Operating Like a Turnaround (Before You Have To) — Part 3

[Part Three in a three-part series discussing the benefits to healthy, profitable companies in taking a page from the turnaround management playbook.]

In our previous blogs, we discussed operational analysis and expansion planning as it pertains to unlocking capacity and growth. In this installation, we focus on the projection, timing and tracking of cash flows.

HOW CAN YOU HIT A TARGET IF YOU’RE AFRAID TO CREATE ONE?

The 13-week cash flow forecast is the industry standard for basic performance measurement in a turnaround situation. Every cash inflow and outflow is matched against projections, with variances (positive and negative) scrutinized for the underlying causes.  This tool provides an enhanced level of transparency into a company’s performance, which is at the same time crucial for management and demanded by creditors.

When applied to a healthy company, the 13-week cash flow forecast allows management enhanced clarity and transparency at a granular level. This can lead to quicker, more informed decision-making in both the core operations and expansion initiatives. This level of clarity, starting at the C-Suite, can be pushed down into the entire organization, unifying all manager-level employees with a common language.

The 13-week cash flow forecast can roll forward on a weekly or monthly basis, creating benchmarks for monthly tactical reviews and quarterly strategic reviews.  Essentially, it becomes the core tool to benchmark a company and its management against an agreed strategic operating plan, with factual data forcing accountability for performance.

IMPLEMENTATION & TRACKING

Tracking actual performance to projections is a powerful indicator for your business. It provides a crucial level of awareness, giving you the opportunity to detect problems, recognize strengths and evaluate initiatives. Without some form of tracking vs projections, you’re really on a road trip without a map: no destination and no evaluation of progress towards the same.

Cash inflow projections are based on detailed knowledge of your operational capacity, sales cycle and customer pipeline. They should reflect what you can realistically expect your system to generate: known customer demand, order backlog, production capacity, inventory, length of sales cycle – all these factors must be carefully considered in creating your revenue projections.

Remember that you’re not just projecting revenue – you’re anticipating when cash will actually hit your bank account and be available for use. Cash inflows that fall short of projections provide notice as to a host of potential issues, including operational/production, sales efficacy, customer demand and customer solvency (collections).

Alternatively, cash inflow actuals deviating substantially to the upside alert you issues such as market demand and “sweating” assets, potentially indicating the need for expansion and investment. In either case, deviations from projections can be given immediate attention rather than delaying or ignoring issues due to ignorance or untimely knowledge of them.

Cash outflows are created based on when you anticipate actual payment of expenses. Factors to be considered are escalations (think rent and inflation), anticipated equipment/asset purchases and hiring initiatives. If you pay expenses with a credit card, those payments should be considered cash outflows – money that has essentially left your bank account and is no longer available for use. Actual outflows that exceed projections could be an indication of a lack of grounded operating knowledge, inefficiencies, supply chain issues or a lack of proper controls.

TIMING & ALLOCATION

It’s also important to get the timing of cash flows right. Every business essentially matches cash inflows to outflows, with the goal of being able to meet obligations as they come due and to calculations of IRR. Cash that comes in later than expected can cause a lot of heartburn when outflow obligations materialize, leading to ad hoc cash management that diverts cash from other pre-planned activities. Cash flow mismatch also communicates to investors that you don’t have a solid grip on your cash management, eroding confidence in management and the business in general, potentially resulting in valuation discounts.

Projecting future cash balances allows you to plan for capital allocation and anticipate financing needs. Accurate cash flow forecasting shows lenders/investors/buyers AND current shareholders (including yourself) that your company is tightly run and it instills faith in your management acumen.

Perhaps most critically, a well-executed cash flow forecast creates a level of fact-based understanding of your company’s operations that can be used as benchmarks for accountability for you and all those in executive or management functions.

The bottom line is that as a business owner, you must have deep knowledge of how both cash and work flow through your business. Lack of visibility on either of these key aspects leaves you vulnerable to very unpleasant, yet very avoidable surprises.

Mark Taffet is CEO and Wolfgang Tsoutsouris a Managing Director at MAST Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle market companies.

Securities Offered Through SPP Capital Partners, LLC. 550 Fifth Avenue, 12th Floor, New York, NY 10036 Member FINRA/SIPC

/0 Comments/by

Operating Like a Turnaround (Before You Have To) — Part 2

[Part Two in a three-part series discussing the benefits to healthy, profitable companies in taking a page from the turnaround management playbook.]

In our last blog, we discussed how and where you are generating your profits and how detailed examination of this can unlock capacity and growth. In this installation, we address growth via both expansion and acquisition. This may seem a departure from the Turnaround theme, but the rigor of critically evaluating opportunities is indeed applicable.

How and Where Do You Want to Expand?

Many companies begin their expansion planning focused on what THEY do well, or where THEY have additional capacity for new products/services that THEY have developed.  This internally focused methodology often leads to a “Ready, Fire, Aim” scenario and disappointing outcomes.  A far more effective approach is to start with a verified knowledge of demand rooted in the perspective of YOUR CUSTOMERS & CLIENTS.

