The current economy has brought many
changes to business, particularly
regarding financing. The multiples of
cash flow that most banks are lending has
decreased significantly, anywhere from one
to 1.5 multiples, and many banks have
stopped cash flow lending. Banks are also
more cautious when lending to businesses.
“What were the standards 12 months ago
are no longer in place because so many
banks are looking to deleverage,” says Barry
Worth, CPA/ABV, CVA, CM&AA, member
and head of mergers and acquisitions and
turnaround consulting at Brown Smith
Wallace LLC. “Bank lending policies have
changed significantly to where they will lend
much less money at today’s levels than they
did 12 and 15 months ago.”
Smart Business spoke with Worth about
how different areas of financial analysis and
structuring can help you improve your financial position.
What financial analysis and structuring
measures should be used during these
times?
In all types of transactions, a debt and capital structure evaluation, along with a working capital review, are key to structuring debt
and equity. These analyses require planning
and forecasting on the front end. Working
capital is one of the major lifelines of the business — it’s operating capital. You can’t get
through a 12-month period or a growth period without having adequate working capital.
So, you should definitely conduct a study of
the working capital needs of the business.
You should look at planned inventory
returns, how long the receivable collection
period is, and what the normal payment period would be for accounts payable. These all
have a bearing on cash flow, which affects
how much working capital is required on a
periodic basis.
How can businesses plan and forecast in
these areas?
You really need estimates of revenues and
expenses, looking out over a three- to five-year period, to prepare budgets. People who
have a good handle on their business generally have a feel for what their growth percentages will be and how they’re going to
achieve those. What they can never fully
know are what the market conditions will be.
For instance, some businesses go through
cycles. But, whatever the situation, the
important thing is that a company prepares
forecasts. They need to roll those forecasts
forward based upon current conditions as
they change, so they’re prepared to either
recapitalize the business — put in additional
equity — or determine that they’re going to
have greater borrowing needs — increase
the debt. If either of these options aren’t available to you because banks believe you’re
over-leveraged, you can pursue either additional investors or mezzanine lenders, which
provide funds that are always subordinated
to senior debt.
Can you still effect a merger or acquisition?
Sure. A number of companies with strong
balance sheets are looking to acquire strategic assets. Whether you are seeking acquisitions or considering selling, a strong financial
position will help you.
From a financial perspective, most deals
will be successful or unsuccessful based upon the structuring of the debt and equity.
There’s always a balance you have to strike.
Banks will lend primarily based upon collateral, so some deals may not go through
because the banks have cut back on how
much they will lend on a transaction.
Look at how you’re going to structure the
total needs of the business, between how
much debt you’re going to be able to get from
the banks and how much equity you can
raise, either from yourself or yourself plus
investors. If there is a gap, you can go to the
mezzanine players, where the funds can be
interest bearing and/or interest bearing plus
some convertible securities.
What options does a troubled company
have?
Troubled companies have had significant
losses, and banks demand a lot more from
them, including ‘find another bank.’ A lot of
companies that are hurting now are going to
have to get capital infusions of additional
equity. There’s always reluctance on the part
of the company owner or owners to take in
additional investors because it cuts down on
their percentage of ownership. But, in most
of these cases, the owners won’t have a
choice, it’s a matter of survival. Generally, the
debt restructuring or refinancing will require
additional equity. These owners will have to
show some improvement or a plan on how
they’re going to improve the business before
they can get additional capital or refinancing.
We’ll be seeing a lot of these transactions in
the next couple of years.
What are the benefits of a financial analysis
and structuring initiative?
The critical value comes from understanding your business and establishing strategic
positions and directions that you might not
necessarily have thought of if you didn’t
plan. The practical value is that you’ll be better able to convince a banker or investor to
provide you with the funds to achieve your
plan.
BARRY WORTH, CPA/ABV, CVA, CM&AA, is a member and head of mergers and acquisitions and turnaround consulting at Brown
Smith Wallace LLC. Reach him at (314) 983-1202 or [email protected].
