Competitive Edge Magazine - Debt Refinancing

April 1, 2002

A Closer Look at How to Ensure a Smooth Transaction and a Better Bottom Line for Your Company

By James Grien

With short and intermediate-term interest rates at historic lows, many companies - both large and small - are contemplating refinancing. Since the benefits of a well structured refinancing or loan-restructuring can extend far beyond lower borrowing costs, many factors should be considered in the process of evaluating and completing a refinancing. While the objectives for refinancing may be straightforward, the refinancing process is less defined and can follow a variety of paths.

Why Refinance?

As a result of the Federal Reserve Bank's response to a slowing economy, as well as a lack of inflationary signals, interest rates have fallen. In this low-rate environment, many corporate balance sheets are saddled with fixed rate debt originated when rates were much higher. Refinancing is an easy way to lower borrowing costs and increase pre-tax earnings. However, in considering
refinancing, companies must look beyond the interest rate savings and consider all of the costs associated with refinancing to determine the true savings, if any.

Increased Availability of Capital

Even in a tight lending environment, refinancing can result in increased capital availability. One company's recent refinancing resulted in a new lender being identified through a competitive process, increasing available capital to the company by nearly 25 percent. This was despite the fact that the company's prior lender refused multiple requests for additional capital.

All else being equal, increased availability may also result from different credit policies among individual institutions or a lender's willingness to increase advance rates on collateral for asset-based loans, or expand debt to cash flow multiples in the case of cash flow-based loans. Usually, that willingness is underpinned by some combination of the new lender's greater comfort with the borrower's industry and a borrower's history of consistent financial performance.

Modified Repayment Terms

Refinancing can be utilized to extend principal repayment terms in order to free up cash flow for other uses, including increased capital investment and acquisitions. Recently, a company faced significant scheduled principal repayments at the same time that it was seeing unprecedented acquisition opportunities. Refinancing resulted in an extension of the company's debt maturities, which enabled it to redeploy cash flow in favor of several exciting acquisitions.

Accommodating Structure Changes

Companies often undertake refinancing transactions to accommodate changes in existing or prospective corporate structure. For example, one company recently decided to exit a non-strategic line of business. Because the exit was not expected to generate sufficient proceeds to pay down the loan, the company requested that the lender restructure the loan and accept other comparable collateral as security.

How Do Companies Refinance?

Find An Agent

While the objectives for refinancing may be straightforward, the refinancing process is less defined and can follow a variety of paths. Individual circumstances may dictate one approach over another, but there are several benefits to using an agent to facilitate the refinancing process.

An experienced agent can design and manage an orderly process that encourages competition among lenders and results in optimal terms to the borrower. Competition encourages lenders to be more aggressive in the rates, structures and terms they offer. An experienced agent also can ensure that the process of refinancing does not sidetrack a management team's focus away from the daily operations of the business.

Finally, an experienced agent can often serve a vital role as the "bad cop" in negotiations with prospective lenders. An agent is able to negotiate aggressively without concern for the long-term relationship implications. Clients often view this as an agent's most critical role.

Determine the Most Suitable Structure

Typically, the agent will begin the process by assisting a client in developing multiyear projections, analyzing capital structure and determining the capital needed to support current and projected business needs. During this phase, the agent works with the client to examine various repayment terms, interest rate assumptions and covenants to arrive at a transaction structure that matches the specific financing needs, balance sheet and cash flow characteristics of the business.

Prepare a Confidential Memorandum
Once an optimal transaction structure has been determined, the agent along with management, creates a confidential information package. This package includes the proposed loan structure and terms, and a detailed company description. In a private market refinancing transaction, the package will be a more aggressive "selling" document than you might see in a public offering.

Design a Management Presentation

The next step is to develop a presentation used in face-to-face meetings with selected lenders who have expressed interest, based on the information package. The presentation serves to introduce prospective lenders to management. The importance of the presentation cannot be overstated. Bankers will tell you that, while most companies look good on paper, they base decisions on "the whites of management's eyes." The quality and content of the presentation will ultimately dictate the outcome of the process.

Identify Potential Lenders

All lenders are not alike. Often, a lender with experience in a particular industry can move rapidly and aggressively. The agent's key roles include bringing market knowledge to bear in selecting the "most likely suspects" to approach and maintaining up-to-date information on a wide range of traditional and non-traditional lending sources.

Typically, the search for a lender begins with discussions with a broad group that appears to fit the client's objectives. Next, a smaller group is chosen to review the confidential financing memorandum and submit written expressions of interest. After reviewing these expressions of interest, a group of finalists is invited to meet with management.

The finalists will submit binding term sheets, and the agent will negotiate any remaining terms, select a partner and circle the transaction. The concept of a circled transaction is unique to private market debt deals. It means that once the parties have agreed to terms, the debtor can count on its cost of capital as agreed to, notwithstanding changes in rates between circle and final funding.

Managing a Competitive Process

An agent should work to maintain a fair and orderly process, trying at all times to assure that information is flowing simultaneously to competing parties. Nothing chills competition faster than the perception of favoritism.

While there are many factors to consider in selecting a lending partner, chemistry, although intangible, is one of the most important. Often, agents and clients pay too little attention to chemistry in the selection of a lending partner. An experienced agent understands that a lender is not just a source of capital, but a fundamental partner in a business.

The best chemistry often exists between the company and its existing banker, who best understands the business and has built a solid relationship with management. Often, the targeted outcome of a competitive process is one in which the existing lender, prodded by competition, moves aggressively to preserve a relationship.

Deciding to pursue and complete a debt refinancing process may not be as hard as it looks. While many companies are successful doing it for themselves, and others choose to use an agent, having the right tools will ensure a smooth transaction and a better bottom line for your company.

James Grien is a managing director and partner at TM Capital Corp. (www.tmcapital.com), a merchant banking and financial advisory firm with offices in New York and Atlanta.