Successful growth planning begins with listening: What are your clients’ problems and pain points? They may not tell you up front, or even have clear ideas on what they are. They may not even be totally aware of them.  Invest in understanding your clients’ needs better than they do.  Invest in this with both internal and external resources.  Then look inward and match customer demand against the specific product/service extensions where your company has a competitive advantage.

When expanding into new customer segments for your existing products/services, examine each opportunity and how they match with your specific competitive advantages.  Keep this examination simple:  if your company has the production capacity, expand where there is a proven demand that fits your strengths.

Once an addressable demand is solidly identified, investigate your company’s ability to address it. Is the solution within your current skill set? If so, it may be as simple as making minor adaptations to existing products/services or Sales & Marketing programs that can be easily implemented. If not, can you develop it internally with existing resources, perhaps supplemented by some key hires, technologies or other assets? If internal development is not realistic, then one must consider an acquisition, joint venture or partnership. This process is more succinctly described as the classic “build vs buy” analysis.

Whether expanding more deeply into current markets or new markets, whether expanding organically or via acquisition/partnership, the key determinant in assessing viability is current or potential customer demand.

Regardless the path, simplicity is critical. It is usually most effective to focus on 1, or perhaps 2 things at a time. Trying to “multi-task” often leads to dabbling and confusion, and when you make the decision to play, don’t play for pennies; allocate the necessary resources and play to win.  Alternatively, if you don’t have a verified market edge or lack the willingness to invest sufficiently to truly win, don’t start.  Don’t dilute your human, financial or operational capital with multiple, complex and/or poorly funded initiatives.

“Operating like a turn-around” means identifying and investing in the specific things needed to succeed. This doesn’t mean under-investing: it means focusing resources on the simplest path to achieving as close to a pristine implementation as possible.

It also entails creating a realistic budget that your company can fund. Establish benchmarks to justify the ongoing investment and the discipline for monthly tactical and quarterly strategic reviews. If the project progresses successfully, please revert to the discipline outlined in Part 1! Then keep at it or double down.  If performance lags the established benchmarks, determine the specific reasons. You may have to change tactics or even recognize that the initiative should be re-thought and/or perhaps curtailed.

Negative Example (“Ready, Fire, Aim”):

A specialty food manufacturer desired expansion into markets tangential to their core customer base. A thesis was developed internally as to the potential accessible market without any research or fact-driven confirmation.  Loathe to spend money on consultants or market experts and relying solely on their own perceptions, the company simply applied the same marketing and advertising approach that had worked in their core business. They then proceeded to commit significant capital and resources to a build out, tripling their production capacity.

Fast forward 18 months, having failed to confirm and identify the accessible market, the increased production capacity remained unused, and the static marketing strategy not only failed to reach a new audience, but even grew stale with their core customers. This in turn resulted in shrinking of revenues and a significant decrease in their optionality for either a desirable liquidity event or attraction of growth capital.

Positive Example (“Ready, Aim, Fire”):

A home goods manufacturer grew exponentially in one specific product category by providing a key client with extraordinary service and consistent quality.  As the client’s demands grew, the company applied financial and human capital in a well-planned strategic initiative.  The result was a nine-fold increase in revenue from that account in eight years, taking total sales into nine figures.  Then, having established mutual trust, the company approached this key customer to manufacture products in a second category requiring a very similar manufacturing expertise.  The client accepted the proposal and participated as partners in a tightly planned product line expansion.  Within three years, this category too generated mid-eight figure revenue for the company.

“Operating like a Turnaround” means taking a “Ready, Aim, Fire” approach focused on meeting proven demand in the simplest manner.  This will diminish internal friction while increasing the odds of sustainable top-line growth, stronger bottom-line results and much higher ROI.   That in turn optimizes value, whether for a liquidity event or in seeking further growth and funding capacity.

Mark Taffet is CEO and Wolfgang Tsoutsouris a Managing Director at MAST Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle market companies.

Securities Offered Through SPP Capital Partners, LLC. 550 Fifth Avenue, 12th Floor, New York, NY 10036 Member FINRA/SIPC

/0 Comments/by

Operating Like a Turnaround (Before You Have To) — Part 1

[Part One in a three-part series discussing the benefits to healthy, profitable companies in taking a page from the turnaround management playbook.] 

How & Where Are You Generating Profits?

Imagine running your company with a laser focus on where it is generating profit.  Imagine trimming or eliminating unprofitable functions, retaining only those aspects of the business that provide the best returns and opportunities for growth.

This is the discipline that turn-around professionals bring to troubled businesses.  This discipline, when applied to healthy companies, makes them even stronger. It rallies resources around the company’s core mission, manifesting profitable growth and allowing significant, retentive awards for the company’s key assets: its people.

Many companies have a great set of core products/services.  They have developed a competitive advantage in those offerings and understand the specific market subsegments that find value in their purchase.  These core activities create strong, sustainable profits.

But then arise the dual temptations of 1) “mission creep”: the expansion beyond these core offerings, and 2) “avatar creep”: marketing/selling to customers who do not perceive/receive the highest value from these products/services. These diversions start out innocently enough, often as tangential add-ons, but are borne not of true market demand, but from an inwardly focused culture.  These initiatives may appear to address customer/market needs, but often merely distract management from addressing growing internal problems. They add operational complexities, confuse both consumers and employees, and can ultimately lead to cultural friction and diminished financial performance.

