Downloaded articles

Expanding Credit Lines in

Order to Expand: Assessing a Company's Viability for Expansion Financing

While at oiie poiiit it seemed like compa- nies would never emerge from what has been termed the Great Recession, they are now not only emerging, but actually growing and expanding. However, one big issue from both the borrower and the lender side has been challenges related to expansion financing.

By Steve Agran

For recovering companies, additional financing for working capital increas- es would be necessary, but increasing- ly difficult to come by at reasonable interest rates. During the recession, bank loan commitments were re- duced, while mounting losses were financed by utilizing availability under the working capital line of credit. As the economy recovered, liquidity was much tighter while availability was lower. Companies did benefit from the fact that the recovery was slow and, therefore, rapid working capital requirements often associated with growth did not materialize. Ultimately, the recovery has led to companies needing expansion capital but finding it hard to come by.

Many companies facing this exact situation have turned to MorrisAnder- son to discuss ways to improve liquid- ity and availability for credit. The squeeze on expansion financing was particularly difficult for companies that had recently experienced poor results and earnings, but had turned the corner and were trying to expand.

The issue for lenders, of course, is that, in order to accurately approve a company for expansion financing, they needed to gain a holistic look at the company's past performance and projections for future growth to un- derstand both the benefits and risks involved in expanding credit lines.

Starting in 2008 or 2009, financial in- stitutions began consolidating and be- ing much more stringent and selective in the expansion financing process - doing so because the demand for capital was plentiful, regulation was heightened, while the credit risk was increased. As a result, many lenders needed to determine - particularly with accuracy -whether a potential borrower was economically stable enough to have its lines of credit increased.

Lenders have frequently turned to turnaround restructuring firms to help with distressed clients (from The Secured Lender's October 2009 issue, "Restructuring and workout consul-

THE SECURED LENDER OCTOBER 2013 29

tants are still finding their hands full

as lenders pull them in to help w i t h

troubled clients") but also for inde-

pendent assessments on the ins and

outs of a company's expansion plans

and provide guidance on financing

options.

Considerations for Expansion

Financing: A Checklist

It's essential to regularly assess a company's issues, opportunities and overall viability. When assessing expansion financing and lending op- tions, consider the following checklist: > What are the company's specific

expansion plans and projected timeline?

I What are the financial projections? > What is the projected cash flow? I What are the capital expenditures

and projected timing on return on investment?

> When does the company expect to realize profitability?

> Does the company have a solid base from which to expand?

I Will the company be able to main- tain a high level of quality prod- ucts/services?

t What resources are being dedicated to product and process improve- ment?

> Will management be able to main- tain control during the period of growth?

> Will management be able to main- tain focus on employees as well as client needs?

Below is a recent case study to illus- trate the above checklist in action.

Case Study: Medical Device

Contract Manufacturer

The Challenge

The client, a medical device contract manufacturer, had historic annual rev- enues of S30 million with a $5 million EBITDA. In 2011, the company agreed to build a manufacturing facility in Asia and transfer some IP to its larg- est customer, representing 40% of its revenue. The company and its equity

sponsors were comfortable with the negotiated purchase price, the trans- fer of production and construction of the new facility was expected to take 12 months and they planned on replac- ing the lost revenue by the time the transfer took place. Unfortunately, the construction of the new plant in Asia, for unrelated reasons, took 18 months to complete and new business took longer than projected, leaving the company with an SG&A structure they might have, otherwise, reduced sooner.

Additionally, two new customer product launches had start-up issues, resulting in losses (adding to the bur- den of SG&A from the Asian contract) and expansion plans in its Caribbean operation were costly, resulting in 2012 EBITDA being reduced to Si.2 mil- lion. On a positive note, the company was approached by a multi-billion dollar medical device company to transfer the production of one of its products that, once implemented, would result in $20 million of annual revenue at a 22% gross margin.

When the company approached its bank regarding the new business and the need for additional expansion financing, the loan was transferred to the bank's restructuring group. The company was highly leveraged, based on the 2012 EBITDA, and the loan officer asked the company to hire a turnaround firm to review the project and recommend a financing solution.

