Securing debt during Covid-19

Navigating the current debt landscape – with a materially different outlook than it had at the start of the year – will be essential to finding a funding solution that works for any business’s specific requirements.

Many privately owned businesses will take on debt to fund positive events in their lifecyle, such as geographic or product expansion, or inorganic growth through acquisition; or to fund liquidity events for the shareholders, such as dividend or shareholder recapitalisations. This can often be preferable to equity funding because it allows owners to retain control of their business and the returns expected by debt holders are usually lower.

But in the current environment, few businesses are likely to be able to take on debt to fund these growth or liquidity events. The coronavirus crisis has given an enormous economic shock to many sectors, and the recovery period is expected to be anything from six to 12 months or more. In this situation, debt is more likely to be required to plug a liquidity gap and help the business survive, or potentially to hibernate the business until it can generate revenue again.

Banks are taking a portfolio-first approach and conversations centre firmly around protecting their existing customer base. Demonstrating long term viability – and a plan for trading through, and beyond, the Covid-19 period – is essential.

For some businesses, there may be the potential for growth in the current crisis, such as opportunistic M&A deals. For others, this period can be used to consider the longer term strategy and ensure they have a medium term liquidity position that allows them to take advantage of opportunities in the post-Covid-19 world.

For these businesses, there are alternative pools of capital available that can allow them to be agile, without giving away equity.

Even ten years ago, the number of different debt products available to businesses was relatively few. These were often ‘vanilla’ in nature and could be sought only from a handful of lenders including the high street banks.

Over the last decade, the options for businesses looking to access debt funding have mushroomed into a diverse range of products, from a diverse range of sources and with varying levels of complexity. And with more complexity comes a need for more sophistication in the way businesses secure and manage their debt – especially in times of crisis.

Preparing the groundwork

For businesses that need to secure debt finance as a matter of survival, fundamental priorities have not changed, even if the circumstances have. The most likely provider for emergency support, at least in the first instance, is likely to be your existing provider and probably a high street bank.

Since the coronavirus crisis started to intensify in Europe in early March, banks have been inundated with requests to extend facilities, offer repayment holidays and to access loan schemes guaranteed by the government. Most have taken a positive and understanding approach to meeting these needs and responding to the requirements of their portfolio businesses.

One of the first priorities should be to consolidate your existing debt with your core banks – those which have been supportive in the past, which continue to be so during the current crisis, and which you can expect to be so during the economic recovery.

Be careful not to over-consolidate, though. You need to maintain some diversification in your sources of funding to minimise the risk in case one funding source closes or becomes uncompetitive. After the 2008 economic crash, for example, a major international bank in France was initially supportive of small and non-investment grade medium sized companies hit hard by the downturn. But two years later many businesses were left struggling when the same bank withdrew from the country’s small and non-investment grade business sector.

Choosing the right product

One product that can support businesses where there is a downturn to revenue is likely to be asset-based lending, including invoice factoring. Most banks will offer a variety of asset-based lending products and there are an increasing number of alternative asset-based lenders who are active and can provide financing across a range of asset classes. Invoice factoring, in particular, could be relevant for businesses facing stretched payment times due to the current crisis.

There will undoubtedly be some disruption and delay in being able to access asset-based financing, due to the need for site visits and valuation inspections, for example – and there is a greater administrative burden for finance teams. However, once businesses have secured their short-term emergency funding needs, this option can provide an immediate source of working capital and can be easily flexed and increased as the business grows.

There are also a number of alternative lending options to the traditional banks, such as challenger banks, private debt funds and family offices, which have grown in prominence, sophistication and appetite in recent years. These providers can often be more flexible than high street banks in terms of the level of funding and repayment terms. They might offer repayment holidays, for example, which could be a huge benefit for businesses facing temporary cashflow problems, and in some circumstances will continue to support growth or liquidity events in the short term.

Furthermore, these alternative funding solutions offer diversification in terms of lenders, maturity and security package, which strengthens the financial structure. The offset, however, is they tend to be more expensive or more secured than traditional banks.

Five steps to success

Given the unprecedented circumstances, banks and other lenders will be overloaded with enquiries for debt funding. Existing portfolios might be supported but new opportunities will be considered on a selective basis to reflect increased market risk.

This makes it more important than ever for businesses to be as diligent as possible in preparing their application. When working with businesses to help them secure debt during these challenging times, we recommend five key steps to success:

1. Demonstrate in detail how the business was performing pre-Covid-19. If loss-making, explain the turnaround strategy and how it was seeking to improve performance.
2. Include prudent short-term cashflow forecasts, with good scenario and sensitivity analysis around drops in revenue. All businesses will be hit by Covid-19 so don’t be afraid to be prudent.
3. Clearly identify the liquidity gap that needs funding and explain how the funding will be used.
4. Show you are doing all you can to support the business, whether it’s accessing government support schemes, senior management pay cuts or cost reduction measures across the firm.
5. Highlight your medium-term liquidity. What’s the plan for emerging from the situation in a stronger position once the lockdown restrictions are eased? Longer term, fully integrated forecasts to support this will be looked upon very favourably.

It is not a case of trying to predict when we will be out of lockdown and when the wider economy will recover. Rather, it is about justifying a clear set of assumptions in forecasts, and illustrating comprehensive strategic business plans for both the short and long term. This helps to demonstrate your ability to manage the cash flow and solvency of the business in the short and medium term. It shows you are being proactive and have a strategy for survival. As such, it is likely to reassure lenders that you are less risky than other businesses that have not been so diligent.

Businesses that are able to raise and manage debt will be in the strongest position to take advantage of the opportunities that inevitably follow a crisis. There might even be a possible upside to this situation, for example being able to acquire under-valued assets that were not so successful in managing their liquidity.

To discuss securing and managing debt for your business, you can get in touch below or using the contacts on the right. At Forvis Mazars, privately owned businesses are at the heart of our business and we are here to help you through this challenging time.

This article was written by Josh Thorneycroft, UK Debt Advisory Lead at Forvis Mazars, and Grégoire de Blignieres, Debt Advisory at Forvis Mazars.