A ”mission creep” example: a company offering a nascent, evolving technology finds that their  offering(s) are not performing exactly as anticipated or promised. Customers ask for supplementary or stop-gap services, which customer service staff tries to accommodate. Instead of confronting the core issues around product improvements, a spiral of ad hoc deliverables takes hold. This unsanctioned “sub-division” consumes the attention of your most valuable people, squeezing out bandwidth for critical “must-have” improvements which would more effectively improve customer satisfaction. This bandwidth shortage leads to more hiring, misaligned with the company’s core mission.  Before you know it, payroll has ballooned past the point of profitability without cementing core customer relationships.

An ”avatar creep” example: An industrial services company finds that a particular type of client receives very high value from its services. These clients are large, sophisticated, and their needs align precisely with the company’s services. In an effort to generate growth, the company markets to smaller, less sophisticated customers. While sales to these customers increase revenue, it is at far smaller margins. Customer acquisition and service costs increase, production assets are strained and customer service demands may skyrocket – all contributing to decreased profitability, and if left unchecked, a potential cash crunch.

Examples of how this looks when acted upon: a healthy restaurant group operating in multiple venues undertook a broad analysis of their portfolio. This analysis revealed underperformance in a distinct segment, which led to shuttering numerous locations. While revenue decreased, margins strengthened and bandwidth was unlocked, allowing them to double-down on their profitable core and pursue a new venue type with far stronger growth potential.

A profitable 3PL enterprise performed a granular review of their client base, which revealed that many of their customers were in fact unprofitable. This detailed analysis resulted in culling 60% of their clients, refocusing on their best clients, and increasing EBITDA margins from 5% to 16%. This allowed the company to explore additional services and expansions that will further serve their core customers and at stronger margins, positioning them to attract additional clients of similarly high value.

In short, when companies take a page from turnaround management, doing a deep dive into core competencies that match specific high-value customer demands and shedding margin dilutive activities, friction in product development / distribution is minimized and Sales & Marketing messaging is clarified. Costs are reduced, and while revenue may lag in the short-term, increased margins and customer satisfaction open the door to far greater, more profitable revenues in the future.

This also highlights the rigorous due diligence necessary to undertake expansion. It involves an examination of specific customer demands, how they match with the company’s capabilities and a robust buy/build analysis. Stay tuned for our next blog, which will address this in greater detail.

____________________

Mark Taffet is CEO and Wolfgang Tsoutsouris a Managing Director at MAST Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle market companies.

Securities Offered Through SPP Capital Partners, LLC. 550 Fifth Avenue, 12th Floor, New York, NY 10036 Member FINRA/SIPC

/by

Funding From the Private Capital Markets Can Help You Reach Your Strategic Goals Without Bringing in Equity or New Partners

CEOs may pursue multiple avenues to growth and strengthening their company’s strategic position. Investing internally via capital expenditures (CAPEX) or making key hires may be appropriate for some companies, while others may find more attractive opportunities in acquisitions.

A business owner may have as a priority the diversification of their personal wealth so as not to be overly concentrated in the business.

Other business leaders may need to reorganize ownership of their companies.  This could mean concentrating ownership through the buy-out of shareholders who no longer wish to participate in the company. It may also entail passing ownership to the next generation or an executive team.

These actions share a common denominator: the need for external capital.  For a company to achieve its fullest potential, a CEO and their advisors need to understand how much capital is available to them, from whom and at what price. This is especially true if shareholders do not want to give up equity or bring in new partners.

Many CEOs hold a now obsolete view that commercial banks are the best, preferred and perhaps only source of non-equity capital for their companies. Even trusted advisors such as attorneys and accountants can share this bias. And while commercial banks remain excellent sources for asset-based lending, they may not be able to provide cost-effective capital beyond what can be secured with tangible assets.

Funding alternatives abound for CEOs

The corporate landscape has evolved; a greater percentage of companies produce profits and cash flow uncorrelated with or disproportionate to their tangible assets. Essentially, there has been a shift from manufacturing toward services. Companies that provide services, such as technology, distribution, marketing, light manufacturing, healthcare and others, do not require heavy investment in property, plant or equipment, or other physical assets.

CEOs of such companies may find that their trusted commercial bank cannot provide capital beyond the liquidation value of their tangible assets, totaling no more than 1x or 2x EBITDA, even though their business is highly profitable and has a track record of high quality of earnings.

Fortunately, the private capital markets have evolved and grown in recognition of this shift in the U.S. economy.  In addition to commercial banks, debt capital can be sourced from a large and rapidly growing pool of institutional non-bank lenders.  Pension funds, insurance companies, business development companies, family offices, credit opportunity funds and hedge funds are among the capital providers in this market, which currently number over 6,000 participants providing over 50% of the private commercial credit in the United States.

These institutional entities are not bound by the same regulations as commercial banks, allowing them to lend against cash flow and quality of earnings, rather than the liquidation value of tangible assets.  A borrower EBITDA of $5 million is generally the minimum to attract this type of capital, with no upper limit. Types of financing range from senior secured all the way down the capital stack, and current market conditions provide borrowers access to senior debt of 1.75x to 5.5x EBITDA depending on the amount and stability of EBITDA.  The amount of additional capital available to companies can be significant.

