Looking for debt finance to drive organic or inorganic business growth?
Here are some top tips from our debt experts
Lenders tend to focus on downside risks when assessing a business’s suitability for lending. When making their assessment, lenders are primarily looking for evidence of resilience, that the business will sustain current activity levels and profits and not go backwards.
Key areas of focus
Lenders assess resilience by looking at many factors, and the key ones include:
1. Historical resilience
Profit margins are scrutinised as indicators of value and resilience. High margins can suggest a high-value business with importance to customers, while low margins might indicate lower value to customers and vulnerability to economic shocks and cost base rises.
Lenders review past performance, including at times of stress, for instance, they might review performance during Covid, to assess the business’s resilience and ability to survive future shocks.
2. Quality of earnings
Lenders evaluate the quality and sustainability of earnings, ensuring profit figures are representative and can withstand due diligence. For example, they will interrogate any add-backs to profit levels for one-off events and take a view on these themselves.
They look for unusual costs, non-recurring expenses and potential underinvestment in the business. Has the asset base been maintained properly or have the assets been left to deteriorate in return for short-term profits?
3. Sustainability of income
Is the income one-off in nature or can it be described as repeat or recurring, which is preferred. Does the business have a strong forward order book, repeating customers over many years, long-term contracts and recurring revenue streams (e.g. subscriptions)? These are crucial for demonstrating sustainable income.
4. Management team
A credible and cohesive management team that works well together with no conflict is essential. Lenders also need confidence that the team is well-incentivised and will remain with the business over the medium term. For example, is the incentive structure across the management team fair? Is there a risk of any of the senior team leaving? Lenders like a stable and effective team and want to meet the key characters in person.
5. Market positioning
Lenders will assess the business’s position in the market, including competition levels, risk of new entrants, barriers to entry and customer satisfaction scores. You will be much less likely to raise financing if you are a bottom-quartile operator.
6. Quality management information
Reliable and robust management information (MI) is a given. Lenders are hesitant to lend where MI is poor, as they have no comfort in the numbers. MI should include balance sheets, cash flow, and profit and loss accounts.
7. Sector considerations
Lender credit teams have personal and institutional preferences and aversions based on recent and past experiences, macroeconomic factors and reputational concerns. Sectors like software, business services and healthcare can be favoured. Meanwhile, companies operating in, say, fossil fuel, gambling, parts of the defence and adult sectors are seen as having high reputational risk and face challenges.
What to think about before starting out on a debt raise
1. Clearly define your objectives
Consider your business objectives and potential changes over the next three to five years, including possible acquisitions, asset purchases and other financial goals. Understanding possible changes to your business in the next few years helps you shape the right debt facility and terms for you.
2. Understand risks
Be aware that adding debt to a business increases risk, so assessing it ensures that it is at an acceptable level. The risk arises due to new interest payments, capital requirements and potential restrictions on spending in certain areas. Lenders want to see a financial model for any material lend for at least three years and use this to assess risk levels and a suitable level of debt for a business.
3. Ensure readiness
Prepare your business for the diligence process by organising legal paperwork, financial reporting and management information. Ensure that your financials are reliable, robust and on time. Cover off any outstanding legal issues such as employee and customer contracts and any financial matters like defined benefit pensions liabilities.
4. Personal guarantees
Understand that some lenders may try to encourage you to give personal guarantees. This should be avoided where possible. Speak to more than one lender to maintain competitive tension here.
Consider that personal guarantees are relevant for smaller loans but less common for larger, leveraged deals.
Summary
To secure financing, ensure your business is well-prepared, understand the risks involved and focus on business performance throughout the process. Lenders become very nervous if financial performance stalls during the closing phases of a lending process.
Make sure you are ready, have a plan for the next three years and understand your downside risk if you’re going through a debt-raising and diligence process. Make sure that business doesn’t fall off during that lending process.
All this increases your chances of successfully obtaining the necessary funding.
For more information or advice, please get in touch.
