This article was written by Nick Welch, a Senior Manager in the Advisory and Restructuring practice at GlassRatner who specializes in Corporate Finance, Mergers & Acquisitions and Business Valuation. Nick also undertakes Litigation Support and Interim Management roles.
The bad news is refinancing can be a stressful undertaking. The good news is many obstacles can be overcome with expert help.
Other reasons to refinance include:
- Broken relationships can cause the borrower to seek an alternative – amicably or hostile (we see both);
- A change in product, for example switching from a line of credit to a factoring facility to match cash receipts;
- A better deal, e.g. lower interest rate, less collateral, a longer term or a principal repayment holiday;
- Niche products offered by a sector specialist lender – such products cater for industry nuances, for example healthcare lenders financing “out of network” receivables vs. a traditional Asset-Based Lender (ABL); and
- To extract more cash, for example if real estate values increase.
Refinancing could occur for any one, or more, of these reasons – we dealt with a growing number of cases in 2017 and to assist those needing to refinance, we have summarized the key areas to focus on.
Corporate refinancing takes time. It’s a big event and has serious implications on the lifeblood of a company – its cash flow.
Various stakeholders, both internal and external, need to be aligned. These include: attorneys; the existing lender; the new lender; the management team; regulators (if applicable); and auditors. Therefore set some time aside to plan the process.
Sometimes advance planning isn’t possible, for example in a hostile situation when things can happen suddenly. In this case it will be necessary to negotiate a reasonable time period for replacement funding. Expert help is recommended to management faced with this situation.
Auditors and regulators are very important stakeholders. If refinancing is fundamental to going concern it may affect the audit opinion, or regulatory capital requirements, in which case it is necessary to complete the refinance before a final audit report is issued or regulatory returns are due.
Seasonality is important. The time of year will dictate cash needs and peaks and troughs in a debt facility meaning greater, or lesser, exposure to the lender (and company). By planning an exit in a low period, the risk will be mitigated and refinancing will be more attractive to a prospective lender (this mainly applies to working capital facilities and not term loans).
Other matters to plan for are time sensitive clauses in facility agreements. If there are early repayment penalties they need to be factored into the timetable. Careful negotiation can usually mitigate some of these, but if your company is a ‘good’ credit the lender may be strict on enforcing the penalties as a disincentive to the exit.
All strong relationships benefit from good communication. Whether the refinance is at the lender’s or the borrower’s behest, there should be clear communication with all key stakeholders.
Frequent meetings can be held and can be used as an opportunity to demonstrate management’s willingness to achieve an orderly exit and present its plans.
Milestones should be agreed and individuals assigned as the key contact points on both sides. These individuals will manage all communication and information flow.
Financial monitoring will be part of the existing lender’s exit conditions. The package and frequency of financial information should also be agreed by all parties. Involvement of an expert third party consultant may be helpful to provide independence and coaching if management are not familiar with the process.
Anomalies in trading, one-off events, key staff leaving and “force majeure” can impede corporate performance and result in loan default and contribute to the reason for refinancing. It is important to present this ‘story’ honestly and to reconcile why the relationship was a bad fit. A prospective lender will want to understand the reasons for the refinance and the chances are, a new lender has heard them before.
Consider how the story will be communicated to the new lender. It might be that a different approach from a lender such as less collateral, cheaper rates, seasonable repayments or other alternative products will plug the holes in the existing relationship.
Take the time to prepare a lender presentation which tells the mission of the business, the historic results, the prospects, the competitive environment as well as the strategic challenges, how they will be overcome and how funding will be used. Inclusion of sensitivities is also recommended to demonstrate how any downside will be managed.
Most importantly, support how the projections will be achieved (using third party data where available) to demonstrate the company’s ability to service the new debt package.
- TYPE OF BORROWING
What type of funding does the business need?
This will vary based on sector, seasonality, life cycle of the business, the term, collateral, capital structure and risk appetite of shareholders/management, among other factors.
