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Guest Editorial

Financing Flexibility

By Gregory Eck

Hybrid loans can help metals companies enhance working and growth capital

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December 2011- To remain competitive, U.S. middle market companies are seeking financing solutions that offer greater flexibility in structure and price as well as certainty and ease of execution.

Although traditional financing options are well suited to most companies, they don’t fit the needs of every business. As a result, lenders increasingly are providing financial products that offer new levels of flexibility.

This rising tide of creative financing vehicles is giving companies more options. The advantage to businesses is clear: They can enhance their working and growth capital to fuel business plans and help maintain a competitive edge.

Traditional financing 
For short-term financing needs, mid-market companies (those with $50 million to $1 billion in annual revenues) traditionally have relied on either asset-based revolvers or cash flow lines of credit, depending on the nature of their business. For financing of $10 million to $20 million, a single lender generally was sufficient. For larger and more strategic financing needs, companies turned to syndicated and structured loan facilities.

Asset-based lending, structured as a line of credit, has been used by companies that have large inventories, receivables or fixed assets. The amount of credit extended by lenders is based on the liquidation value of the assets owned by the business. Asset-based revolvers help companies bridge the gap between the cash flow they eventually will receive from sales and the amount of their current expenses.

On the other hand, cash-flow lending is based on the company’s projected future cash flows. It’s structured usually as a funded term loan and a revolver. The lending limit is based on the enterprise value of a company, including its ability to generate cash, rather than the value its assets would garner if liquidated. Companies such as service providers—those that are light on assets but heavy on process and enterprise value—use this approach. Also, it’s used commonly by companies employing leverage to finance acquisitions and recapitalizations and to pursue high-growth initiatives.

Market shifts In the current economic landscape, many mid-market companies cannot rely on just one type of credit facility. Dynamic shifts in the economy have increased the need for flexible financing options. As the economy continues to become more service-based, many companies are considered integrators rather than pure manufacturers. Integrators assemble products from various suppliers, leaving the raw manufacturing to others. Their true worth lies in a mix of both assets and proprietary capabilities. It stands to reason these companies may require a blend of both asset-based and cash flow-based lending.

Meanwhile, the timing of the economic cycle also plays a part in borrowing needs. Companies may have weaker cash flows than they did three to four years ago, but they are again ramping up and forecasting stronger sales down the road. Asset or cash flow-based lending alone may not be enough for them to finance a growth spurt.

Hybrid structures
To meet customer needs in the new economy, lenders are providing a combination of both asset and cash flow-based lending in one credit facility. With a hybrid structure, a borrower can have an asset-based revolver that’s based on its inventory and receivables along with a credit line and/or term loan based on the company’s cash flow.

For greater and longer-term borrowing needs, such as recapitalizations and acquisitions, unitranche loans offer another alternative for borrowers. These loans bundle several debt tranches into one, with a single blended interest rate, one set of closing documents and one lender. On top of the unitranche loan, lenders may offer a revolving credit facility.

These loans often are administered by joint ventures composed of a senior lender and another lender that has an appetite for unsecured debt, such as a hedge fund or private equity firm. By design, the joint venture spreads the risk over a pool of assets, virtually eliminating the need for syndication. That means the entire closing process is simplified greatly.

The interest rate on a unitranche product is slightly higher than with separate tranches but borrowers have the benefit of certainty on pricing, avoiding the possibility of upward pricing adjustments that can take place when syndicating loans to outside investors. The result is a workable solution for companies going further out on the leverage curve.

A new era
Although hybrid loans aren’t new, they are tailored increasingly to borrowers’ specific needs. In fact, they’re becoming an essential tool for the new breed of mid-market companies that exist outside traditional industries.

It’s important for borrowers to work with lenders that understand the unique needs of the middle market—those that understand their industry and their business model. In the search for the right lender, borrowers might decide the best option isn’t a standard loan. Working with an innovative lender is essential for businesses to get access to the flexibility they need to grow and succeed. MM

Gregory Eck, senior vice president, is the metals, mining and fabrication industry leader for GE Capital, Americas. He helps companies identify trends and critical developments affecting the industry. His understanding of the dynamics allows GE’s originations, risk and underwriting teams to customize financing for metals customers. Greg has been lending to the metals industry for more than 15 years. Visit www.americas.gecapital.com for more information.

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