Frequently Asked Questions
Senior debt: If your company is consistently profitable, with assets that can be secured, you’ll likely qualify for conventional bank financing, called senior debt, either as a line of credit, a term loan or mortgage financing if real estate is involved.
Subordinated debt: If your company lacks the assets to secure a loan, you may face limitations on what you can borrow. Subordinated debt is available to companies that demonstrate historical cash flow but may lack sufficient tangible security to pledge to a bank.
If your business is an early-stage company (less than five years old), you may still qualify for subordinated debt financing if you can show a history of cash flow sufficient to service debt payments, or clearly demonstrate that you will reach that level shortly. Cash flow is commonly referred to as EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization.
Start-up or very early stage companies are not our focus for financing. Angel investors, venture capital or government sources might be able to help.
We look for cash flow, in addition to a strong business case and experienced, capable management. We loan to all industries and focus on Western Canada. We have financed companies in manufacturing and distribution, as well as technology, services and retail.
If you are buying a company, we prefer to see that you have managed the company (management buy-out), managed a similar business or have a track record of successfully running a company.
Our loans range from $500,000 to $7 million and our total loan limit per client is $10 million.
While every situation is different, we use some rules of thumb as a rough guide for how much subordinated debt you can borrow. In both corporate transactions and growth situations, we see maximum total debt to EBITDA or leverage multiples between three and five times. This can vary significantly depending on the nature of the business, and specifically how much senior debt is available in the form of lines of credit or term loans.
A business with high senior debt capacity generally can afford to borrow more, because senior debt has a lower interest rate and therefore less debt servicing requirements. Senior lines of credit, for example, are interest only and have a relatively low interest rate. For companies with no senior debt capacity, the leverage multiple is usually in the low end of the range.
First West Capital interest rates depend on the level of risk. If we do not have much in the way of security, we charge an interest rate ranging from 13 to 15 per cent. If some security is available, we can reduce that rate as the risk is lowered.
For high-risk loans, if the company is earlier stage or there is a low level of equity being contributed in a management buyout, we add an equity component to the loan in the form of options, warrants, shares or conversion rights, which provides additional returns based on the success of the company. Together with the interest rate, the total return on these loans is between 17 and 19 per cent.
Subordinated debt is usually structured as a term loan for a fixed period of time (three to seven years) with regular monthly payments of interest and/or principal. We can also provide lines of credit where appropriate. We do not provide bridge or short-term financing.
The loan is secured with a general security agreement on the company, supported by guarantees by related companies. We do ask for limited personal guarantee from the principal owner or partners to support the loan, and we often ask for an assignment of life insurance on the key person.
Repayment of the loan is quite flexible. We often provide interest-only periods, followed by scheduled repayments of interest and principal. The schedule can take into account company growth, seasonality and, in the extreme, we can provide a non-amortizing term loan with one balloon payment of principal at maturity.
First West Capital only provides subordinated financing. You may have senior debt that ranks in priority or we may finance alongside senior debt in a transaction. Either way, we work with your bank to make sure you can maximize your senior lending capacity, as this is less costly for you. We enter an inter-lender agreement with the bank to ensure they are comfortable with subordination and postponements of claim in their favour.
We work with all the major banks and are often regarded as equity finance, which means we can improve your banking covenants, allowing you to finance more with your senior lender.
During the term of our loan, we work constructively with your senior lender. If you require additional financing, and your bank is willing to provide it, we will stand down. If your bank says no, we may be able to help. It’s important to choose a subordinated lender that can work constructively with your bank, so that you don’t get stuck with only one type of financing.
Our qualifying process involves reviewing your financial statements, projections and business plan, and meeting you to get a sense of the company. If there’s a fit, we provide an interest letter, which is a non-binding summary of the major terms and conditions of the proposed loan. Once we agree, we complete our due diligence and submit your loan for approval to our Investment Committee, made up of executives from First West Credit Union in Langley, BC. You’re welcome to come and meet them! Once we obtain an approval, we have the loan agreement and securities drafted for your signing.
The loan process usually takes about a month assuming you provide timely responses on the interest letter and our due diligence requirements.
We see a lot of transactions involving small and medium sized, mostly private, companies with revenues between $1 million and $100 million. Every company is different but we have considerable experience in seeing company valuations as part of real-life transactions, meaning the value is based on a multiple of historical cash flow, or EBITDA.
To arrive at historic cash flow, adjustments are made to historic results to take account of non-recurring items and discretionary income taken or expenses charged to the company by a selling owner. Once normalized, the multiple that is paid depends on the company’s growth potential, consistency of cash flow, the market demand for the company and negotiations between the buyer and seller. We often see small and medium sized companies trade at between three and five times historic EBITDA.
Other factors that can influence company value are the degree to which the company is being marketed, whether the deal is ‘friendly’ involving management or partners, the level of obtainable third-party debt financing, the amount of vendor financing the seller is being asked to carry and any strategic or synergistic benefits to the buyer.
Senior debt: Senior debt may be available if you have cash flow and security. Some banks offer term loans stretching to one to two times EBITDA to support a business acquisition based on the asset security supporting the loan.
Subordinated debt: First West Capital provides subordinated debt financing for business purchases based on the company’s ability to service the debts via cash flow.You will need to provide equity financing to show you have skin in the game. How much depends on your personal circumstances; we do not have a hard and fast rule.
Vendor financing: Another useful source, vendor financing has the benefit of aligning the vendor to the continued success of the company. It also acts as a set-off to false representations and warranties contained in the purchase agreement, and provides equity-like financing that lenders view favourably. We often see vendors carrying 10 per cent or more of the financing in transactions. While not a pre-condition to our lending, vendor financing is often a useful and lost-cost form of capital.
We often see growing businesses with working capital issues because the bank will only finance a percentage of the accounts receivable and inventory. We finance to allow companies to continue to grow without lifting that constraint.
After an initial meeting, during which we’ll learn about you and your company, we’ll need to see:
- Historical financial statements, audited or reviewed by an accounting firm
- Business plan
- Financial projections
If we proceed to a due diligence process, we’ll request additional details.
First West 2011 annual report
Connect with us