Raising capital for the right reasons

 Regardless of the type of capital you wish to raise, it has to be in the context of a rational business strategy.  If your focus is growth, how would having 2x-4x your current presumed funding capacity impact the company’s strategic plan?  Would that increased funding allow for more aggressive organic growth?  Would it allow you to consider more significant acquisitions to fuel enhanced competitiveness, drive growth and increase the value of your business?

There are numerous situations where an owner would benefit from recapitalizing their business, but the limitations imposed by the false belief of needing to raise equity or sell their companies unduly narrow the array of perceived options.

For example: Imagine a CEO who is uncomfortable with having a disproportionate percentage of their personal wealth concentrated in their company.  A recapitalization could be used to fund a dividend, allowing for the de-risking of their personal wealth portfolio. Another familiar situation is a desire to buy out partners or other shareholders who no longer wish to have their lives and financial risk tethered to a private company.

Common wisdom might suggest selling the company or bringing in a private equity investor, even if the CEO has no wish to sell or take on new partners.  However, a debt recapitalization allows the buy-out of some or all such shareholders, concentrating ownership with the CEO and aligning shareholder interest while avoiding governance issues.

Knowing how much funding is available to your company may provide fuel to reach your strategic goals, and even recalibrate your vision.  Whatever your funding requirements, business owners and CEOs should know that they have alternatives.  The Private Capital Markets have the depth and flexibility to allow you to reach your goals without compromising control of your company.

/0 Comments/by

Playing the COVID Bounce

There is a saying: “A crisis is a terrible thing to waste”.

The COVID pandemic has been a monumental crisis that has impacted our way of life and virtually every business.  Most business leaders have gone from anxiety to adrenalin rush, to frantically addressing never before seen challenges.  Many business leaders are now happy to have regained some normalcy and are perhaps a bit numb.

We are not yet out of the pandemic woods.  But increasing distribution of vaccines and acceptance of business and lifestyle practices that mitigate health risks are creating light at the end of the tunnel.

Some CEOs simply want and expect things to go back to “business as usual”.  Others are repairing companies that have been weakened financially, operationally or culturally by the pandemic.  If you have competitors who fit those profiles, opportunity may be knocking at your door.

Right now the time to capitalize on the expected post-pandemic economic bounce.

There are two paths to address specific opportunities COVID presents to your company:  Internal evolution driving organic growth, or external growth driven by acquisitions, joint ventures or partnerships.

It is a classic “Build or Buy” scenario.

Builders will have the advantage of tailoring an exact fit to their strategic needs. Resources can be allocated towards competency enhancing investments, including but not limited to:

  • Talent Acquisition: “Work from Anywhere” is a pre-pandemic trend that is accelerating. This creates opportunities recruit outside normal commuter geographies, with talent and fit overwhelming proximity as key drivers.  For companies in expensive metro areas where demand for talent is high and supply dear and expensive, recruiting remote workers in other regions has become a practical option.  For businesses in less populace geographies, recruiting high value remote workers outside their footprint is likewise a practical option.
  • External communication: Prior to the pandemic, video calls were a tool to be used judiciously. Now they are an accepted norm.  Your company requires technologies and training to execute on this evolving “business process”.  Client/customer exchanges are made more efficient, allowing your best client facing people and teams to interact more frequently with a greater number of accounts.   Business travel has been reduced and will be a source of continued savings.
  • Digital Customer Interaction: In-person B2B interactions are becoming increasingly digitized, fundamentally changing both the creation and implementation of “go to market” strategies.  Order lists, product availability, scheduling, exchange of documents and plans were all trending digital pre-pandemic, and those behaviors have accelerated.  Even more stark is the rapid acceptance of digital purchasing in the B2C sector.  This trend is over a decade old and is still picking up speed.  The pandemic has made it clear that consumers will engage in digital purchases even of products thought to necessitate in-person “touch” (perfume, candles, food products, furniture, etc.).  The extent of “Brick & Mortar Retail” disintermediation from the
  • Supply chain has yet to be seen; but retail real estate investors are clearly concerned. In either B2B or B2C interaction, business processes including but not limited to message crafting, customer acquisition, sales & marketing, and customer relationship management need to adapt both in terms of optimal skill sets and optimal business process platforms.
  • Reduced physical footprint: As a portion of employees work remotely part or full time, the need for office space will decrease, creating potential savings in physical plant.  Office space will need to adapt and be more flexible to meet those evolving needs.

Becoming “leading edge” in business processes might be considered primary targets for investment.

These might also be among the areas requiring a highly tailored tactical implementation of a company’s strategy.

Buyers may find opportunity in transactions involving wounded or distressed companies or assets.  A buyer can use their existing commercial platform to create operational leverage, significantly enhancing the performance of acquired assets or organizations.

Combined with efficiencies gained through business process evolutions described above, does this create an opportunity for your company to:

  • Acquire or merge with a competitor and materially rationalize staff and physical plant
  • Acquire or merge with a competitor and upgrade their business process through implementation of the acquirer
  • Acquire or merge with a direct competitor to drive increased market share
  • Acquire or merge with companies at rational values that are in adjacent markets or geographies
  • Seek any of the above in a manner that would scale your business to a point where its valuation is enhanced, access to financing increased and/or it becomes an attractive home to superior talent?

