Mezzanine financing does not require much, if any, ownership dilution and is more patient and forgiving than bank debt.
Once a business moves beyond the start up phase the challenge becomes how to finance growth, including product development, marketing and geographic expansion. Thankfully, during this stage of development there are various financing options that can provide non-dilutive and flexible solutions to take your business to the next level.
Many Canadian businesses strive to grow through exporting, however the banks are not always willing to go where the entrepreneur seeks to tread. Export Development Canada (EDC), which is best known for insuring foreign accounts receivable, offers a range of commonly overlooked export financing options to solve this problem:
– Export lending: Did you know EDC lends directly to Canadian exporters? Vivian Kan, financing manager at EDC, explains while banks may lack an overseas presence or have insufficient comfort lending in foreign countries, EDC has extensive overseas networks that can overcome concerns around security.
EDC can provide growing exporters a loan, averaging between $1 million and $10 million, over assets in foreign jurisdictions. This is meant to compliment a domestic line of credit, at rates comparable to the banks.
– Export guarantee program: EDC also administers an export guarantee program to provide the bank with a risk share, allowing them to include foreign working capital assets in the borrowing base. These assets include inventory, equipment, and even foreign acquisitions.
“The guarantee gives the banks the ability to offer a line of credit or term loan to enable your export business to grow,” says Kan.
– Contract bonding: Contract bonding can be used when a company enters export contracts and receives milestone payments which require a performance bond or guarantee to ensure the delivery of the end product or service.
EDC offers a guarantee to the bank that is unconditional and irrevocable to back stop a standby letter of credit to the customer. This can really help free up resources to focus on servicing the next customer.
Mezzanine finance, sometimes called subordinated debt, is term debt used by businesses to grow their cash flow and business valuation. It’s advantageous for companies with a real and compelling expansion initiative with the only missing ingredient being capital.
For companies who are in strong growth mode, mezzanine financing can be the best option next to the senior debt. If you expect the investment to generate a high return, mezzanine financing can be used in replacement of equity, and carries terms of three to seven years and interest rates in the mid-teens.
The benefit of mezzanine financing is it does not require much, if any, ownership dilution, and is more patient and forgiving than bank debt.
Growing businesses with working capital assets can leverage the value of their accounts receivable or inventory to obtain asset-based lending. This type of lending is ideal for retailers, distributors, wholesalers and manufacturers, or any industry that is not contract or performance risk-based.
According to Wayne Fraser, Director, RBC Capital Markets “Instead of lending primarily on covenants or the balance sheet, asset-based lending focuses on asset value. This flexible model enables layering of the capital structure as well as a higher lending capacity.”
Lending is determined by the underlying value of the assets during a due diligence phase where the value is verified through field exams and appraisals. Borrowing costs range from three to six per cent, depending on the value of the assets and the credit worthiness of the borrower, and businesses can expect to leverage 85-90 per cent of the value of the assets. It is best employed for companies needing more than $3 million in borrowing.
Asset-based lending can be used as a quasi-replacement for equity which can help to scale a business faster than traditional lending would allow.
The growth stage is exciting and highly rewarding for entrepreneurs, but needs the right financial partner to provide this key resource. Choosing the right type of capital, as well as a partner that is onside with your strategy and aligned in values, is a key to success.
This column is the second in a series on financing options for stages of business. The next installment will discuss sources of capital for mergers and acquisitions.
This column was originally published in Business in Vancouver, Issue #1287.