Help Middle-Market Companies Get Funding

Lenders continue to tighten the requirements for making loans to businesses with annual sales of $50 million to $500 million. CPAs should advise such middle-market clients or employers to take a two-pronged approach in their search for credit: Don’t rely solely on existing banking relationships; instead, consider investor equity or “mezzanine” financing—interim financing that usually carries a higher interest rate—to help alter an existing capital structure or provide new capital for growth and acquisitions. In liquidation it is subordinate to a company’s senior debt but ahead of junior debt.
Lenders judge an applicant’s creditworthiness by examining its business history, growth prospects, asset base, cash-flow stability and the cyclical nature of its industry. Middle-market companies should expect the types of loans they can get to be a product of their risk profile and the amount of leverage they already have in the marketplace, says Michael E. Gibbons, managing partner of investment banker Brown, Gibbons, Lang & Co. in Chicago. CPAs familiar with the current lending criteria also can help their clients or employers take the necessary steps to attract financing in this environment by advising them to follow these eight tips.

Remain focused on core competencies. “Lenders want to see a company with a strong focus on the aspects of its business that are tried, true and profitable,” says Gibbons. “No longer are banks excited by companies that are branching out in several, untested directions.”

Maintain a strong asset base. Because a company’s assets, particularly machinery and equipment, are a central component of collateral, banks are aggressively demanding updated and frequent independent appraisals on machinery and equipment. Practitioners should tell clients to also pay close attention to their accounts receivable and inventory—two other key assets that serve as collateral.

Be prepared to accept tighter stipulations in financing pacts. It’s a lender’s market today. Borrowers simply have fewer options and little or no leverage to negotiate more favorable terms. There still are loans out there, but fees and spreads have become major issues. CPAs therefore should recommend clients adjust their expectations in this area.

Pursue a more flexible structure. Blend bank funding with junior debt (which can provide a company with incremental capital) and subordinated debt (which also has a lower claim of payment than senior debt) and equity. “Middle-market companies no longer have the luxury of raising capital from one or two sources,” says Gibbons. “They should actively look for additional lenders who, in exchange for higher rates of return, are willing to assume more risk and provide subordinated debt.”

Address “skeletons” up front. No lender wants to learn at the last minute that your employer or client is facing serious—or even moderate—business challenges. And it goes without saying that no one wishes to discover such problems indirectly or from a third party. CPAs should advise companies to be honest and forthcoming with lenders and err on the side of overdisclosure.

Rationalize operations and eliminate unproductive overhead. Banks want to have confidence that your client or employer runs a tight ship. Extravagant expenditures—such as luxury car rentals or season tickets for sporting events—are a surefire way to raise a red flag in today’s lending climate.

Reduce dependence on individual customers or suppliers. A client’s reliance on a particular supplier or customer in this economy represents a risk to the lender. Middle-market companies should seek to broaden their base of customers and suppliers so that if one or two “go south,” the company won’t be overly affected. Advise your client or employer to take a look at any customer or supplier that accounts for more than 10% of its total business and analyze its options.

Build a strong management team. The confidence your employer or client’s management team exudes represents the most persuasive factor in almost every lending decision. Banks can become comfortable with the challenges a company may face in production, distribution or marketing if they have faith that the people running the show have the experience, expertise and sound judgment required to deal with any problems that might come along.

Source: Brown, Gibbons, Lang & Co., Chicago, , 2002.


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