Does it make sense / possible to borrow debt against company's future cashflows?
I know that typically once can borrow debt against company's assets, thereby using assets as collateral. For those working in credit, are you willing to lend against a company's future cashflows / financial health? What do you look for in a company as a creditor?
Not an expert, but don't lenders obviously take into consideration cash flow when they're structuring the loan? The cash flows are implied, hence why the assets are collateral. Cash flows are not guaranteed so why would you loan against them as opposed to fixed, relatively stable-priced hard assets?
Yes this makes sense. I'm wondering if it's possible to use cash flows as collateral or if that doesn't make any sense b/c those future cash flows are already being taken into account to pay the debt payments every quarter
If lending against cash flows didn't happen, there would be no Private Equity industry. Most deals are done as future cash flow based loan because a lot of companies simply don't have a lot of physical assets.
Can you expound on this? I would think any company would have a lot of physical assets? Even a software company probably has data centers / hardware stuff right?
You're loaning "against" the future cash flows, but you're using assets as collateral..Loaning against cash flows and using cash flows as collateral doesn't really make any sense when you think about it. You're loaning to a company based on how much cash flow they generate, ie the higher the cash flows the more you'll lend. How would you use this cash flow as collateral if that's what you're basing your lending decision off of? If they don't meet interest/amortization payments, what are you going to secure it against, the cash flow they didn't generate in the first place? You see where this is going?
Not really. Think about it in terms of scalability and the size of the loan they need. Sticking with the tech co example, let’s say they have $100M in EBITDA and assets of $250MM. If a PE Shop is LBO’ing them and can only use the assets as collateral to raise debt, they’d only get 2.5x leverage, which is generally not enough for a PE deal. However, they could raise 4.5x leverage from a cash flow loan (aka Leveraged Loan), which is closer to typical PE leverage. For what it’s worth, at one point in the late 90s/early 2000s MSFT had over $5bil in EBITDA with $42Bil if assets...of which $37Bil was just cash. The lack of assets is what makes SaaS such a good business model.
OP not all businesses that generate strong cash flows have huge assets - say a school doesn't own its building and leases it instead. Cash flows are strong cause students are locked in, and assets are light cause they just own laptops / whiteboards - lenders can still lend to that
Yes, you can lend "against" the equity of a business as well (which technically is derived from discounted future cash flows).
Lending greater than the asset value is additional risk and there is usually a higher interest rate. Unless this is a PE sponsored business and the lender has reasonable assurance that the fund will continue to support the company. That said, lending significantly higher than the asset value is where mezz debt plays.
Not sure if this is answering your question better than anyone else so far but... In real estate lending you provide a mortgage typically based on 2 metrics, loan-to-value and debt service coverage ratio. Let's assume LTV is not part of the equation in the following example.
ex/ Property A produces cash flow. It is currently 80% occupied (but historically 100%). Because of this, Property A's cashflow is 80% what it usually is. The owner of Property A goes to get a mortgage and tells the Lender, "Listen, this is a minor blip, I want you to give me a mortgage based off of my property being 100% occupied." What to do here? If you tell the owner "Hey sorry pal but rules are rules, we'll base the mortgage of your cashflows and right now your cashflows are X (ie. 80%).", then you'll lose the deal. How do you get around this? Approve the guy based on 100% occupancy, but do it in 2 tranches. eg. "Hey Owner, because your property is so great and you are such a great guy we'll do a great deal for you. We'll approve you based on 100% occupancy, but today we'll only give you the funds that reflect 80% occupancy. As soon as you fill up that vacant space and get to 100% occupancy, we'll send the rest of the money over."
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