Leverage is key to growth. Think about it – borrow at 24 times to create recurring revenue worth 40 times? Of course, if it were that easy everyone would be doing it; yet, only a few industry players are. Borrowing in our industry has requirements and costs a borrower must be willing – and able – to satisfy.
As part of this month’s “money” issue, here are my six keys to closing an industry debt transaction.
1. Get out of the gates. Most industry lenders cannot do business with you unless you can borrow somewhere north of $3 million (or $5 million for some lenders). With an advance rate of 24 times, to borrow $3 million, you will need more than $1250,000 in “Eligible RMR” – a term with specific requirements detailed in the credit agreement. Every industry lender also requires audited financial statements, which means you need to have your financial house in order and pay an accountant to provide audited statements on an annual basis.
2. Understand what you are getting into. These transactions require financial commitment. The interest rate generally floats just above prime – that is the easy part. Borrowers pay lenders a closing fee, often in the tens of thousands of dollars, and reimburse lender’s legal fees (yes, the fees lender’s counsel charges lender) – whether or not the loan closes. You will have legal fees, too, which can be significant. For example, the “closing binder” for a typical first-time industry transaction runs 8-10 inches thick, and someone has to read, understand, prepare and negotiate all that stuff. You will also reimburse the lender for periodic business reviews, and many lenders impose a fee on the unused portion of the loan. Some lenders require owners (and spouses) to personally guaranty the loan. If you are not financially committed, do not borrow – but understand you are limiting growth.
3. Make your lender your partner. This is perhaps the most important advice. Consult your lender; keep them in the loop; and spend time with them. Like a good marriage, your relationship with your lender requires constant communication. Keeping your partnership solid will pay dividends in bad times – and there will be bad times.
4. Debt deals are unique. These deals have their own rhythm. If you do not have a good dance coach, you will look ridiculous. These aren’t typical “arms-length” transactions – your lender is giving you a boatload of money and needs protect ion, by saying what you can and cannot do with your money, including limiting salaries, distributions, capital expenses, etc. They will also require you to meet debt and industry metrics, want detailed reports periodically (or when you draw against the line) and require you to certify those reports are correct.
5. Know your business inside and out. Industry lenders are savvy, seasoned financial experts. They’ have looked at a gaggle of industry borrowers and lent to a select few, which they then follow assiduously. Assuming you have the right resources invested in the right reports, most lenders will understand them quickly. If you do not truly know your business, the prospective lender soon will, which will put you at a disadvantage. Retain a knowledgeable industry debt broker to prepare for this transaction – it will add to your expense, but it also likely increases your odds at landing the loan and could even shorten the process.
6. Put the money to good use. Once you have closed, use the proceeds wisely – to generate RMR. If your creation cost (fully loaded cost of creating RMR) is 20 times on a $3 million facility, you should generate nearly $150,000 of new RMR (worth $6 million at 40 times). New RMR should lead to more RMR. Keep your eye on the ball: manage attrition; generate RMR efficiently. Before you know it, you will have an even more successful company.
Eric Pritchard is a Philadelphia Lawyer who works to make the world safer for security and life safety providers. Reach him at [email protected]. This column does not constitute legal advice; please contact an attorney with questions.
