Emergence of Alternative Lenders
Over the past number of years we have experienced a changing landscape in finance. The current financial environment requires a variety of funding options to be assessed to identify the most suitable solution to meet the evolving needs of businesses. Whether a business is raising finance for capital expenditure, acquisition, refinancing debt, or cashflow etc. there are now many options available. In today’s environment, the main metric for debt approval is based upon sustainable free cash flow and trading performance, along with Loan to Value (“LTV” – a percentage of the value of the asset provided as security to the lender).
Traditional banks (AIB, BOI etc.) have continued to lend, albeit with tight policy guidelines, to businesses that can show experience, a track record and lower perceived risk. As a result of the traditional banks lending policies we have seen the emergence of alternative debt lenders in the marketplace (backed mainly by international investment funds); for example Origin Capital, LeBruin, Profunder, Finance Ireland, Earlsfort Capital Partners, Close Brothers and BIBBY.
Alternative lenders are offering a viable option for Borrowers. They provide different levels of senior debt across a wide range of sectors and specialise in niche areas of the market (hotels, property, trading entities etc.). Generally alternative lenders will provide higher capital amounts (higher LTV c. 70% – 80%) toward transactions than traditional Banks. However finance is usually offered at a higher interest rate (coupons of c. 6% – 9%), over shorter periods (5 year terms), with arrangement fees (entry & exit).
The continued recovery has led to increased transactions in new fund raising for growth, M&A’s and refinancing. Alternative lenders are increasingly assisting in funding this activity. It is expected that we will continue to see the alternative lenders play a strong role in funding transactions going forward, even with traditional banks competing strongly in the senior debt space.
The funding gap
Indicators suggest that the economic cycle has turned with the Irish and world economy emerging from the downturn. As the economic environment improves we are seeing a change from business survival to growth. This has created future strategic opportunities in areas such as:
- Succession Planning
- Management Buyouts
- Management Buy-ins
- Organic Growth Financing
- Acquisition Growth Financing
- Corporate Restructures
In the current climate both Banks and Alternative Senior Debt Lenders LTV policies will not usually cover 100% of the capital required (standard LTV 50% – 80%) to complete a transaction. This can result in a funding or equity gap – requiring capital input by the borrowing party. As minimal capital has been built up within businesses over the past number of years this funding gap can create road blocks for parties seeking to raise finance to implement future strategies. A business may not have the required capital available to fund the gap, making it difficult to take advantage of opportunities. Traditionally businesses without access to further equity lacked the ability to execute their planned future strategies. Senior Debt Lenders require sizeable equity contributions from businesses to fund strategies.
Narrowing The Funding Gap – Opportunities, Capital Structure & Equity Partners
Cost savings, revenue synergies and an ability to purchase acquisitions at lower EBITDA multiples (valuations) currently make expansion or buy and build strategies highly attractive. In a welcomed new development we have seen entities enter the marketplace who assist in narrowing the funding gap by way of offering capital for equity positions within a business; for example Renatus Capital Partners, Causeway Capital Partners, Kish Capital. While angel investors tend to focus on investing in early start-up phase or pre-revenue lifecycle businesses, these new equity partners look to invest in medium sizes SME’s that, already generate revenue, have had a number of successful trading years, and operate in growth sectors. These partners seek to combine great companies with ambitious management teams, and take an equity stake within the business. They are actively looking to form longer term partnerships with performing businesses. They take an active role in the management and direction of the business in order to assist SME’s to think strategically, optimise operational structures and maximise growth potential.
Recent market transactions have been structured on Debt/EBITDA multiples as high as 4.5-5.0x including identifiable hard synergies. Typically, this is subject to 30%-50% implied equity (the funding gap) in the structure from the borrowing business based on conservative valuations, with the remaining 70%-50% being provided from senior debt lenders – as per 1 & 2 in graph. The diagram illustrates simply how the capital input required from a business to complete a transaction/strategy can be reduced by using alternative lenders and equity partners within the capital structure, thus assisting in narrowing the funding gap (reducing the capital input from the business) – as per 3 in graph.
It is important to note that equity partners are extremely focused on growth and look to invest in well managed, cash generative businesses, who demonstrate some or all of the following:
- Talented management with track record
- Growing Market
- Competitive Advantage
- Strong Cashflows
- Ambitious but realistic Business Plan
- Clear exit plan
Traditionally Irish shareholders have been reluctant to give up equity in their businesses as they can understandably be protective over what they have created. However incoming partners can bring the necessary industry expertise and capital to scale the business and realise its full potential. Partnering can accelerate the growth of the company and assist in growing shareholder value in the shorter term. It may be the springboard to help bring a business to the next level and can help to ensure that the business the founders built is preserved.
In a recent market transaction Renatus Capital Partners bought a stake in flight training specialist, Simtech. The partnership has been undertaken with the aim of scaling the business to reach its full potential and to assist in implementing a succession plan (with one of the founders retiring while the other founder remains with the business). A new chief executive with extensive industry experience is being appointed with the objective to expand the company by exploiting the current growth in aviation.
MC2 – How we assist
If seeking capital investment or an equity partner it is vital to have a clear strategic vision for the growth of the business. It is essential to put an appealing case forward, as you may only have one opportunity. MC2 Advisory examine all funding options suitable for businesses and/or projects. We utilise our wide network of contacts and expertise to ensure the correct funding model is put in place. We source finance through all available providers in the marketplace – Banks, Alternative Lenders & Mezzanine Debt Providers & Equity Partners. It is important to note that even with the increased number of different niche lenders within the marketplace, obtaining approved finance has not become any easier. It is very important present applications in a clear professional manner, helping to make the review and decision process as easy as possible for your potential capital provider.
Please contact the author, Stephen Parker for more details.