Monday, April 4, 2011

Debt Options for Mid-Sized Companies

I attended a seminar on financing sources. (Yes, I do continuing education!) I thought some of the comments on various debt types were worthy of sharing. Here are the comments I  noted:

Convertible debt is
  • more dilutive than mezzanine financing
  • usually has 4-8% coupon
  • more subordinated than mezzanine financing
  • can slam you in a downturn
Convertible debt converts to equity when payments cannot be made as scheduled.  Consequently, when a business encounters cash flow problems, as often happens in a recession or industry downturn, and must forgo paying debt so it can pay employees and key suppliers, that convertible debt becomes equity. How quickly it converts to equity depends on the loan agreements and covenants.

Convertible debt can be just what a struggling or rapidly growing company needs to access debt at low interest rates they can readily pay. (Both struggling or rapidly growing companies have similar cash flow shortages but obviously for different reasons.)

Mezzanine Payment in Kind (PIK)
  • used when a company can't make debt payments, so it will "pay in kind"
  • For example, if a company can't make a 12% interest payment in a particular month, then it will have an additional 5% PIK tacked on, which will bring the total interest to 17%.
  • Or the additional PIK will be equity, as is the case when the PIK is warrants. 
I've written about mezzanine debt before and will again. This is not meant to be an exhaustive description of mezzanine but to acquaint you with the concept of PIK.

Asset-based Lender (ABL)
Asset-based lenders lay off risk by knowing deeply the type of asset involved and mitigating those risks. For example, an ABL will set aside enough accounts receivables (A/Rs) to cover payroll for a staffing company.
Why? Because payroll is a MUST to pay. A company and its owners will be pursued by the federal government and could even have criminal charges filed against the owners neglect to pay payroll and the associated payroll taxes.

In summary, the key to remember here, as is my mantra, is that there are numerous types of financing options for all situations, industries, and companies. If you own an asset-rich company, consider asset-based lenders or ABLs. If you have a strong, profitable history or high growth prospects and are having cash flow issues, consider convertible debt. If you are financing an acquisition, buying out a co-owner, or have high growth prospects, consider mezzanine payment-in-kind or PIK.

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