Money Money Money Makes the World Go Round: Accessing Capital

You already know that your company needs a constant infusion of capital, especially in a capital-intensive industry like manufacturing.  But let’s explore that issue further.

Why Do You Need Capital?

As a capital-intensive business, you will need capital for:

(a) Working capital – routine on-going needs for materials inventory, financing works-in-process, marketing expenses and operating expenses; the cashflow cycle of a manufacturing firm, where you are sometimes ‘under-water’ during the life-cycle of a specific project, can further increase your working-capital needs.

(b) Growth and expansion capital – new major pieces of equipment, or new building and land for expansion, a new software implementation, or a major new marketing campaign.

(c) Funding a new large order – managing a very large new order will require additional working capital, beyond the normal level, since you may be ‘under-water’ for part of the life-cycle of that order, and the size of that cashflow need may exceed your existing debt or line-of-credit limits.

(d) Acquisition – the merger & acquisition market is strong today, and there are potentially opportunities for you to buy another company, either for expanding your market, expanding your technology and products, adding customers, or eliminating a competitor; this will require capital, either in the form of additional debt, or equity (yours or an outside partner’s), or a Seller’s Note.

(e) Recapitalization – restructuring your debt to take advantage of more favorable rates and terms, to lower overall debt service, and to improve your debt-to-equity ratio, especially in the current low-rate environment.

(f) Deleveraging and Liquidity – adding more debt into the company in order to take out some of your existing owner’s equity or to cash out an existing partner, or through a partial sale of the company to an outside investor.

What are the Sources of Capital?

Seeking capital is a little like seeing a rain shower a short distance away, while you are standing in the middle of a desert.  Lenders will tell you that there is a lot of capital out there and available (their favorite term is “dry powder”), but at the same time they will tell you that only simple and ‘vanilla’ deals have any chance of getting done.  The market is edgy (especially the regulated banks) and nervous, but still awash in cash.  The challenge is presenting your story in such a way that you increase your odds of getting some of that rain.  Let’s focus on the various sources of capital, and their best use:

(a) Banks – Banks are still your first source of accessing capital, in most cases, either in the form of senior debt (term loans), or lines-of-credit (LOCs).   An LOC functions like a credit card: it has a maximum limit, and you can withdraw from it as needed, repay, withdraw again, and repay.  Banks will require a lien on most or all of your assets in exchange for a loan, so if you are also looking at other sources of capital to blend with bank senior debt, be careful about how your assets are secured and allocated.  However, bank senior lending and term loans are the cornerstone of most companies’ financial structure.  Sometimes, banks will use the SBA loan program, which can be an effective tool.

(b) Asset-Based Lenders (ABLs) – ABLs are non-bank senior (and sometimes junior) lenders, who are not regulated, unlike banks, and therefore have some added flexibility in their credit review process.  However, while banks will consider your cashflow as well as your assets in evaluating you for a loan, the ABLs usually only consider your unsecured assets.  Still ABLs are often a viable form of debt, especially when a bank turns you down.  In fact, ABLs get a lot of their business from banks as a referral.

(c) Subordinate debt (sometimes called mezzanine debt, or mezz debt) – This debt is junior to the senior debt, and can be secured either by a second lien (like a second mortgage on your house) or can be unsecured.  If unsecured, it can be combined with senior bank or ABL debt, as long as the available cashflow can accommodate the combined debt service.  There are mezz-debt funds (investment funds) that specialize in providing mezz debt to company borrowers, usually unsecured.  In some cases, the mezz debt is accompanied by warrants that give the lender the option to convert all or part of their loan into equity in the company.  These are expensive financings, but sometimes the only option when a bank refuses your loan request.

(d) Unitranche loan – Unitranche loans are loans from a single lender that combine a senior secured portion with a subordinate unsecured portion, at two separate rates (blended together) and with a single set of documents.  These can be less expensive and faster to close than going separately to senior and sub lenders.

(e) Leasing – If you are acquiring large pieces of capital equipment, consider leasing them instead of borrowing (or using on-hand cash) to purchase them.  Depending on the original cost, the estimated economic life of the equipment (how long do you expect to keep it), and the residual value at the end of the lease, it is easy to compute the relative advantages of a purchase versus a lease.  Be aware of the differences between an operating lease (you don’t have title or get the depreciation, you can deduct the entire lease payment, and you have to return the equipment at the end of the lease or pay the residual amount) versus a financing lease (where you have title and get the depreciation, you can deduct only the interest portion of the lease payment, and you keep the equipment at the end of the lease).  There are significant differences in costs and tax advantages between the two.

