At the top of businesses' hierarchy of needs, cash reigns. While cash (or, speaking more generally, capital) is harder to find today and takes longer to get than before the housing crash, there are still viable capital options for most pro dealers.
In essence, you get capital either by going into debt or exchanging equity—a stake in the business—in return for money.
Debt is typically the cheaper form of capital in terms of cash paid to lenders/investors. Because debt involves layering fixed obligations onto a company's uncertain income stream, it creates substantial additional risk. But when used in moderation, debt can be a prudent component of the capital structure. Options include:
Conventional Banks Local, regional, and national banks and credit unions provide asset-based lines of credit (often called "revolvers") and term loans secured by accounts receivable (AR), inventory, and fixed assets. Loans for pro dealers based on cash flow are virtually nonexistent. Banks offer the lowest annual rates (5% to 7%), but their criteria—usually profitability, assets put up for collateral and personal guarantees—are the most stringent. For smaller firms, programs offered through the Small Business Administration can make loan terms more favorable, but they do not relax banks' criteria.
Non-bank Asset-Based Lenders (ABLs) Local and regional non-bank ABLs provide revolvers and term loans to businesses whose low profitability keeps them from getting conventional bank loans. ABLs charge 10% to 18% annually, but require less current profitability than banks.
Other Non-bank Lenders Structured finance companies, hedge funds and AR factorers provide varying cash flow- and asset-based loans, often to businesses that can't qualify with banks and ABLs. Lenders' criteria and costs vary, but they're generally as or more expensive than non-bank ABLs (with costs as high as 25% to 30% at factoring companies—firms that give loans based on ARs). Still, in today's financing environment, these non-traditional lenders can be lifelines for businesses starving for cash or that risk being "fired" by their banks.
Mezzanine Lenders These "sub debt" lenders provide cash-flow loans that supplement bank or ABL financing, typically receiving in exchange a second-lien position on assets. These lenders also take small equity stakes and have all-in annual costs of capital of 18% to 25%. Because cash flow is low among dealers today, sub debt is unavailable to all but the most profitable.
Equity investors provide capital in return for ownership in businesses. Equity capital's "cost" is high because these providers share in the business's future profits. But equity providers are willing to take significantly more risk than lenders. Also, equity does not create fixed obligations (leverage) and so is a lower risk capital structure component.
Private Equity Capital Private equity (PE) firms invest pools of capital into private businesses, typically in amounts of at least $5 million. Most PE firms purchase only majority ownership stakes but some can also buy minority positions. PE is typically available only for larger, cash-flow-positive pro dealers with more than $50 million in sales. PE firms are equity partners, so chemistry and alignment of vision is critical. High-quality PE firms can provide long-term capital and strategic support to help businesses achieve their long-term objectives.
Angel Equity Equity capital raised from friends and family or from third-party individuals is often called "angel" capital. This is typically appropriate for amounts under $1 million. Terms can be extremely favorable for businesses, depending upon how generous your friends and family want to be or what you can negotiate with individual investors. However, value-add can be very low from this form of equity capital.
Understanding today's capital landscape, and the fit between a) your objectives and risk tolerance, and b) capital providers' criteria, is a prudent first step in successful sourcing. Start your trek here.
Matt Ogden is managing principal of Building Industry Partners LLC, a building products-focused private equity investment and M&A/debt advisory firm that is a co-founding equity sponsor of US LBM Holdings. E-mail: email@example.com. 214.550.0405