The Solution

During the one-month assessment pe- riod, it was evident that the company was well positioned for rapid growth. Company management dedicated sig- nificant resources to product develop- ment and product improvement, while still maintaining high quality. The company's focus on client needs and service, while maintaining open book accounting, was very attractive to its existing and potential clients.

The company had always manufac- tured some products in the Caribbean and had built a base of employees and management from which to expand.

The favorable labor rates and relative proximity to their headquarters in the US provided the company with a cost advantage, while allowing them to monitor and maintain high quality control. The issue, though, is maintain- ing the high quality and profitability during these rapid growth periods and management was concerned if they had the proper controls in place. The turnaround firm identified the weak- nesses in their corporate structure, management ranks and reporting, and the company was quick to embrace the recommendations for improvement.

By this time, the reasons for the new product launch losses had been identified, corrected and eliminated. More importantly, the new $20 million product was being fast-tracked and the company needed financing in place for the june 2013 new product launch.

The Result The turnaround firm worked with management to develop integrated financial projections for 2013 and 2014. While earnings were improving, real profitability would not be real- ized until Q3 2013. The construction of another new Caribbean facility and the anticipated working capital squeeze required an additional S6 million. The turnaround firm identified numerous financing options for the company and the bank to consider. It quickly became evident that the bank's restructuring group was not in the position to provide the additional $4 million of construction financing that was required plus $2 million for working capital.

The issues were twofold: I The company's weak earnings dur-

ing 2012 were not enough to cover the term debt outstanding and the fact that the new facility would be located in the Caribbean made it difficult for the bank to lien the property.

> The bank also expressed interest in providing the additional working

30 THERE IS STILL TIME TO REGISTER FOR CFA'S ANNUAL CONVENTION, WWW.CFA.COM

capital funding, but would need the results through June 2013 before finalizing a commitment.

In order to finance the construc- tion costs, the company reached out to its private equity partners for new capital. The equity partners expressed concern regarding the bank's position, but a forbearance agreement brokered by the turnaround firm provided the comfort they needed. The company was also able to push back some of the timing of its construction payments to ease the cash burn as sales and profit- ability improved during Qi 2013. The company was also able to purchase some inventory with extended pay- ment terms that would also improve liquidity. Finally, the company began to explore alternative lending options that would provide it with the working capital necessary during the start-up phase of its new project. The turn- around firm projections demonstrated that the working capital squeeze would reverse by January 2014 but short term liquidity would be an issue. The financing was viewed as a bridge to January 2014, when new financ- ing would be established, resulting from the improved operating results. Having the projections in hand, all parties were able to easily assess the risks and the timing of completing the turnaround.

interest rates) to support the growth. The difficulties that most companies experienced between 2008 and 2011 have made historical financial perfor- mance an albatross around their necks as they emerge while trying to expand. As a result, companies are in need of strategic reviews to ensure they will be prepared for the liquidity required to succeed as they expand. At the same time, lenders require indepen- dent assessments of past performance and projections for future growth, as well as an in-depth analysis and under- standing of the risk associated with the expansion of credit lines beyond current levels, TSL

Steve Agran is a managing director at

MorrisAnderson. Steve has spent more

than a decade providing turnaround and

interim management services to middle-

market companies. He also has experience

handling liquidation and asset sales,

budgeting and cash flow for distressed

and failing companies and bankruptcies.

Steve is an ABI member, a Certified

Public Accountant (CPA) and a Certified

Insolvency and Restructuring Advisor

(CIRA). He can be reached at sagran®

morrisanderson.com

Conclusion

As was done with our Medical Device Contract Manufacturing client, the turnaround firm was able to provide an independent assessment that helped the bank and other inter- ested parties better understand the company and its expansion financing requirements, while helping the com- pany review its processes and better understand its borrowing needs.

Without a doubt, the current environment in commercial lend- ing still makes it difficult for growth companies that are re-emerging from the recession to obtain increases to their lines of credit (at reasonable

THE SECURED LENDER OCTOBER 2013 31

Copyright of Secured Lender is the property of Commercial Finance Association and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.