Source: Pepperdine University Private Cost of Capital Survey
Pepperdine University, along with research contributor Robert Slee, conducted the first ever private cost of capital survey (PCOC), which was the first survey of its kind to provide information on the capital markets for small to midsized US companies.
They surveyed senior lenders (typically banks), asset-based lenders (ABLs), mezzanine capital, private equity and venture capital as they relate to midsized private companies.
This survey may be useful for your business, as the results highlight the benchmarks that must be met to qualify for capital, along with the required investment returns for the capital providers.
Armed with this information, you should be better able to plan your budget, your ideal capital structure and determine the likely cost of capital in 2010.
We are going to summarize what we think are some of the most important points, but would also encourage you to download the full 67-page survey.
At the end of this email, we provide a link to go to Pepperdine University's website to download the complete survey.
BANKS (Cash-Flow Lending)
Interest Rates
According to Pepperdine's survey, over half of banks responded that their current all-in interest rate (including spreads over prime and LIBOR) is between 6% and 6.5%, with the remainder lending at rates between 6.5% and 7.5%.
44% of loans were refinancing existing debt as opposed to loans for working capital, acquisitions, new equipment and other purposes. While they didn't expect lending rates to increase significantly, most banks expect lending to become more restrictive through the middle of 2010.
ClearRidge: Please take action early in preparation to refinance debt. A major concern is the number of business owners that are going to be surprised by higher loan costs and tighter credit requirements when it comes time to replace debt. That, coupled with declining bank lending levels throughout 2010 will likely lead to liquidity problems for thousands of US businesses.
Fixed or Variable Rates - 38% use fixed rate and 62% use variable rates, of which most are pegged to prime.
Median Credit Ratios
Fixed-Charge Coverage (Min): 1.2
Funded Debt to EBITDA (Max) 3.0
Debt Service (Max) 1.25
Debt to Net Worth (Max) 3.0
Covenant Thresholds
Max Debt/ Total Assets 3x
Min Cash Flow Percentage 125%
Min Fixed-Charge Coverage 1.2x
Max Debt/EBITDA 2.75x
You will notice that these ratios and thresholds are more restrictive than in recent years when many businesses last refinanced debt.
ASSET-BASED LENDING (includes some banks)
Asset-Based Lending focuses mainly on collateral and liquidity; whereas a traditional bank loan focuses mainly on cash flow. An ABL is a loan secured against the assets of a company - mainly inventory and accounts receivable, but sometimes also machinery and equipment, intellectual property or trademarks.
[Banks also operate within this category and sometimes offer a blend of cash flow and asset-based loan.]
Asset-based loans are typically categorized into three tiers depending on loan dollar amount:
Tier 1 loans : >$10M; Tier 2 loans: $3-$10M; Tier 3: <$3M
Interest Rates
According to Pepperdine's survey, variable interest rates in 2009 and 2010 are ranging from prime plus 0.5% to prime plus 16%. For larger loans typically pegged to LIBOR, rates range from LIBOR plus 3.5% to LIBOR plus 6%.
Other fees
ABLs may also have closing fees ranging from 0.5% to 4% of the loan amount; modification fees from 0.1% to 3%; commitment fees from 0.5% to 1.5%' collateral monitoring fees from 0.1% to 12%; unused-line fees from 0.25% to 1%, as well as audit fees, attorneys' fees, insurance, annual and due diligence fees.
ClearRidge: In other words, it's important to look beyond the headline rate and determine the all-in cost of an ABL, which will likely cost you north of 10% and can be as high as 35%.
Over half of Asset-Based Lenders expect prime rate to increase, LIBOR to increase and credit spreads to widen through mid 2010.
Median Credit Ratios
Fixed-Charge Coverage (min): 1.0
Funded Debt to EBITDA (max) 4.25
(compared to bank lending max at 3.0)
Debt Service Ratio (min) 1.2
Lending Advance Rates
Accounts Receivable: 85.0%
Inventory - Low quality: 22.5%
Inventory - Intermediate quality 35.0%
Inventory - High quality 55.0%
Equipment 67.5%
Real Estate 65.0%
Land 50.0%
Firm's Cash Flow 65.0%
Marketable Securities 80.0%
Refinancing accounted for over half of ABLs, followed by acquisition and growth financing. In spite of rising costs, almost every asset-based lender expects demand for ABLs to increase through 2010.
