Benjamin Franklin once said, “Think what you do when you run in debt; you give to another power over your liberty.” I suspect if Ben were around today, he would be delighted to appear on the $100 bill; but he would also stand by his admonition.
That said, I also suspect he would approve a security provider leveraging debt to generate RMR — so long as the security provider used the debt efficiently. Think about it this way: If you can create a single dollar of RMR for $25 and sell that dollar in future for $40 plus keep a significant portion of the RMR before you sell it, then using debt to create RMR may be a very effective tool.
Can You Afford It?
Before getting too far, figure out if you can afford to borrow to generate RMR. Most industry credit facilities limit the amount you can borrow to a multiple of RMR (similar to industry acquisitions but the multiples are much less). To do this you will need to know your “creation multiple,” which is the number of dollars you invest to create a single dollar of RMR. There are industry-accepted formulas to determine your creation multiple, but essentially, you take all direct costs and a portion of your indirect costs and spread them across the RMR you generate for a given time period.
There are a number of well-established, experienced and sophisticated lenders in the electronic security space. Most of them focus on more significant credit facilities — tens if not hundreds of millions of dollars; and most have a minimum borrowing requirement. In my experience, most lenders will not commit to lend less than $3 million.
The Expenses of Borrowing
For some time now, the cost of money is inexpensive. That is generally true for industry loans as well, but if you are going to borrow from an industry lender, there are a number of expenses to undertake.
For example, you need audited financials, which will increase your accounting costs. The closing binder — the collection of legal documents assembled by lender’s counsel to protect the bank’s interest — for an industry credit facility is thick. If you use knowledgeable industry counsel, you will need to carefully budget your legal fees. If you don’t, will likely be paying your lawyer to learn the industry. You also have to pay the bank’s legal fees and pay the bank’s auditors when they periodically check in on the bank’s collateral.
There are other costs, too. In the end, given the cost of borrowing money, if you can create RMR efficiently, borrowing under an industry credit facility can make a great deal of sense.
If you are not in the position to borrow enough to justify an industry loan, there are a couple of long-time industry lenders who can lend you much less (think hundreds of thousands of dollars). These loans tend to be more expensive and the lenders are often more conservative and cautious in terms of collateral and other terms. Still, these lenders know the industry, know what they can lend you and can move quickly to get a deal done.
Other Sources
Occasionally, I also see borrowers that effectively exploit their relationship with a local lender, even though most local lenders focus on asset-based loans, not cash-flow loans — which is the basis for most loans in our industry.
Another possible source of credit may be a Small Business Administration (SBA) loan, for which you need to locate a knowledgeable, experienced and effective local SBA lender. SBA loans require a personal guaranty (a downside), but this may be the way to go to get a new enterprise off the ground.
No matter who you borrow from, cultivate a strong relationship. Make your lenders a great partner. It will pay off, and it never hurts to have a good relationship if things go wrong.
Eric Pritchard is a Philadelphia lawyer who spends his workday making the world safe for electronic security providers. He can be reached [email protected]. This column does not constitute legal advice; please contact an attorney with questions.
