Got a portfolio company where we can only count $2mm of cash against our debt for net debt covenants. We have significantly more than that on the balance sheet, and we also have a revolver that has a minimum commitment that we're already paying for. Is there any reason why we'd keep additional cash on the balance sheet instead of paying down the debt? I've heard "It's good to have cash to weather any storm" but isn't that exactly what the revolver is for, especially if we're already paying a commitment fee?
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There's also springing covenants on the revolver so you maybe don't want to overdraw depending on overall leverage etc. and idk your nwc needs and how drawn you guys get through the year. TBD also what cash is trapped etc too if you're operating abroad as well but yes as a rule of thumb you shouldn't need a lot
Typically, a company may keep some cash to purchase assets, do M&A, manage debt, make investments, pay out dividends, for reserves, and for general strategic and financial flexibility
Bro straight copied and pasted from an interview guide on something
probably just chatgpt'd the post lmao, lemme see what i get when i do it
Depends on whether/how quickly or easily you can reinject cash if there's a technical breach or dispute that the revolver not to be available. If you can recycle capital it's easy to deal with contingencies but if distributed cash gets paid out and a new capital call is needed to top up that's a real hassle.
Reminds me of a company that relied on factoring to fund operations. You can see where this is going. Drop in bookings, drop in receivables, no more liquidity.
Sometimes it's not worth running on razor thin buffer just to eke out a little bit extra IRR that doesn't really move the needle on its own
In general, I think you thinking about cash solely as a mechanism to manage your covenants is probably not the best way to go about it. Cash has uses, and depending on what the cash needs of the business are, having more cash on the b/s (despite it not counting towards your net debt cov) could be a good thing (i.e. in O&G we only get paid revenues once a month so it merited having more cash than the threshold amounts in order to manage working capital in between the revenue cycles). If you do indeed have "excess" cash from a maintenance capex standpoint, then you can maybe look at alternative uses of cash, short term in nature, to generate some additional yield (i.e. tbills).
Your question on the revolver having a minimum commitment fee is a little vague, but if it's anything like what I've seen, the fee is usually ~50bps of the commitment, whereas actually drawing on the facility is SOFR+450ish (at least in O&G), so that's not an insignificant difference...I'd rather pay 50bps on a $100MM commitment all day long and have some cash on my balance sheet than get put in a bind and have to draw $25MM and pay 9.5% on it.
There could be a lot of random reasons but under most normal circumstances, no, there's no real reason to keep excess cash on the BS with a revolver balance. For a revolver, it typically takes a few business days from time of notice to actually getting cash in the bank account, so I suppose if you have material expenses, purchases, etc over the next 2-3 days, cash is king (even so, you can usually borrow on the revolver at a much higher rate and get same day or next day proceeds). Only other real reason I could think of would be technical -- to satisfy any covenant in the credit agreement (else you are in technical default lol).
I think just scale it up and ask the same question. Why does Apple have so much cash and no revolver. Short term for maximizing value you might be right, it makes sense, but the world and the economy changes and a lot of liquidity is ultimately a very strong indicator. On a deal right now where a founder owned company never took any outside investment or debt and the organic growth has been insane and they leveraged that cash for capex/R&D throughout the years. Now when it’s time to sell the value prop is huge because funds will inject debt for efficiency, but that’s contrary to the founders original vision.
Can help shed some light on this for the LMM end of things.
Many founders do not fully understand debt, and prefer to simply avoid using it. I have a few friends that have bootstrapped brands to 9 figures with almost no debt usage outside of unsecured vendor debt. Keep in mind, most entrepreneurs talk to lenders early on, realize rates are kind of high and you need a PG, then dont really bother looking at credit again if the biz is doing amazingly well. Doesn't occur to people that terms change dramatically as the co scales.
One friend for example scaled a consumer brand to ~$125m in rev, and was thinking of selling a chunk to a PE firm because he hasn't paid himself anything chunky yet. Turns out he has 0 credit utilization and could easy do a recap to get the liquidity he wants without needing 3p equity.
Personally, I like running extremely leveraged & pay a higher premium for flexible credit that can not fuck you if things go sideways.
I think the common PE method of using very structured debt that can not be easily pushed around puts LMM companies in a spot where they are forced to grow slowly. Can't take big swings without betting the company.
So basically, the PE backed co takes small incremental swings and will likely only build a marginally better company over a 5 year period, but the other co can take huge swings and will build a MUCH better business in 5 years.
This is why I like my method of running with a ton of low risk debt. I can make big swings and simply push creditors around if things dont go to plan. Stressful, yeah...but it works well.
The one danger is if you do not grow quickly yearly, you basically end up paying a huge amount of interest for nothing. So you need to make sure you are taking BIG swings, not dumb shit like "switch ERP systems". That is not a big swing. It is a big swing if you have never run a company or are a cucked executive with no real track record of doing anything impressive. I could go on a rant about that but lets just say if your C-levels are corporate ladder climbers with relatively slow career growth, then you are not going to deliver exceptional returns. IMO most PE firms underpay severely for C-level talent.
*YMMV, all for consumer, I am clueless outside of consumer
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Well said
I don't cover Apple and this might be outdated, but I think Apple and alot of US-HQ MNCs actually do this for tax avoidance reasons / to avoid repatriating profits back to the US. So completely not applicable here.
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what do weapons have to do with the financial statements?
So to clarify on the paragraphs above:
In the consumer company example of your friend that hasn't utilized any debt, it would be better to raise non-recourse debt through some form of recapitalization, and take proceeds to further funnel it into ideally large growth, and that would be more favorable compared to selling equity to 3p?
What would be the issues with selling equity to 3p aside from less flexibility?
The co is growing fast and is objectively great. Never sell a company that is delivering exceptional results.
Personally, when I find some of these I just hold them with no intention of selling unless someone walks in and offers a stupid multiple.
I see your point and I agree. But is this only if they’re a cash cow asset?
What about high growth business that are currently breakeven on cash flow, wouldn’t founders still want to take some chips off the table and find a way to accelerate their development?
Echo the theoretical and consumer examples above. But in a more practical matter, it’s just not worth the hassle to dividend up small cash. PE is all about managing upside and downside. There is no upside from dividending up petty cash (from IRR / LP mgmt perspective). There is plenty of downside in case you need some incremental cash (making incremental equity in the middle of an investment without some strategic move is a very negative news to LPs which is sometimes why PE firms will lend at the GP level or have GP guaranteed debt structure. But that is an administrative hassle if the amount in question is sub $10M for example.
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