Driving growth through organic or external initiatives can both succeed.  The choice is case-specific.  The critical point is that if you and your company “lean into” where your industry is evolving, you have a competitive advantage over companies and executives who are just happy that the pandemic is receding, waiting for a return to the way things were, are still a bit numb and/or have seen their companies weakened by the pandemic.

It’s time for a “bias towards action”.

/0 Comments/by

Predictive Analytics for Your Business Cash-Flow Forecasting

By Mark Taffet & Wolfgang Tsoutsouris

CEOs set a goal, develop strategies to achieve it and undertake tactical implementation.

How do you know if you can “fund the plan”?  How do you know if you have the capital to really “play to win”?

One source of capital to “fund the plan” is your company’s ability to access the private capital markets; a topic we’ve addressed in prior blogs.

A second source requires you to be a visionary and understand how much cash your company will produce that can be reinvested to “fund the plan”. Fortunately, you have a crystal ball at your disposal: Your cash flow forecast.

An effective cash flow forecast ties into your company’s operating plan and budget, telling you what your cash position will be at any point during the projected period (usually 9 – 12 months). Understanding your free cash flow and ability to raise capital will give you a realistic and reasonably precise picture of your total funding capability.

Creating a cash flow forecast requires that you and your team determine the cost of the tactical implementation of your strategic plan. It requires rigorous dialogue where your teammates make and challenge assumptions. The discussions will explore how daily execution ties to the broader strategy. They will involve measures against KPI’s – past successes and failures, improvements and shortfalls. The degree to which you and your team understand your business machine will be evident in those assumptions that survive to the final forecast model. An effective cash flow forecast helps to determine your company’s ability to:

  • make an acquisition,
  • invest in equipment or technology,
  • measure team performance,
  • guide tax strategy, and
  • fulfill hiring needs

With foreknowledge of your cash position, you can present funding requirements to lenders and investors. You can then layer in those actions and financing assumptions as a “scenario” in your cash flow model.

What if your assumptions are incorrect? After finalizing your cash flow projections, you carefully track actual performance to the forecast on a weekly, monthly and quarterly basis. If the cash flow forecast is your crystal ball, the Budget-to-Actuals Report (“Variance Report”) is both your report card and your thermometer. The Variance Report tells you:

  • the accuracy of your assumptions,
  • how your team has performed vs. KPIs, and
  • what tactics/strategies are (or are not) working.

Your Variance Report provides an early warning for where your attention is required, re-allocation of resources and/or a re-prioritization of strategies might be necessary.

The Variance Report creates an irrefutable record which measures the performance of you and your team.  If variances are recognized, acknowledged and discussed in a frank manner, you can change course rapidly, creating a culture that is nimble, evolving and dynamic; driven by data and analysis and focused on achieving your goal.

The frequency of the budgeting process varies depending on the nature and volatility of your business and industry, but the review of actual performance vs projections should be ongoing. Problems are often unexpected and you need to find them before they find you.

______________________

Mark Taffet is CEO and Wolfgang Tsoutsouris a Director at MAST Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle-market companies.

Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

 

/0 Comments/by

Funding Your Company’s Organic Growth Plan

Step 1 in developing a strategic growth plan for your company is determining the scale and scope of its market opportunity. Expansion may come from taking market share away from competitors, participating in overall market growth, innovating superior customer solutions, geographic expansion or through other channels.

Step 2 in developing a strategic growth plan for your company is understanding how much investment you can fund. It’s great to have a fantastic plan, but if you cannot fund it, it cannot be implemented.

If you are not aware of what funding is available to your company, you may materially underutilize its resources and capabilities. If you agree that a CEO’s job is maximizing value for all stakeholders, underutilizing your company’s resources and capabilities must be avoided.

CEOs often believe that funds available for organic growth equals free cash flow and what a commercial bank will lend against tangible assets such as receivables, inventory and equipment. For successful “asset light” businesses, this is an untrue limiting belief.

As described in previous articles, approximately 40% of US institutional corporate lenders make lending decisions on the quality of a company’s cash flow rather than the liquidation value of tangible assets. The CEO of a company with $5 million in EBITDA, $5 million in receivables and $5 million in inventory may believe that their borrowing capacity is $6-$8 million, when in fact it might be $12-$20 million. This capital availability is in addition to your company’s free cash flow.

If your business has significant, realistic growth potential, a practical plan for addressing the market and a management team capable of implementing the plan, why be limited by a false belief that you cannot fund the plan? If your ROI is projected to be 2x or more than your cost of capital, why would you not put capital to work to make your company more competitive and profitable?

Based on the fact pattern above, let’s assume that a company has 1x EBITDA for a working capital revolving line of credit.   Further assume the business can invest $1.5 mil in annual free cash flow. If you only consider asset based loans from commercial banks, it will be difficult to invest more than free cash flow and perhaps $1 million from an asset based borrowing facility.

That same company can go to an institutional cash flow lender and potentially arrange a $15 mil to $20 mil credit facility, including a $5 mil revolver. Let’s assume you do not want to fully extend the company but are willing to access debt of $12 million: $5 mil for your revolver and a $7 mil term loan to fund growth. Your company will invest $1.5 mil from free cash flow in each of two years and draw $3.5 mil on its term in each of two years to fund a growth plan.

