Question: Micro Private Equity
I'm kicking around the idea of asking for a local bank to supply debt for a business that I want to purchase. I want to restructure the company to slash costs, much like a PE fund does. I'd like to know if my idea is possible, and I welcome anyone with experience / opinion to comment!
A business has no debt and makes a healthy 20% FCF margin, and just shy of $1M revenue per year.
I have no cash of my own to put up, so I'm considering a 100% debt deal. In essence it's an LBO but on a micro-scale.
Let's assume the owner is willing to sell at a fair price.
Is this debt situation possible? Would banks support this kind of deal?
Best bet is to work with a small community bank. For such a small deal, the bank will need to be secure by assets (not just a negative pledge either). Banks will usually advance 80% against A/R, 50-70% of book or appraised value of equipment, 80% of real estate. They will also want a personal guarantee from you (even though you may not have much) and expect Fixed Charge to be above 1.2x (some community banks won't mess around with fixed charge and just used "debt service coverage" which is EBITDA / CMLTD + Interest) and leverage less than 4x (most larger banks will require 3x or less). That being said, even a small community bank will want you to put some of your own equity in it. They may try to utilize the SBA, which could be option, although both the bank and SBA would have issue with you not having experience (unless you know/work in this industry/sector).
FYI, I started at a small community bank and we financed a few (like 3 total) of these type of transactions.
excellent thank you for the insight SurrealEstate
Good stuff. I've never ventured down this far in size (and never without equity behind us) so I have no idea how things work in this arena but how would a community bank (or a regional if that still exists) look at a seller's note if it sits 100% behind the bank financing? Would they look at it as equity even though the buyer doesn't have skin in the game?
I'm also curious as to the amount of equity a bank in this situation wants. Is it just to make the numbers pencil or do they want the buyer to have skin in the game?
OP, outside of the financing piece I wouldn't concentrate only on cutting costs but go in with a plan to grow revenue organically, expand market share and product/service offerings, perhaps have an M&A strategy for other similar businesses once you've stabilized and things along those lines. Cutting costs at a company that size isn't like doing a big LBO, cutting costs then selling pieces and parts off because that business isn't big enough to do that. You also don't want to rely on only improving margins because even big percentage improvements aren't big dollar amounts and this will be your full time job-busting your balls over a 10% improvement will bring you home an extra $20k, which will be peanuts compared the amount of work that will take. I have no idea what your background is but I also wouldn't assume that it's really easy to jump in and start operating a company if you don't have experience doing so or a decent amount of experience in that business. Ask your self questions like why can I grow sales/rev when the current owner, who has been in the business for longer than I have, hasn't done so? Do I have deep connections in the industry? Am I bringing a new strategy to it? What happens if my strategy doesn't work? There are dozens of things along these lines to consider.
I know to finance types $1MM rev co's seem like a monkey could make it work, but small companies can be more challenging to operate because operations have to run lean and you will have to personally be knee deep in running the operations. You won't be the CEO that's shielded from customer interaction or unloading boxes from delivery folks by dozens or hundreds of people between you and those tasks. Also, in real PE you don't run the company. You have professional management run the company, people with deep industry experience and who typically have been involved in running a PE backed company, so as the PE guy you sit at a Board/Advisory level and tackle issues at a high level but you don't actually implement and manage those "operational excellence" changes at a micro level. I have taken roles in a couple of our portfolio co's (that were much larger than what you're considering-bigger can mean more complicated but it also means more resources) to get operational chops and I can tell you that it is an entirely different world than being an investor and it is not easy.
I'd also look to finding an equity investor if possible. It obviously wouldn't have to be huge but I'd imagine that will make not only the financing easier but getting someone to agree to sell because they'll be more confident you can close. I don't mean to discourage you at all but if you want to actually do something like this you need to have a really good strategy and be able to execute on it.
Dingdong08 that's a great post, cheers for the time taking to write that!
I'll be speaking with relationship managers at a couple of different banks soon, I'll report back to this thread with their input.
This is smaller than I have ever dealt with too, but although the bank views a seller note (or any sub debt) as quasi-equity, there is no way the bank would finance a sizable portion of the purchase price without the buyer having some skin in the game (via personal guarantee or collateral pledge, equity investment, etc.).
The underwriter is going to look at this from a worst-case scenario and immediately think about what would happen in the event the business needs a capital infusion or is forced to go into bankruptcy. Since the buyer has no incentive to make it work, and the prior seller ran an inefficient or struggling business, there is literally zero value as a going concern.
Even though the bank may have adequate asset coverage, smaller banks aren't interested in ABL financing unless there is a large RE component. The bank doesn't want to go through the process of bankruptcy and liquidation.
You'd be hard pressed to get a bank to give you this loan with no money down. Most local/regional banks aren't in the business of funding startup PE firms, and they absolutely do not want to do 100% debt deals. No amount of financial analysis or golden projections on your part is going to matter to them if you don't have any skin in the game.
My advice if you really want to do this: save up some cash, put money down, request the loan. They'll probably want to mortgage some of your assets (assuming you have any, and assuming the business is liquid). Banks need to make money and cover their asses, too.
I have thought about this before. There are plenty of business brokers out there selling small businesses with "high free cash flow". I have never delved into the specific financials of any of these, however most banks will not provide a nominal cash flow-based loan without a personal guarantee and assets that can account for the balance.
Here are some of my financing thoughts:
1) Revolver: Revolving credit facility based upon A/R (typically ~85% current) and inventory (mix of finished goods, raw materials and WIP) 2) Factoring: If the business has cash flow and/or significant misalignment in WC payment/collection terms 3) Reverse Equity Line of Credit: If the business owns real estate, you probably won't have access to the sale leaseback (which is more about credit worthiness of the business as an ongoing, viable entity), but you could do an equity line of credit. 4) Sell equipment for cash up-front to lower outlay at transaction and rent the equipment back; keep in mind this would be a deduct to EBITDA. 5) Seller Note/Preferred Equity: If you are taking out an asset based facility, this should not impact that. However, this could hurt the ongoing liquidity of the business, but you could structure as a PIK note to avoid cash payments in early years. When combined with the prior options, this is the most feasible. 6) Small Business Loan (SBA) or industry-specific Federal Loan Programs (e.g., Farmer MAC)
In reality, the best way to limit your initial investment is to combine a number of these options, based upon whichever the business is suited for.
Also, when looking at EBITDA and FCF of these businesses, make sure that the number includes the departing owner's salary or a reasonable compensation. If it doesn't, then you should add that back.
Best of luck and keep us posted.
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