Time to Borrow or Refinance?
by Lindsey Norris
With interest rates at historic lows, it’s hard not to ponder the possibilities: pain-free expansion, acquisitions of pesky competitors or just lower loan payments. It’s a chance for smaller players to get a larger piece of the market. But debt should always be looked at warily, and capital is still not available to every business. Here are some things to consider before you sign those loan documents.
Balance opportunity and risk
An Ernst & Young survey released in December revealed that 57% of respondents found the current mergers and acquisitions environment favourable, with 25% likely to acquire another company in the next six months. Why? When the market isn’t growing, there is less business to go around, and plenty of distressed competitors to be had. Aroon Sequeira, the Alberta director of M&A services at Ernst & Young, suggests companies proactively search for distressed competitors – cautiously. “Leverage is your friend, to a point. If you take on too much, your capital structure becomes too risky. It is a bit of an art to find the right capital structure where you’re using debt to the fullest without taking on too much risk.”
Factor in volatility
Interest rates will go up. They are already higher in Australia, for example. “Whether it’s the right time to borrow or refinance is not necessarily related to interest rate structures,” says Kelly Rich, vice-president of Agriculture Financial Services Corporation. “The decision should be based on the opportunities for individual companies. If your business can grow or constrict to take advantage of interest rates, make it happen.” However, many sectors and most highly leveraged companies aren’t that flexible. Bottom line: “Any time you’re going to borrow, it is really important to have a properly structured balance sheet.”
Don’t Kiss Toads
Famously, Warren Buffett once said that many executives look at acquisitions as princes trapped in the bodies of toads: all they need is a special kiss from the right owner to set them free. But sometimes a toad is just a toad. Sequeira has a less warty description: “The ideal scenario is to acquire a sound business with a broken balance sheet. That means a good underlying business in some distress from improper capital structure or over-leverage, versus a broken business with a broken balance sheet.”
Exploit personal equity
If you want to refinance or take on debt and discover those enticingly low interest rates aren’t available to your business, don’t despair. “If your company is already leveraged, you’re going to pay a premium to borrow in the business market,” says Rich. “One of the most underutilized tools for small businesses to access those extremely low rates is to leverage their personal assets.” So if refinancing will lower loan payments and improve cash flow, it may make sense for business owners to mortgage their own homes or other property.
Consider debt alternatives
If you do decide lower prices for assets and operating businesses make expansion wise, think outside the debt box; after all, many people will be eager to get any deal done. For example, in an acquisition, Sequeira says cash alternatives include using company shares as currency, vendor take-backs, vendor notes and vendor financing. Finally, if there is a disconnect between the buyer’s and the seller’s expectations for the business – perhaps the seller thinks the business will do $5 million next year and the buyer thinks $3 million – make some of the purchase price contingent on performance.
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