Over a two year period, the company will have $5 million available for working capital and an additional $10 million to invest in growth. For this example, let’s assume that:

  • Interest on all debt is 7%
  • Mandatory amortization for the term loan is 5% of principal plus 50% of available free cash flow
  • The company’s $5 mil baseline EBITDA has no growth
  • EBITDA generated by new investment has no return the year it is made, 15% ROI the following year and grows 15% annually thereafter

In this scenario, the company’s Debt to EBITDA ratio rises from 1-1 to 2.4-1 at the beginning of year 1: with $3 mil to $8 mil of additional borrowing capacity. It will rapidly de-lever through both debt amortization and increasing EBITDA. This can be seen in the chart below:

Funding Your Company's Organic Growth | MAST Advisors

In this scenario, your company’s Debt/EBITDA ratio falls to 2-1 by the end of year 1 and 1.4-1 by the end of year 2. Thereafter, EBITDA growth brings the company’s remaining working capital debt below the original 1-1.

Importantly, even with the reinvestment of cash flow and debt amortization, the company is still able to maintain moderate distributions to shareholders in years 1 & 2, with substantial increases in distributions in years 3-5.

Perhaps most significant, implementing the strategic growth plan will increase the profitability and competitiveness of your company. Those trends most often result in a substantial increase in the value of your business that can equal an additional 1x-3x EBITDA. In this example, the original company might be valued at 7x EBITDA, or $35 million. After growing from $5 mil to $7 mil in EBITDA, that value might be 8x EBITDA or $56 million.

If your company has the opportunity and ability to achieve significant growth and you as CEO want to maximize value for stakeholders, understanding the amount of capital that can be deployed to implement a well-structured strategic growth plan is a fundamental aspect to success.

If you have any questions, please reach out to me at mtaffet@mastadvisors.com.

______________________

Mark Taffet is CEO of Mast Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle-market companies. Information regarding specific aspects of the private capital markets has been provided by SPP Capital Partners, an investment bank focused on raising funds in the private capital markets.

Securities offered through SPP Capital Partners, LLC: 550 5th Ave., 12th Floor, New York, NY 10036. Member FINRA/SIPC

 

/0 Comments/by

Cashing In Without Cashing Out: Dividend-Levered Recapitalizations

You own and run a successful company.

You feel strongly that your company will do well, grow and increase in value.

You want to continue to run your business and don’t want or need any, or any more partners.

The company is worth a lot. It may represent 60%-90% of your net worth.

Even though your company is doing well and has rosy prospects, there is always the possibility that things will go wrong and your business will falter.

Having the majority of your wealth tied to a single asset creates great risk. You wonder, “How do I mitigate that risk while continuing to own and run my company?”

A most efficient way to mitigate your risk of wealth concentration is to do a dividend levered recapitalization.

This uses the same financial engineering that private equity firms employ. The difference is that you can:

  • Maintain your existing ownership position
  • Take almost as much capital out of your company as you would in a PE deal
  • Maintain management control and continuity
  • Avoid the fees PE firms charge and disruption they can create

An example of how a levered recap mitigates your risk of wealth concentration in your business might go as follows:

  • Your company has EBITDA of $5 million
  • The Company borrows $20 million – 4x EBITDA – on a NON-RECOURSE basis
  • $5 million remains with the business for working capital
  • $14 million is paid out to you as a dividend, with ~$1 mil paid in fees & expenses to the various parties to the transaction
  • Your cost of capital in today’s market will be 6%-7% above LIBOR
  • The multiple of EBITDA and interest rates available improve as EBITDA grows

The $14 million you take as a dividend will generally have significant tax advantages vs. receiving annual profit-sharing at ordinary income rates.

You and your family have greater financial security if anything should happen to your business.

What happens to your company? Isn’t the risk to the business increased?

The answer is, not really.

Management hasn’t changed and the company has adequate working capital to continue to grow and thrive. After taking the dividend out of your company, debt is quickly amortized: not so fast as to eliminate growth investments, but fast enough to “de-lever” your company rapidly.

In the example below, the assumption is that your company’s EBITDA will grow at 10% annually and that you will want to balance debt amortization with growth investments and continued cash distributions to shareholders.

Year 1

Year 2

 Year 3
Company EBITDA $5.0 million $5.5 million $6.0 million
Existing Debt $20.0 million $19.0 million $16 million
Amortization – Scheduled $1.0 million (5%) $1.0 million (5%) $1.0 million (5%)
Remaining EBITDA $4.0 million $4.6 million $5.2 million
Amortization – ECF Sweep

(see note below)

 NA $2.0 million (~50% After Tax Cash Flow) $2.2 million (~50% After Tax Cash Flow)
Ending Debt $19.0 million $16.0 million $12.8 million
Ending Total Leverage 3.80x 2.90x 2.13x

 

This example demonstrates that by year 2 after the dividend, shareholders can again begin to take distributions from the company, and that the ratio of debt to EBITDA reduces from 4x EBITDA to begin to 2.9x at the end of year two, and 2.13x at the end of year three. Please remember that 1x EBITDA is your working capital line.

