Appropriate financing is a fundamental component of a company’s execution of its strategic plans but, for some businesses, it may be difficult to access it.
Private debt, also known as direct lending, can provide capital for expansion, acquisition, or other strategic initiatives. “It solves a gap in the market in Canada,” says Trevor Simpson, Partner, Private Debt at FirePower Capital. “Historically, for asset-lite businesses in the lower mid-market, it’s been very difficult to get meaningful financing from a bank. They typically look for tangible hard assets, personal guarantees and/or margin against accounts receivable and inventory.”
Companies can also raise funds by selling shares, known as equity financing, but this can be costly and dilutive. Furthermore, bringing in new shareholders could leave owners vulnerable to actions taken by these new shareholders that may not align with the company’s growth strategy.
“When a company is actively pursuing an acquisition, the need to be flexible and to act with a sense of urgency is of the utmost important.”
Often, time is of the essence. “When a company is actively pursuing an acquisition, the need to be flexible and to act with a sense of urgency is of the utmost importance. ” says Ryan Plener, Associate, Private Debt at FirePower Capital. “They need a partner with the ability to roll with the punches and be creative in the financing provided, and that’s where our offering really thrives.”
Private debt funds have grown tenfold in the past decade, according to S&P Global Ratings Research Report. FirePower Capital, a player in the Canadian lower mid-market lending space since 2016, has completed 34 deals across a variety of sectors including tech, services, cannabis, and financials.
The difficulty in accessing financing from traditional lenders is because they continue to look for hard assets as the borrowing base. Many businesses are now technology or “technology-enabled” service businesses that generally lack a tangible collateral base, and don’t fit the lenders’ “box”.
Furthermore, asset-lite companies are investing aggressively in growth (tech, people, and marketing, for example), which comes at the expense of today’s EBITDA. This is an additional constraint on their ability to borrow from traditional lenders.
Simpson explains that it is easier for companies to access funding from the banks if they have tangible collateral or $5+ million in EBITDA. For companies with less than that, or with negative EBITDA, a real gap in the Canadian market exists for growth capital in the form of debt. With access to private debt, they won’t have to rely solely on banks or equity to raise funds. They also gain a new way to bridge themselves to a future equity round with little to no dilution.
Plener says that despite interest rates being higher with private debt than if a company goes with a traditional financial institution, private debt is more accessible and customizable. Compared to equity, it is also much less dilutive than equity, and therefore generally has a lower cost of capital for growing companies.
How private debt deals are structured
Since private debt offers greater flexibility, companies can work with FirePower Capital on uniquely tailored deals. “We did a deal with a publicly listed company who was looking to grow through acquisitions,” explains Simpson, who says the company’s share price had been negatively affected in the market. “What made this deal special was that the borrower already had a major bank behind them, vendor take-back financing agreements, and had used equity before to acquire other businesses.” But because of how the deal was structured, “they came to us, and we were able to provide them with debt that was far less dilutive than raising equity while working with the existing cap table. This meant the company was able to execute on the acquisition and increase their overall profitability, resulting in a much higher share price post-close.”
“If you can fund the growth of your business without diluting your ownership, why wouldn’t you wait another year and increase the valuation of your company?”
The increasing popularity of private debt means companies and owners can avoid dilution. Private debt, which has an expected return that is much lower than that of equity, allows owners to continue growing their business, such as through scaling their sales and marketing efforts, as well as making acquisitions.
“If you can fund the growth of your business without diluting your ownership, why wouldn’t you wait another year and increase the valuation of your company?” asked Simpson. “If you’re confident in the growth of your business, debt is always cheaper than equity”.
In another deal that FirePower worked on, there was a company looking to expand into the U.S. within the next 12 months. “They knew they were going to attract new customers and double their revenue,” says Simpson. The company considered equity fundraising but didn’t want to give up a piece of ownership just yet, so they worked with FirePower Capital on a private debt deal.
“We created a plan that gave them additional runway to grow and scale so they could get a better valuation in the future. That way, they were able to maintain ownership of their business but still fund their growth.”
Then there are the intangible benefits of using private debt. “Ultimately, they were looking for a lender that would move relatively quickly and would also prove to be more of a long-term partner,” says Plener.
It creates a lasting relationship. Plener and Simpson both say that clients return to FirePower as a result of the positive overall experience. This experience typically garners additional rounds of funding as they continue to grow, or alternatively, they may use another division when they decide to sell their business. Having that relationship history, says Plener, means FirePower can be that long-term partner throughout a company’s lifecycle.
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