If you are a private equity sponsor or a company leader with a business that is poised for a new stage of growth, debt financing can be critical to carrying out your strategic plans. There are many loan structures to choose from, depending on the business’ needs and financial situation. There are also different types of lenders, with different qualification requirements.
Lump Sum or Flexible Withdrawals?
Term Loans
Term loans have set terms. The business receives a specific lump sum of cash upfront, which is repaid with interest according to a predetermined repayment schedule. Term loans may have fixed or variable interest rates. Companies generally use term loans to purchase major assets such as equipment or real estate, because these loans have long-term payoff periods and interest rates can be low for well-qualified businesses.
Lines of Credit
Credit lines give borrowers more flexibility on borrowing and repayment than term loans. Borrowers can use funds as needed from a line of credit, up to the limit of the loan. There is no fixed number of payments and, with a revolving loan, money can be withdrawn, repaid and withdrawn again. Funds can be used for any reason, including cyclical cash flow problems, payroll expenses, or financing ongoing projects. Although interest rates are typically higher than for term loans, interest is charged only on the money actually used.
Delayed Draw Term Loans
This is a special type of loan that stipulates that the borrower can withdraw predefined amounts of the total pre-approved amount of a term loan at set times. It requires that special provisions be added to the borrowing terms of the agreement. This type of loan can be effective for companies that have a series of scheduled upcoming purchases or expenses that they want to cover with one credit facility, while minimizing interest expense.
Performance Based or Asset Based?
Traditional Bank Loans
Traditional bank loans are coveted because qualifying for one enhances a company’s financial reputation and may lower financing cost. However, not all businesses can access traditional bank loans because of the stringent limitations and covenants required by the banking industry.
Banks require borrowers to meet and maintain certain financial metrics, such as a maximum total leverage ratio or a minimum fixed charge coverage ratio. Lender-protecting covenants include financial maintenance tests requiring the borrower to meet monthly or quarterly performance standards. Debt/EBITDA is a measure of a company’s ability to pay off its incurred debt and lenders want early warning of any EBITDA deterioration. However, companies in transition, including those backed by private equity firms, may find conforming consistently to these standards problematic as they pursue creative strategies to boost performance and equity.
Alternative Lending
Alternative lending offers options to get around the stringent performance requirements of banks. It allows for more creative financing solutions since funding is based primarily on assets. Costs, benefits and limitations depend on the type of loan. But alternative loans are generally quicker to close than conventional loans, with fewer covenants.
- Asset-based lending is secured by qualified assets of a company, including inventory, property and equipment and/or accounts receivable. It can be structured as a long-term loan or line of credit. Lenders require regular monitoring and reporting on asset value and condition.
- Invoice factoring is a short-term financial solution that pays the borrower a percentage (typically 85%) of accounts receivable immediately through sale to a factoring company. The factoring company collects on the open invoices and then pays out the remainder of the total original accounts receivables amount minus fees. This eliminates waiting on slow-paying clients.
- Merchant cash advances are loans based on the credit sales of a business. Repayments are set as a percentage of daily credit sales. These loans offer limited funding fast but at a cost premium.
A Smart Choice for Companies in Transition
For companies in a transitional or high-growth period, asset-based lending may be an excellent solution, alone or in combination with private equity financing. Gibraltar Business Capital is an expert in working with equity sponsors and their portfolio companies. Talk to a member of Gibraltar’s professional sales team to learn how our asset-based credit facilities and multi-industry experience can support your business growth.