Where a company is on its growth journey influences the proportions of debt and equity in its capital stack. In general, early-stage companies have more equity than debt because debt providers may want at least interest payments on a timely schedule whereas equity investors will wait for a return on their capital in exchange for ownership.
Nonetheless, every financing challenge has the potential for a debt solution, and most companies can attract some level of debt funding so long as they have a compelling enough proposition and offering. The providers of that debt, however, are often more diverse than company leaders realise.
To find the most appropriate lender, business leaders need begin by identifying their current investment needs—after all debt tends to be an event-led requirement—and then determining the driver of those needs, such as their strategic plan. Next, they should evaluate the key players in the debt landscape—including both traditional and private lenders (aka alternative lenders). By mapping this landscape and thinking about funding participants in the context of their current business operations, leaders can establish which participants and products they have access to and which of these available options best fits with both their current financing needs and long-term strategic plan.
An Overview of Traditional v. Private Capital Lenders
In general, traditional and private capital lenders will have different risk appetites, so they may evaluate businesses differently and prioritise different criteria when determining whether to extend credit to a candidate. Because of their differing risk models, these funding participants are more attracted to some businesses and types of investments than others.
Traditional lenders such as banks may have lower risk appetite for certain sectors or asset classes than private capital lenders, and they may require a higher level of control as well as interest and principal repayments over the life of the facility. In exchange, the borrower likely gets access to a lower cost of credit than with a private capital lender.
Banks often work repeatedly with the same customer: they operate by participating in lending cycles in which businesses leverage up, pay down and leverage up again. They evaluate a company’s EBITDA (earnings before interest, taxes, depreciation and amortization)—a metric representing the profit generated by a business’s operations and available to service its debts—to determine which lending products to offer and how much debt (often represented as a multiple of EBITDA) to extend. They focus on a candidate’s past performance and the stability and sustainability of its business model when establishing the structure and form of debt financing that they will provide.
On the other hand, private capital lenders such as credit funds or direct lenders focus heavily on a company’s business plan and potential for future success. They have a forward-looking proposition: they expect the business use the loan to deliver its business plan so that in a few years’ time, it will be more valuable and more attractive to other investors or capital providers. Then, they can either exit the investment by refinancing it to a bank or follow on with new investment as the business continues to grow. Private credit funds often loan more multiples of EBITDA than traditional lenders, and they may only mandate interest repayments during the loan, with repayment of the principal being due at end of the tenor. However, they tend to charge higher interest rates since they may take more risk than traditional lenders, making the overall cost of servicing the capital more expensive.
Mapping the debt landscape is challenging, and a business’s performance history, growth trajectory, investment needs and future plans all influence the funding participants and products to which it has access. Below are three illustrative scenarios in which support from a debt advisor can help business leaders find the best funding solution.
After developing a five-year business plan, a company with a strong record of past performance determines it needs financing to build an extension to its factory. The profitability and sustainability of the business makes the company an attractive candidate for debt financing from its current bank.
How Debt Advisory Can Help
The bank servicing the company knows its business model and financial history, so it’s likely that the company’s request will be well received and that they will have access to various debt products from this provider. However, fund raising processes benefit from competitive tension to ensure that at the end of the process the company receives the best possible deal. A debt advisory team can help the company create that tension by approaching other lenders in a structured and managed way—particularly traditional lenders offering similar products—and discovering the terms that they would provide to the company. Armed with this external and independent guidance, the company can review all offers and negotiate with support from the debt advisor, ensuring that they end up with the best possible deal in the current market before executing the deal and securing the debt.
The management team of a longstanding manufacturing business is seeking to buy the company from its founder. The company has a long track record of successful trading, a strong reputation and a solid growth trajectory. The business’s continued success will be driven by its professional management team who have been in situ for a number of years. A management buyout (MBO) of the business is the preferred option for the founder and management.
How Debt Advisory Can Help
Management teams may waste time writing a funding proposal in hope that a lender might grant them 100% of the funding required to acquire the business via debt. However, a debt advisory team knows that this scenario generally only happens in a small percentage of cases usually with the support of the vendor. The more likely outcome is that the management team will need a combination of debt and equity (of which various instruments could be considered) to accomplish the MBO.
A debt advisory team can engage with management throughout the buyout process, designing the optimum funding structure to achieve the goal of acquiring the business while also ensuring that the business has a stable and secure capital structure that provides a platform for continued growth. The advisory team can help the company prepare a business plan and approach funders across the capital stack that have a future-focused mindset, ensuring that the business has the greatest chance of completing the MBO.
A private-equity sponsor is buying a business with a strong record of past performance, and it also wants to purchase the two competitors that the company had intended to acquire as its ‘buy-and-build’ business strategy. The buyer needs an acquisition loan that allows them to acquire the target company and a committed future acquisition facility that de-risks its growth strategy by having the capital available to complete the buy-and-build strategy. In effect, the sponsor is seeking to leverage all the companies and to maximise the amount of debt that can be achieved.
How Debt Advisory Can Help
The buyer has a number of strategic goals that they wish to achieve in addition to generating a leveraged return on their equity. Therefore, the buyer may wish to explore debt options that meet all their needs or the majority of them. For example, by minimising the amount of equity they put into the business and maximising the amount of debt the business can carry, they can guarantee that there’s a better return for every euro invested.
To find the best financing solution, the buyer needs to employ a dual strategy in which they approach both the banking and private capital markets. A debt advisory team can help the buyer explore all possible avenues for debt financing and then compare and contrast the different options available within the debt market.
The banking market will likely provide the capital at lower cost but with more restrictive terms about the actions that the buyer can and cannot take. The private capital market will likely be more expensive to access but will provide the buyer with flexibility and optionality within the deal structure, offering the trade-off of higher cost for higher control. The debt advisory team can provide an independent perspective about which of these options might be best suited for the buyer’s particular goals.
Our Debt Advisory team works with professional investors and corporate clients, advising on all debt capital markets products locally and globally. We provide trusted expert advice, assisting clients with sourcing, negotiating and structuring new or existing debt.
The team has expertise in various sectors and markets, including bank facilities, debt capital markets, alternative lenders, leveraged finance, asset-based lending, real estate finance, structured finance, non-profits and charities and company-side restructuring finance. The Debt Advisory team is integrated with and works in collaboration with Grant Thornton’s Deal Advisory. The team is also complemented by Grant Thornton’s global debt advisory network and other professionals throughout member firms.
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