When to Maximize Secured Debt Financing?
Maximizing secured debt financing should be considered: to undertake a growth initiative when the shareholders of the business either do not have the financial capacity to further invest equity into the business; or, to undertake a transaction such as an acquisition or management buyout which may require the maximum borrowing capacity of the business to execute the transaction.
Maximizing secured debt financing provides the following advantages: it enables growth initiatives and transactions to be implemented; it maximizes the availability of the lowest cost of capital for a business; it enables shareholders to minimize their equity investment thereby minimizing their financial risk; it provides access to leverage to enable the maximum return to be achieved on the shareholders equity investment.
Maximizing secured debt financing may require accessing non-traditional lenders including: asset based lenders which provide operating lines which typically offer improved margining on working capital assets and less restrictive financial covenants; and, term lenders or lease alternatives which lend on the value of the assets of the business.
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ABC Co. (“ABC” or the “Company”) had a fully utilized operating line which was constraining the day-to-day operations and growth of the business. ABC management estimted ABC sales could be increased by 75% if the Company could access sufficient secured debt financing to fund its working capital requirements.
ABC management and its trusted advisors undertook a refinancing to increae ABC’s operating line from $17.5 million to $35 million and increase the Company’s long-term debt from $1 million to $3 million.
ABC's balance sheet, income statement and selected financial statistics/ratios are presented before and after the refinancing. In the illustration: the interest rate on the operating line was assumed to be 6% before the refinancing and 7% after the refinancing; margining was 75% of receivables and 25% of inventory before the refinancing and 80% of receivables and 50% of inventory after the refinancing; and, the long-term debt was adequately secured by the Company’s capital assets. The refinancing enabled ABC to supports its growth in sales by 75% and increased the Company's net earnings by 64.2% without any increase in the equity investment by the Company’s shareholders.
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Claude Conan, CA, CPA, CBV, MBA (Founder and President of Quantum Advisory Inc.) can be reached by telephone at 780.669.9724 or email at firstname.lastname@example.org.