How can your business refinance its debt?
Over the last few years many businesses have found it difficult to refinance their debts. Although the overall economy is improving, most evidence shows the position is not getting any easier. This should not be surprising. Banks are still repairing their balance sheets which reduces their ability to lend. The situation will probably only improve slowly as some banks may still be carrying doubtful quality loans, many are still paying compensation for previous mis-selling and all need to meet tougher capital adequacy requirements. Banks are responding by demanding tougher terms from the businesses they are financing, in particular:
- Higher margins – for example, businesses that were able to borrow at margins of 150-250 basis points over LIBOR three years ago may now only be offered finance at LIBOR + 300-450 bps
- Lower loan to value ratios – whereas it was common to be advanced 75-80% LTVs before the credit crunch, 60-65% is now more typical
- Tighter financial covenants, particularly in respect of EBITDA multiples and debt service (cash flow available to service interest and repayments)
- More intrusive monitoring of business performance
In addition, banks are conducting more rigorous due diligence before advancing new loans. Consequently, the refinancing process now takes longer with banks’ credit committees requiring greater disclosure from and asking more questions of potential borrowers. Against this tough background, there are some actions you can take to improve the chances of refinancing your business. If your business holds debt that is due to expire in the next two years, you should really start planning your refinancing now. First, you should prepare a robust business plan. Your business plan will need to be realistic – banks are likely to challenge many of your assumptions – and you should carry out sensitivity analysis on the key variables in your plan. You can expect prospective lenders to ask for sensitivities, probably with (what you consider) fairly dramatic downsides on your base case. Second, you should analyse your cash flows in the period before you are due to refinance, as well as after, and maximise available cash – in case you aren’t able to refinance all your existing debt. With reduced LTVs and a more pessimistic valuation of your assets and future cash flows, it is likely that any new advance will be less than your outstanding debts. You therefore need to prepare for this by having more stringent criteria for your investment decisions and by careful management of working capital. Otherwise you may have to inject equity into your business to cover any shortfall. Third, you should research which lenders are currently providing finance in your sector. You may find that your existing lender is not the best choice (even if willing to lend) as many more non-traditional financial institutions are available than in the past. A well-prepared business that can pull together a credible proposal, underpinned by a robust business plan, and pitch that proposal to the right lenders should be able to refinance successfully, even in the current difficult financial environment. After all, banks are in business to lend – you have to make the lending decision easy for them.