What are Cashflow based Loans ?
This is also known as leveraged debt and it is lending as a multiple of sustainable cashflow, usually irrespective of the security available. Security is a backstop, but of more interest is that the ability to repay is robust.
Type of funding : Senior, unsecured term loan (pari passu with other unsecured lenders)
Size : £0.5m – £5m
Term : 3 to 8 years
Interest : 6%+
Leverage : typically up to 4x (Net Debt/EBITDA)
Repayment profiles : 5 to 8 year amortising
Security : Varies, however some offer to take no security, no warranties, personal guarantees, inter-creditor agreements, debentures or guarantees.
Other features : Could include capital repayment holiday options.
We see these type of facilities utilised where there is an established business with regularised cashflows that have a track record of stability, because ultimately the lender is backing the continuation of this as the source of repayment.
Often this funding is used for Management Buy Outs (MBOs) – where the management team have a proven ability in the business and typically have been running the business for a period without the close supervision of the party being bought out.
Some clients look at this funding to support a “cash out” i.e. the shareholders seek to extract some cash from the business to themselves or to be invested into other businesses.
Funding like this can be used to support acquisitions of other businesses, however serviceability is typically based on the performance of the existing business as well as the one being acquired – again it goes back to getting as much certainty behind the numbers as possible and it’s likely the knowledge of the existing business is deeper, but the target is a bit of an unknown.
Sometimes this sort of finance can be used to fund a share buy-back of shareholdings acquired by PE so that the business can exit the PE relationship.
This sort of facility requires some deep analysis of the financial performance of the business (Financial Due Diligence or “FDD”), with at least three years forecasts overlaid with the proposed facility.
Scrutiny of the past three year’s financials is also normal and up-to-date management information will be required (P&L, Balance Sheet, Cashflow). It is normal to outsource this work to an accountancy firm and we can help you choose the right one.
Legal Due Diligence (LDD) is also normally required – understanding what rights and contracts the business has in place to both protect the future revenue streams and also ensuring there are no particularly onerous obligations.
Some providers of this type of lending will be able to provide the day-to-day working capital the business requires where others would put this funding in as a loan alongside a separate working capital funder.
When funding is in place, the business will be expected to continue to produce financials for monthly or quarterly analysis by the lender, typically to check that performance has not dropped off by reference to lending “covenants” which are agreed at the outset, for instance the business performing within 20% of forecast EBITDA. It’s important to have the right set of forecasts and the right covenants at the outset, otherwise if they are breached then lenders have a raft of remedies that they can put in place if required.
Where funders are working alongside one-another they may require an agreement on “stand-still”, this means that if the covenants are breached or something goes wrong, the lenders agree to notify each other but not enforce their security or other remedies for an agreed period of time. This gives people an opportunity to get round a table and agree a way forward.