2.9x EBITDA – 2.13x EBITDA do not represent a high leverage ratios that should create risk to your business.

In years 2 & 3 after required debt amortization, you have the option to apply the second 50% of after tax cash flow to distributions to shareholders, further balancing your wealth portfolio. You may also apply those funds to growth initiatives.

An alternate path is to apply those funds to faster debt amortization. If this tact is taken, ending debt at the end of year two will be $14 mil – 2.55x EBITDA. At the end of year 3, ending debt will be $10.6 mil – 1.77x EBITDA; a conservative level.

It is important to re-iterate that a dividend recap is a RISK MITIGATION STRATEGY for balancing your wealth between your company and personal holdings.

The borrowings described above are NON-RECOURSE to you. Should something go wrong in your business, you and your family have – in this example – $14 million more held outside your business to mitigate risk to your personal wealth.

This article covers a lot of ground quickly and may leave you with more questions than answers. If you do have questions, please contact Mark Taffet at mtaffet@mastadvisors.com

 

 

Mark Taffet is CEO of MAST Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle-market companies. Information regarding specific aspects of the private capital markets has been provided by SPP Capital Partners, an investment bank focused on raising funds in the private capital markets, and an affiliate of MAST

NOTE: Cash payment of Excess Cash Flow (“ECF”) sweep amortization occurs after the yearly audit is completed. ECF is generally defined as EBITDA less the following: (i) capital expenditures for the period; (ii) cash taxes; (iii) principal payments; (iv) cash interest expense; (v) cash management fees; (vi) restricted distributions for each year. ECF is a highly negotiated term of any credit agreement.

 

 

/0 Comments/by

Accessing the Private Capital Markets: Cash Flow vs. Asset-Based Borrowing

Many CEOs believe the amount of reasonably priced senior capital their company can obtain is limited by the hard assets that can be pledged as collateral: inventory, receivables, machinery, equipment, etc.

That is simply no longer true.

Over the last two decades, the success and profitability of US businesses have become less dependent on owning hard assets.

Highly skilled people, technology, customer experience, provision of services, and other forces are the predominant factors in a company’s health. Even for asset heavy businesses, the difference between success and failure is usually not their hard assets, but having the people, strategies, processes, systems, and technologies to beat the competition.

Private Capital Market participants have developed a deep and flexible toolkit to provide capital that fuels this evolution in the US economy.

Commercial banks, especially in the lower middle market, tend to be more asset focused. Their basis for lending is having sufficient collateral so their loans will be paid off if the borrower has to be liquidated.

Non-bank lenders and some commercial banks are increasingly “enterprise” vs. asset-based in their investment analyses. For these lenders, EBITDA, “Adjusted EBITDA,” cash-flow available for debt service, and getting comfortable with the quality and consistency of a company’s earnings have replaced the liquidation value of hard assets as the basis for providing capital to clients.

Asset-based lending is still the least expensive, and for smaller companies perhaps the only form of senior capital available. Once a company passes $3 million in EBITDA, private capital market participants want to talk.

Key differences between asset-based and cash flow borrowing include:

  • Cost: cash flow borrowing can have interest rates 2%-4% higher than asset-backed loans
  • Capital Available: commercial banks and asset-backed lenders are usually limited to fixed percentages of available collateral, and top out at 3x EBITDA. Cash flow lenders can go to 4.5x EBITDA on senior debt. This additional capital availability can make a significant difference for companies that have good use for funds.
  • Amortization: Banks will require a minimum of 10% fixed annual amortization, and often more, depending on the terms of a loan. Cash flow lenders can create amortization schedules that are flexible and may be as low as 1%-5% annually. This allows more of your cash flow to be re-invested or used for dividends.

The flexibility available to companies seeking funds from the private capital markets is not a “one size fits all” proposition.

For many companies, a blend of asset-based and cash flow borrowing might create an optimal outcome. For others, very low cost asset-based borrowing might be the right way to go.

If you are the CEO of a healthy company where success and profitability are not based on having more hard assets, and where growth investments (whether for organic growth or external acquisitions), buying out partners or “taking some chips off the table” are smart things to do, cash flow based borrowing may provide more capital at a lower cost than you had thought possible.

This article addresses only the narrow topic of raising senior capital. Information on other funding options available in the private capital markets will be addressed in future articles.

If you have any questions, please reach out to me at mtaffet@mastadvisors.com

_________________

Mark Taffet is CEO of Mast Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle market companies. Information regarding specific aspects of the private capital markets has been provided by SPP Capital Partners, an investment bank focused on raising funds in the private capital markets.

/0 Comments/by

Accessing the Private Capital Markets: Raising Money for Your Company Without Giving Up Equity

There are many reasons you may want to raise money for your company, among them:

  • Fund organic growth or strategic acquisitions;
  • Provide a dividend to balance your concentration of wealth between your company and investments held as an individual; and
  • Allow for your “Next Generation” or management team to buy into the business for fair value

Your company is valuable and has strong quality of earnings.  Your bank doesn’t “see it” and is limiting capital availability to a percentage of asset coverage AND they want a personal guarantee.

Why can’t you obtain funding the way Private Equity players do; just wave a magic wand and have money go from your pocket to their pocket and back to you?