The main types of debt facilities are term loans, asset based lending (ABL) for working capital management, lines of credit, bridge financing and mezzanine. A business may require a mix, or one of these.
It is fundamental to understand the purpose of the finance before seeking a new deal and historic cash patterns can be mapped out to understand the highs and lows. For example, when payroll is due at the same time as significant AP accounts there will be a shortage of cash and, if the business is seasonal, high and low periods will affect cash flow. This analysis will inform how to structure the finance and make the decision making process easier.
In the case of term loans secured by real estate, there may be a low LTV due to real estate values improving. Additional equity can be drawn from the property for use in the business and may be a cheaper option than a traditional commercial loan.
- AMOUNT AND COST
The cost of debt includes fees and charges which need to be taken into account. It is beneficial to use a specialist refinance lawyer to understand agreements and the nature of any fees as well as when they become payable.
Exit fees may apply when paying down existing debt and administration/arrangement fees may apply when signing up a new debt package. Sometimes, in relation to real estate, ‘property participation fees’ are charged and can be significant.
There may be penalties in the facility contract that trigger if the company does not perform certain conditions, e.g. non-provision of financial information, unauthorized withdrawals, set transaction volumes (invoice financing for example). Be mindful of these and ensure you discuss all costs with the lender.
The type of interest rates charged could also be fixed, variable or payable in future (e.g. PIK). To assist you, each facility should be set out using an Excel spreadsheet and the net cost calculated to enable comparison between products.
Oftentimes lenders are over-collateralized i.e. they have too much asset cover to protect their lending exposure.
This can hinder a borrower as too many of its assets are encumbered meaning excess risk is carried and assets are unavailable as collateral for an alternative lender or investor.
The existing debt package should be compared with the collateral pledged.
What is the value of the assets now vs. when the debt was first taken on?
Have any assets been sold or acquired which may weaken, or strengthen, the collateral available?
Recent appraisals will be needed for real estate, stock or plant and machinery assets. We have seen many cases where some of these asset groups can be released leaving them unencumbered and providing the borrower with greater borrowing capacity, or lesser risk. This can assist regulated entities that need to report on ‘free assets’ to regulators.
Lender permissions can also be restrictive when borrowing against certain assets, for example property refurbishment permission is usually required on an encumbered real estate asset, so remain mindful of this too if there are plans to modify certain assets later on.
Personal guarantees are required by some lenders, usually ABLs, but some are comfortable providing a facility using only company assets as collateral. If personal guarantees are provided and backed by personal assets, it may be possible to have these released on a refinance.
There is no underestimating the importance of information in a refinancing environment. During the process it is probable that additional tasks and reporting will be required of the company’s finance team and expectations should be managed.
Financial information needs to be up to date and timely. Monthly reporting is usually expected no later than 10 days after the month-end.
The information will be expected to be accurate and consistent. For example, all balance sheet reconciliations need to be performed and agreed. The statements should tie back to the accounting system and relevant metrics such as EBITDA, Free-Cash Flow and Debt Service should be presented consistently (e.g. add-backs).
Depending on the type of trade, both financial and non-financial information may be relevant. In the case of a school for example, student numbers, enrollments, graduations and withdrawals will be relevant.
Projections are usually required on a rolling basis pegged against the year to date historical financials. It is important to remain realistic with projections that can be supported. The proverbial “hockey stick” forecasts with no supporting reasons for growth are common.
The borrower should try to make easy for the lender to say “yes” to a refinance. The more reliable financial information is, the greater credibility will be.
Refinancing is necessary for a variety reasons, both amicable and hostile. Whatever the reasons, it is important to plan the process and communicate effectively with stakeholders.
Throughout the process, appropriate analysis should be undertaken to make sure the product suits the business needs and is affordable both in terms of cost and collateral.
For dysfunctional financing packages, there is help at hand if needed where plenty of opportunities can be realized.