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Market Insight – Q3 2016 Can investment banks really help raise debt?

Most boutique investment banks in Canada have built their names on raising equity through the public markets for companies in the resources sector. In recent years, a handful have successfully diversified into tech, in response to dismal investor demand for these resources plays.

But equity is only one half of a company’s capital structure; why should it get all of the attention of investment banks? Debt is more suitable than equity in many circumstances, but putting debt in place is often perceived by companies as something that is easy to do. So they shy away from working with an investment bank, which would add an unreasonable cost to their debt raise. That explains why so few firms have focused on helping companies structuring and raising non-dilutive capital.

This issue of Market Insights looks at the benefits of engaging an investment bank to help raise debt.

What does an investment bank do, and why does that skillset make it a good partner to raise debt?
Successful investment banks, regardless of their focus or specialty, need to excel at three functions: 1. be exceptional storytellers; 2. nurture a network of active investors/​lenders; 3. have the ability to create an auction-like environment for its deals.

With respect to debt, those investment banks that have made it their specialty know to tell a far different story to lenders than they would to equity investors: one tries to protect its downside, the other to maximize its upside. Yet, the mitigating risk doesn’t mean the story is boring, especially for non-bank lenders: it must be compelling enough to rise above the hundreds of deals they see every month; it must be told in ways that facilitate the deal going through lenders’ credit committees; and, it must bridge the gap between the lenders’ capabilities and products, and the companies’ financial strength and growth objectives.

A network of active lenders is of course necessary and must cover alternative and non-institutional lenders as well as the banks because most deals are not straightforward. Within large institutions, it is critical to know who can get deals done, and who cannot — the variance between account managers is often quite dramatic: a no’ with someone could easily have been a yes’ with someone else at the same lender. Technology has enabled new levels of auctioning at some of the more sophisticated investment banks, in addition to their deal-makers. Those tech-supported capabilities have not percolated yet to Canadian boutique firms involved in the debt markets, except for the rarified few. A dynamic auction-like environment is ultimately what bears out the story-telling and network-building and crystallizes value for companies.

Case Study: Management Buyout
In this deal, FirePower Capital was engaged by an executive at a food equipment distributor, to buy out the two shareholders of the company they worked for. It is a great example of why an investment bank can help companies consummate transformative transactions using debt and set them up for success.

The executive of a food equipment distributor had in effect taken over day-to-day operations from two semi-retired shareholders and was looking to buy the company from them, in a friendly deal that had been discussed for years.

The company had been using the same bank, one of the Big 5” Canadian banks since its inception over 60 years ago. The executive and the two shareholders approached the bank to finance this buy-out, however, their request was denied.

With no debt and healthy cash flow generation, it should have been a straight-forward deal, but the trio didn’t present any mitigation for a difficult year they had recently or any details on how the three would contribute to the financing through a vendor-take-back (VTB) and an injection of new cash.

The executive engaged FirePower Capital to put the deal back on track. We addressed the concerns that the company’s recent history raised; emphasized new, recurring revenue contracts that were won this year and would help the company smooth out its cash flows; and helped structure a VTB that was acceptable to both potential lenders and the selling shareholders.

With a new deal package in hand, our team reached out to seven Schedule 1 banks, including the company’s incumbent bank, and let them compete. All seven banks put forward proposals, the best and worst of which are shown in the table to the right.

Ultimately, and in a remarkable twist, it is the incumbent who won the auction — even though it declined it at first.

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