July, 2024- Q: What do lenders look for in family businesses?
A: Overall quality—management, financial performance and future outlook, and inventory management. Can they articulate their strategy? How has management handled market downturns? How has the business performed? Is inventory tracked accurately, and have turns been managed appropriately during market swings and downturns? Actively involved owners also are important, along with strong, flexible vendor relationships, solid customer relationships and tight controls on cash. All these factors combined indicate how well the business will fare during the tough times, especially during market downturns.
Q: What are critical issues for lenders?
A: First, a company needs sufficient liquidity to operate its business, pay employees and suppliers, and maintain strong revolver availability for inventory purchases. Then, we look at established financial covenants— the fixed charge covenant, which indicates whether the company can (and has) serviced debt in the past, and the total leverage covenant. Finally, reliable and timely financial reporting is critical, as delays in reporting can be a red flag.
Q: What are some financing options for family/middle market businesses?
A: The financing options include:
• Finance with asset based loan (ABL)— revolver and term loan with bank and allow seller debt/earnout.
• Finance with ABL revolver with bank, use external term loan and allow seller note/ earnout.
• Finance with cash flow revolver/term loan with bank, and use external term loan with mezzanine lender.
• Finance with nonregulated financial institution (more capital with higher interest rates).
Approximately 60 percent of all metals company deals involve an ABL facility, primarily due to volatility in metal prices, which ultimately affects corporate earnings. Most companies have moved to an ABL structure due to volatility in the industry and the flexibility provided. A cash flow structure works best when a company has relatively low leverage—either due to strong consistent earnings or minimal borrowing. Financing with a nonregulated financial institution/nontraditional institution usually occurs when a company is either in distress or needs additional capital above asset values that the regulated banks cannot provide.
Q: How does a company determine the optimal structure?
A: Outside of hiring a financial consultant, typically the chief financial officer would review the company’s current and future financing needs and discuss that with a lender. At BMO, a team of 22 financial metals professionals assess clients’ current financial situation and provide recommendations on financing needs. It is important for lenders to be engaged and discuss optimal capital structure for their customers. This would involve reviewing financial history and projections, understanding industry trends, and going over company-specific changes/events with management to discuss and lay out an optimal capital structure. This especially holds true when plant expansions are in play and the company needs to raise additional capital. True partnerships and strong relationships in lending to family owned metals companies matter. Management teams that view their lender as a financial partner will realize greater benefits and better navigate them through challenging periods. Therefore, it is imperative for companies to select an experienced lender who can provide value in many ways. Most lenders will look good when the business is doing well, but when the market is down, the lender will show its true value. A lender who truly understands the client’s business and offers solutions for different scenarios will make navigating a tougher environment a lot easier.
Q: Can you provide a lenders’ perspective on the current status of the metals market?
A: Metal prices generally move due to supply/ demand dynamics, economic activity and geopolitical events. In the U.S., higher interest rates and inflation, slowing demand and weaker economic activity have caused a slowdown for the metals market. Most metal prices have declined for fear of slowdown in volume and fear of recession. However, companies are managing their inventory and cost structures effectively. Lower pricing and reduced volumes has led to lower margins for most companies in the sector. Even with significant trade tariffs in place, reduced demand due to a slowing economy has made for a weaker 2024, especially compared to the strong 2021-2022 and the first half of 2023. Most metal companies have consistently proven that they are able to overcome economic downturns.
Andrew Pappas is a managing director/ head of the ABL Metals vertical within BMO Bank https://commercial.bmoharris.com/industry-expertise/metals. He and his team are responsible for 115-plus accounts and $9 billion in commitments. He has spoken as a metals industry expert for Steel Success Strategies, AMM, ISRI and S&P Global Platts and has been a sponsor for the MSCI and Steel Summit for many years.
