Having a deep understanding of the liquidity prospects of your company’s tangible assets and the best way to present this to the debt and capital markets prepares a CFO for a successful refinancing event.
Modern CFO’s are constantly seeking better debt funding and structuring options to support future earnings, profit and growth within the business. This journey to source debt is often undertaken with hopes and aspirations but without a clear understanding or guidance on the eventual outcome. While amortising term loans or cash flow lends are available, often this is not an option or the right solution.
Asset or collateral backed lending (ABL) products are becoming an important option for CFO’s, particularly in circumstances of seasonal, transitional and turnaround businesses, for top up funding, and more frequently those seeking flexibility and covenant light products. Many CFO’s end their journey with an asset backed product and these products require both Lender and Borrower to have a deep understanding of the Company’s assets and how they are utililsed.
To streamline a refinance, CFO’s should plan their approach, spend time presenting the business favourably and pre-empt the requirements of Lenders. Key to this is a deep understanding of the company’s collateral from the prospective of the Lender. CFO’s who prepare early, can control the narrative with potential Lenders and save on the considerable business energy typically needed for a refinancing event.
Understanding the Concept of Availability
CFO’s when considering asset backed products can look to Accounts Receivables, Inventories, Secure Contracts and Property, Plant & Equipment as sources of collateral for security. Further, these assets can be considered individually or as a basket of assets with the scale of the loan only being limited by the size of the “available” collateral.
Availability is a key concept for asset backed products and is derived from an “assets value”, its “eligibility” for security and Lenders “advance rates”, a risk metric. Determining availability is a unique skill and often undertaken by independent professionals, such as Hilco. The independence being critical for both Lender and Borrower to bridge gaps in the understanding and build trust through the transaction. In our experience, a refinancing process is helped if the professional provider (eg Hilco) can speak with authority on both the business operations and capital financing requirements to help bridge any gaps in the process
While availability is initially derived from asset eligibility, asset value and business risk, it is regularly monitored against standard financial reporting produced by the Company. In this way the loan performance can be regularly monitored without excess reporting burdens and also provide a revolving nature to the loan. This can be very helpful to a CFO steering a growing or changing business.
Debtor financing of Accounts Receivables is a common starting point for CFO’s venturing into asset backed products. Industry standards on determining eligible AR are readily understood and its valuation is aligned to the collectability on face value of the individual invoices. Lenders will require a due diligence or field review exercise at intervals or triggered by performance concerns.
Inventory is unique in that reporting standards require inventory to be identified at Cost or Net Realisable Value whereas for lending, the Net Orderly Liquidation Value (NOLV) of the inventory is required. NOLV is considered at the stock keeping unit level across raw material, work in progress and finished goods, by an appraiser and favours the borrower due to its reference to retail pricing. As a result, inventory can support significant debt extensions outside of accounts receivable alone.
P&E can also contribute significantly to availability and is also assessed on NOLV basis. Availability is highly correlated to used equipment markets and also factors in the used equipment purchasers gross transaction costs. Assets that are easily relocatable and have healthy secondary markets are a preferred collateral class. Fleets present an ideal opportunity for Lenders due to its size and premium valuation prospects. It is important to note that individual asset financing is less attractive to CFO’s as it requires consideration of asset values, in the context of orphaned assets and likely only realisable through an auction process.
Control of the Process
Preparing for a refinancing event, through asset valuation and diligence services, provides the CFO with the necessary information, at a quality and independence supportive of a quick result. It imbeds a trusted professional who gains important insight into the business and can thus provide unique perspectives on the opportunity for both the potential Lender and Borrower. It also importantly offers the CFO control of the narrative at the commencement of the refinancing process. This is important because the business, in marketing its opportunity to capital markets, should seek to put its best foot forward to attract the best available capital.
A potential Lender will then conduct its own due diligence and risk assessments utilising internal and the imbedded independent professionals advice. An example of this narrative selection is the length of liquidation period chosen for the valuation with longer generally providing greater asset realisation opportunities or a choice to undertake an initial ‘Going Concern’ equipment valuation to present the fleets value to the business and any acquirer.