Financing organisation growth through cash-flow

By Odhiambo Ocholla

Having adequate cash to operate is critical to all businesses, but often business owners don’t know where to turn after the local bank says no. However, there are many solutions that can help business owners sleep better at night.

Business owners need to build financial strength with improved cash flow. In today’s market, firms crafting a viable growth strategy should examine their capital structures closely and explore new ways to finance their growth strategies.

Many firms find it difficult to raise sufficient capital through traditional funding sources, such as internally generated cash flow, to support aggressive acquisition and expansion strategies.

In such instances, they should consider alternative sources of financing that are tied to their cash flow or asset values more than their balance sheet and debt-to-equity ratios.

Borrowing base

What is most important to the lender is the ability to secure itself with the stock or assets of the operating entity. In general, the borrowing base for non-traditional financing will be either cash flow, also termed earnings before interest, taxes, and depreciation and amortisation (EBITDA) or asset value typically accounts receivable and/or equipment.

A cash-flow-based credit facility typically offers advances tied to a multiple of cash flow, such as three to four times the EBITDA for the previous 12 months. Often, the acquired operations’ EBITDA for the previous 12 months can be included in the borrowing base.

Asset-based credit facilities offer a fixed percentage of financing against eligible assets. Again, the borrowing base will allow for the inclusion of eligible assets of acquired operations.

If an organisation has an investment-grade or near-investment-grade credit rating, a cash-flow-based credit facility might be the best choice, especially if the organisation’s competitive advantage derives more from its service orientation and market position than from its tangible assets.

Such organisations share the following characteristics: A significant market position with strong barriers to the entry of competitors into the market, such as contractual relationships with the leading physician practices, historical financial performance that validates an organisation’s competitive edge, an experienced management team and diversified service and product offerings.

Lenders are likely to view these types of organisations as well positioned for consolidation and competition and, thus, they will be more likely to offer them more favourable credit terms.

Organisations in a growth mode but with lower credit ratings may still access capital through an asset-based credit facility, which is well suited for the working capital, immediate advance against receivables, cash flow to bridge the gap between the typical collection cycle and short-term financial obligations, such as payables.

While relying on assets to make their financing decisions, lenders offering this type of credit facility also look at cash flow and other financial performance measures.

To qualify for this loan, a firm should demonstrate a meaningful debt service capacity. In addition, its management team should be able to articulate how its acquisition strategy will enhance market position, competitiveness, and financial strength.

In essence, credit facilities are financial enabling tools that allow organisations to capitalise quickly on opportunities in a fast-changing marketplace. One facility called an acquisition revolver, for example, allows organisations to access funds on an acquisition-by-acquisition basis and repays the loan as cash flow increases.

Although carrying an unfunded acquisition line of credit has associated fees, this financing strategy is more cost-effective than borrowing a lump-sum amount as is usually the case with bonds that is invested in a low-yielding investment instrument until the funds are needed for the acquisitions.

weigh alternatives

Using such non-traditional financing methods also gives fast-growing organisations the option of switching credit facilities as they implement their acquisition plans. As the number of acquisitions reach an optimal size and significant cash flow is generated as a result, the acquiring organisation may then wish to switch to a cash-flow-based credit facility.

As with any business relationship, the choice of a lender ultimately is a matter of mutual trust and confidence. If a lender’s acquisition covenants are too restrictive, even the lowest financing rates are too high.

— The writer is an Investment Banker. Email: nyabolla@gmail.com