You CAN raise capital just like private equity players do, without giving up equity ownership in your business.  There is no magic or genius to it; just having someone to guide you through the process of raising money on the private capital markets.

What are the Private Capital Markets?

Many CEOs believe that commercial banks are THE sole source of debt capital for their companies.  This was never true, and ignores an enormous shift in capital availability since “The Great Recession”.

Prior to The Great Recession, commercial banks became aggressive in their lending practices and bets  for their own investment accounts.  When such banks had reality bite in the recession, it threatened the national – and international – economy.  YOU, as a taxpayer to the US government bailed out the banks.  The expectation among such banks that they will be bailed out is called “Moral Hazard”.

Regulations were placed on commercial banks to prevent another melt-down and discourage moral hazard.

  • The Federal Reserve, the Office of the Comptroller of the Currency (“the “OCC”) and the FDIC established “Leverage Guidelines”
    • Generally limited commercial banks’ capacity to lend (no more than 3X LTM EBITDA)
    • Enforced higher fixed amortization rates (~10%-15% per annum)

For every action there is a reaction.  In this case, the reaction was the creation of several types alternative “non-bank” commercial lenders that have more than reached critical mass.  There are now over 5,000 such lenders and they comprise approximately 50% of the private debt capital available to corporate borrowers.  These lenders take various forms and include:

  • Credit Opportunity Funds
  • Business Development Companies (“BDCs”)
  • Insurance Companies
  • Non-Bank Direct Lenders
  • Family Offices

Commercial Banks vs. Institutional Alternative Lenders

Fundamentally, raising capital from commercial banks and alternative lenders is identical.  Risk/credit analysis is performed, financings are accepted or rejected.  The debt is “priced”.  Due diligence is completed and loan documentation is put in place to close the deal.

The critical differences today between commercial banks and alternative lenders involves the risk each can take on and the repayment terms they can offer.

As a general proposition, non-bank lenders

  • Tend to be much more comfortable with “cash-flow” lending, and are not limited to   “asset-based facilities” or other measures of the value of the borrower’s collateral
  • Maybe a little more expensive than commercial banks,
    • but have less stringent fixed amortization (1%-7% per annum)
    • looser covenants
    • more generous leverage multiples (4X LTM EBITDA) and
    • no need for personal guarantees
  • The transaction process itself is quite similar to the way a bank approves a loan
    • They receive an offering memorandum, perform their own credit review and engage counsel to document the deal
  • When professionally presented, the transaction process should take 8-12 weeks

Accessing the market

Alternative institutional lenders generally require some minimum deal size to have interest in a transaction.  $10 million as a minimum amount is generally a good rule of thumb.  Accordingly, accessing the entire breadth of capital providers is for companies that are at least mid-sized – $3 mil to $5 mil in EBITDA.  For companies that do not meet this threshold, commercial banks are probably the best capital source.  The best way to create more options for your company is to GROW PROFITABLY.

When approaching the private capital markets, all options should be explored; bank and non-bank lenders should be given the opportunity to compete for your business.  More than one structure for raising capital is usually available.  These alternatives can be CRAFTED TO MEET THE VERY SPECIFIC FINANCIAL AND COMMERCIAL GOALS of you and your company.

Once you broaden the horizon of potential capital sources, it is important to determine the type of deal that is best for you.  The types of debt capital that can be made available include:

  • Senior Revolving Credit facilities,
  • Terms Loans;
  • Mezzanine Securities – instruments that are “junior” or “subordinate” to senior debt
  • “Unitranche” Facilities- all senior facilities that provide senior and sub debt in one instrument.
  • Asset-based  or Cash flow facilities
  • Unique “structured” facilities—debt repaid through a specific contract or asset’s cash flow

It may wind up that the best deal for you and your company is from a bank; or they may take part of the deal.  It may be that several non-bank lenders provide the best solution or that one non-bank lender provides the best opportunity.

Determining the optimal alternative structures for you and your company and allowing the market to compete for the deal is the best way to obtain the most advantageous result.

Process of accessing the market

Accessing the private capital markets is not magical nor does it require genius.  It does require guidance from professionals who know:

  • How to analyze your commercial & financial needs and craft alternatives to raise capital to meet those needs
  • Groups of lenders in each of several categories that want to participate with your company in the various alternative financing scenarios you are exploring
  • How to create a competitive process for potential capital providers to partner with your company so there is an opportunity to negotiate the best possible
    • Rates
    • Terms
    • Covenants
    • Amortization schedules

Experience and diligence, not magic or genius, are what will get you the money you need in the structure you need it.

Approaching this discussion is not about over-levering your company and putting it, and your personal wealth, at risk.  Rather, mitigating and diminishing your risk by getting money out of your company to balance your risk; investing capital in organic growth or acquisitions that will yield an ROI of more than 2x your borrowing costs, or; allowing family members or management to buy into your business, and thus stabilizing it long term are goals deserving of your attention.

This overview covers many points that each deserve dozens of pages of explanation.  Should you wish to take a next step in exploring opportunities your company may have to raise capital, please reach out to me at mtaffet@mastadvisors.com.

 

 

 

 

 

 

 

/0 Comments/by