening up access to capital and debt markets for those willing to invest in the necessary machinery, software and talent to deliver on that potential.

As a result, manufacturers seeking funding for equipment, expansion or M&A activity have a wide array of options, Terence Begley, CEO of corporate banking at PNC, told participants in two roundtable discussions on securing capital held during Chief Executive’s Smart Manufacturing Summit, co-sponsored by PNC. “There is a lot of money out there—bank money, private equity money, equity market money—right now for making these types of investments,” Begley noted. “The tricky part is when do you lock that financing up? Do you wait or do you do it now?”

SIGNS OF A SPENDING SHIFT
Despite greater access to funding, many manufacturing companies have taken a wait-and-see approach to capital expenditures in recent years—although research suggests that may be changing. In 2016, concern about turbulence in the global economy and uncertainty around the outcome of the presidential election had many companies in a holding pattern on capital expenditures.

With confidence higher this year, the National Association of Manufacturers anticipates an uptick in capital spending of about 2.1%, according to its NAM’s First Quarter 2017 Manufacturers’ Outlook Survey. Among survey respondents, 41.6% reported expecting to spend more on capital investments in 2017 relative to 2016, 39.4% anticipated spending to be unchanged, and just 11.7% expected to invest less.

At the same time, many CEOs who recognize the need to update manufacturing equipment and processes find the prospect of seeking financing for such investments daunting.

In fact, the very pace of innovation driving the need to update equipment has a flip side when it comes to capital expenditures. “With smart manufacturing, the useful life of the assets we’re employing could be a lot shorter than we ever planned them to be—and the other assets, the intangibles, may play a bigger role,” said Shamus Hurley, CEO of Parkson, a provider of advanced solutions in water and wastewater treatment, who pointed out that asset-based borrowing becomes more complicated in an exponentially evolving market.

Manufacturing companies that traditionally obtained financing by offering machinery as collateral now find themselves needing to fund programs to train employees on new technology or invest in proprietary software, agreed Teri Jensen, vice president, finance, of the custom packaging company Utah Paperbox. “We’ve always been able to highly collateralize our financing,” she said. “Thirty years ago, when I bought a printing press, I planned to use it for 15 to 20 years. Now the latest and greatest technology is going to be out the next year.”

Such concerns are more common in today’s lending environment, and banks have developed ways of addressing them, noted Jill Gateman, executive vice president at PNC. “We are completely different bankers today than we were eight years ago, and the most transformational piece of that is that we’re advisors,” she said. “We have a lot more tools and do a lot more preparation so that we can really understand a company before we go out on a call. We bring peer analysis, which is something that small privately held companies really enjoy seeing—how they stack up against peers. And it really helps us understand companies in situations like that.”

“We spend a lot of time with our company prospects doing due diligence,” agreed Begley. “To be blunt, we probably are not as comfortable with collateral as we used to be, but if we believe in the company, who they’re selling to, the product and the long-term strategy, we can get a lot more comfortable.”

Several roundtable participants outlined specific funding challenges, one being that most banks are still primarily numbers-oriented, relying entirely on P&L statements and tax returns to assess a company’s capital-worthiness. “All they want are numbers, numbers, numbers, and there’s no real relationship,” said Jerad Higman, president of mining equipment manufacturer Masaba. “They give you an umbrella when there’s sunshine, and then guess what happens when it rains? They want it back.”

Jamie Yelle, president of Royell Manufacturing, added that it’s tough to find lenders willing to finance organic growth for a capital-intensive company that manufactures components for the aerospace industry.

“The bigger you get, the more your customer demands,” he explained, noting that bid packages for [some of our] clients can run $10 million-plus. A project of that size, in turn, requires upfront investment by Royell, which is also in the process of automating operations. “We’re going to more and more automation as we move toward 24/7 [production],” said Yelle. “So you’re talking about a half a million dollars for every asset you buy. It’s all opportunities, but to take advantage of them takes money. Getting an operating line is easy for us, but I find that banks begin to get nervous about that kind of rapid growth at some point.”

What’s more, because of the way manufacturing is evolving, the value of the type of investments some manufacturers need to make can be difficult to quantify. All America Threaded Products employs decades-old legacy CNC machinery that requires expensive maintenance and updating, rather than replacement. “Finding a
way to finance the capital expenditure required to keep a 10-year-old machine running and to automate, add sensors and connect it to an ERP system becomes a challenge for us,” said Casey Broderick, president of All America Threaded Products, a division of the metal manufacturing company Acme Manufacturing.

FINANCING FORWARD
Often, the best solution to challenges like these is for companies to take a proactive approach to accessing capital, noted Begley, who outlined a “rainy day” strategy. “A lot of companies are taking it for granted that there’s a lot of liquidity in the markets and that they’ll be able to get money when they need it even though they don’t actually have it lined up,” he said. “But lining up extra money early while the lending environment is favorable is a good way to make sure you’ll have what you need when you do need it. It sounds obvious, but often it doesn’t happen.”

For Erika Meciar, CEO of electronic components manufacturer Laco, a five-year growth spurt has culminated with an opportunity to gain a competitive edge—one that the company must now figure out how to fund. “Funding is definitely one of our biggest challenges at this point,” she said.

Lewis Tree Service, on the other hand, recently drew on a line of credit to acquire a competitor. “We acquired a competitor primarily for their business, but also for their talent,” said Bob Petrone, vice president of finance. “Some of their people became executives at our company, so both aspects worked out to our
advantage.”

Companies that don’t routinely pursue growth through acquisition often lack the financial firepower to pounce when such an opportunity arises, said Begley, who pointed out that companies that see acquisition as a potential growth path would do well to start securing financing early.

“Companies that are acquisitive by nature are often better about putting away a rainy day fund or adding to their credit line because they know the worst time to go to a bank is when you have to sign a letter of intent by tomorrow,” he said. “Those who aren’t acquisitive by nature have the opposite problem: They don’t want to overpay for credit so they only finance for their present needs. Then when they have an unexpected need, they find it’s tricky or too expensive to get financing. The worst time to borrow money from a bank is when you’re in trouble or when you have a live acquisition in the works.”

In addition to having the wherewithal to take advantage of opportunities as they arise, companies that line up access to capital now can take advantage of today’s favorable lending market. For example, CEOs with floating rate loans may want to talk with a banker about refinancing to a fixed rate.

“A good relationship bank can help you design a financial plan you can live with today that hedges you against some unforeseen event or rate spike,” concluded Begley. “No one knows whether the [low interest rate environment] will end gradually or change overnight if a crisis causes credit markets to pull back fast. But there’s no question that the rate environment is changing.”