ClearRidge: When traditional bank lending becomes too restrictive or is unavailable, many businesses will turn to ABLs to refinance their debt.
MEZZANINE CAPITAL
According to Pepperdine's survey, all-in interest rates for mezzanine loans are currently running at around 18%.
Mezzanine is most often used to fund a management buyout, growth or acquisition financing, with only about a third for refinancing.
Most mezzanine capital loans would be made to firms with more than $10M in annual sales and for loan amounts between $1M and $10M. One in three mezzanine loans are straight interest, with two thirds comprising interest plus stock warrants.
Pre-funding Median Ratios
Total Debt to EBITDA (max) 3.75
Senior Debt to EBITDA (max) 2.5
Fixed-Charge Coverage (min) 1.2
Median Financial Ratios
Maximum Multiple of Recast EBITDA 4.0
Maximum Multiple of Operating Cash Flow 4.0
Maximum Total Debt to EBITDA 4.0
Maximum Senior Debt to EBITDA 2.5
Minimum Fixed-Charge Coverage 1.2
PRIVATE EQUITY
According to Pepperdine's survey, Private Equity in today's market has an expected annual rate of return of between 20% and 30% on new investments.
Only 7.5% of private equity funds will consider an equity investment of $1M or less, but around 40% will consider an investment smaller than $5 million. Two-thirds are control investments and one third are non-control.
The median targeted equity ratio as a percentage of invested capital in each deal is 41%, with a range between 20% and 50%.
ClearRidge: This equity ratio is in contrast to the easier credit days in 2007 and 2008 when private equity would rarely need to contribute much more than 20% equity to the capital structure.
VENTURE CAPITAL
According to Pepperdine's survey, VCs currently have an expected rate of return on investment of 40% to 43% for each investment they make. However, the average rate of return for realized investments in prior funds is between 24% and 29%.
Below is the Pepperdine Survey's summary of VC investment stages:
Stage 1: 22.5% of VC investments fall into this category.
No product revenues to date and limited expense history, typically an incomplete management team with an idea, plan, and possibly some initial product development. Expected exit by VC in 6.2 years.
Stage 2: 17.0% of VC investments.
Still no product revenue but substantive expense history, as product development is underway and challenges are thought to be understood. Expected exit by VC in 5.8 years.
Stage 3: 17.8% of VC investments.
Significant progress in product development; key development milestones met and development is near completion, but generally no product revenue. Expected exit by VC in 5.1 years.
Stage 4: 28.3% of VC investments.
Additional key development milestones met and some product revenue, but still operating at a loss. Expected exit by VC in 4.8 years.
Stage 5: 10.9% of VC investments.
Product revenue and operating profitability or breakeven/positive cash flows. Expected exit by VC in 4.0 years.
Stage 6: 3.5% of VC investments.
Established financial history of profitable operations or generation of positive cash flows. Expected exit by VC in 3.5 years.
Summary of Capital for Business in 2010
To reiterate what we said in 2009, we would urge you to be thoroughly prepared when it comes time to refinance or recapitalize debt. The credit markets and equity markets are open for business, but it will take better preparation than in the past to get through the loan committee and get your loan approved.
If you need to look at alternatives, raise some capital or replace debt, please give ClearRidge a call and we would be happy to talk through your options with you.
Tax Credits
If you would like to learn about business incentives and tax credits that may be available for your business, you may find the following useful:
Pepperdine Survey
Download a PDF of the full Private Capital Markets report from Pepperdine's website:
About ClearRidge Capital
ClearRidge Maximizes Enterprise Value as a business, financial and strategic advisor to midldle market businesses, banks and law firms.
ClearRidge’s Team have completed M&A transactions, provided restructuring advice and secured new and replacement capital for midsized companies across the US and Canada.
Mergers and Acquisitions includes buying, selling, merging and valuing midsize companies. Restructuring includes financial, operational and strategic restructuring. Corporate Finance includes advisory for raising and replacing debt and equity to provide the lowest cost of capital. Turnaround, Bankruptcy and Crisis Management services include debtor and creditor advisory, bankruptcy support and turnaround management. We provide top tier advice and relationships with Middle America values.
For further information, visit www.clearridgecapital.com.
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