(f) Factoring – Factoring is selling your Accounts/Receivable (A/R) to an investor, getting the cash earlier rather than waiting to collect on the A/R.  This is an expensive form of debt, but does not require the same credit approvals as regular debt, since the credit here is the credit of your customer.  If you have strong customers with good payment histories, and large regular A/R balances, this is another valid option.

(g) Purchase Order (P/O) Financing – P.O. financing is based on one or more purchase orders you have received.  It is not a common form of financing, and expensive (more so than factoring), but sometimes it is a valid way of financing a large order from a strong customer if you can’t finance the order through your own sources.

(h) Export-Import Bank – If you are doing international sales, the Ex-Im has several strong programs that can guarantee your payments from a foreign buyer, and sometimes finance the upfront costs of the order.

(i) Sale/Leaseback – This is the sale of your land and building, or large capital equipment, to an outside investor who then leases it back to you.  It gives you an infusion of cash when needed, but it also burdens you with a new debt service requirement.  It is a valid, but expensive, financing technique, more appropriate when other forms are not available and you have valuable unsecured assets.

(j) Equity – Everything discussed above is a form of debt.  But equity is also a source for you, either your own (adding to your existing investment, improving your debt/equity ratio, and not bringing on more debt) or outside investors (which dilutes your own equity percentage, but again does not add more debt and improves your debt/equity ratio, especially important if the bank is challenging you on your existing debt/equity ratio).

How To Access Capital

As discussed above, the financial markets are edgy (especially the regulated banks) and nervous, but still awash in cash.  I likened the quest for capital to seeing a rain shower a short distance away, while you are standing in the middle of a desert  Your challenge is presenting your story in such a way that you increase your odds of getting some of that rain.  To accomplish this, here are some of the tools you need to obtain capital.

(a) Business Plan – A well-structured and clearly articulated BP is an essential tool for convincing lenders or investors that you are a worthy candidate for their money.  This is your platform for informing the financial community of your vision and goal, your strategic objectives and tactical measures, your awareness of competitive forces, your marketing and pricing strategies, the mix of customers and vendors, your technology and product pipeline, the key personnel, and your business infrastructure.  Without this clear statement of who and what you are, you have a relatively poor chance of getting capital; with it, you can now be taken seriously as a reasonable candidate for funding.

(b) Cashflow Proformas – Part of the BP should be a detailed multi-year cashflow proforma.  It needs to walk a balance between being positive (why fund a company that isn’t projecting strong revenues?) yet realistic (no hockey-sticks).  Show detail, by product line, and clearly lay out your underlying assumptions as to costs, prices, product development, and staffing.  More important, show the financial impact of your requested funding: a comparative analysis of sales and net operating income with and without the requested funding, to prove your assertion that the requested funding will take you to new levels of success.  Help the funder understand what you can do with their money.

(c) Financial Statements – You may be using QuickBooks or PeachTree, but it would be wise to spend the money for an outside CPA firm to, at the least, give you reviewed statements, and preferably (very preferably) audited statements.  You want your funding source to believe your numbers, and internally-generated statements are not usually taken as very reliable.  If you are doing well, prove it.

(d) Financial Management System – If you want someone to write you a check, show the funder that you have the sophisticated financial management system to track, monitor and report on the use of those funds.  Lenders and investors want to know where their money is going.  Consider upgrading to an Enterprise Resource Process (ERP) system; the benefits are usually very considerable, beyond just financial management.

(e) Strong Internal Business Infrastructure – You may be very good at the technology of your company, but it is equally important that you are good at the business of your company.  You need to show lenders and investors that you have a well-structured and competent infrastructure within your company: an effective HR function and policies, up-to-date operations and supply-chain systems, a robust IT system capable of tying together the various components of your company, an imaginative sales and marketing group, and access to legal counsel.  Some of this infrastructure can be out-sourced, but it needs to be an integral part of your regular operations. Disciplined well-oiled machines are successful and get funded; machines in chaos with parts falling off aren’t, and therefore don’t get funded.

Summary – There is a lot of cash out there, available for debt lending or equity investing.  But these sources are looking for clean ‘vanilla’ deals, and for companies that are successful, well-organized, and well-focused on their mission.  Approach your funding goals like a military campaign – tighten all the loose bolts, plan carefully, prepare yourself, and you will stand an excellent chance of getting funding.