We are in a new financial world since the Fed started raising rates.
We are seeing more requests than ever before to advise on debt. This might be counterintuitive, as debt is more expensive than it has been in many years.
However, since equity is harder to come by and valuations are down from their astronomic heights, it may be a much more common way for businesses to raise liquidity in the near to mid-future.
Many financing options are based on SOFR, which has risen speedily in response to the Fed's moves. This means that the loans can float if the Fed raises rates more.
This is good for the lender as it protects them as rates rise, but they have to be careful that they don't choke the borrower that they lend to.
For example, in commercial real estate, many lenders currently require borrowers to buy an interest rate cap, which is basically a hedge against rising rates which cap them for a fee.
I wanted to outline a few ways that businesses are raising debt (at a very high level):
Traditional banks
Banks are usually the cheapest but least flexible and slowest moving financing partners.
This may be a revolving debt facility, like a credit line, or it could be a one-time financing like a mortgage collateralized by the EBITDA of the business.
These loans typically have more strict terms and covenants than non-bank funds.
However, since the prices are so much lower than alternatives because of the deeper diligence required, this is usually a company's first choice.
The bank will usually require keeping treasury with the bank.
Ballpark price: SOFR+2-3%
SBIC fund/BDC
An SBIC, or Small Business Investment Company, is a privately owned and managed investment fund that's licensed and regulated by SBA. An SBIC uses its own capital, plus funds borrowed with an SBA guarantee, to make equity and debt investments in qualifying small businesses.
These funds are a bit cheaper than another non-bank financing since they are usually locked into lower rates through their SBA loans.
They can be flexibly structured, sometimes using warrants to give the fund some equity-like exposure to the business.
The terms and covenants here can be much lighter than a bank, but the prices are significantly higher than bank financing.
Ballpark price: 9-14%
Mezzanine financing
Mezzanine financing is financing that sits between senior secured debt and common equity in a company.
This is usually provided by a non-bank institutional investor.
It can be structured either as preferred stock or as unsecured debt, and it provides investors with an option to convert to equity interest. Mezzanine financing is usually used to fund growth prospects, such as acquisitions and expansion of the business.
However, if you do not grow fast enough, high-interest rates can eat up profits quickly.
image: https://corporatefinanceinstitute.com/resources/commercial-lending/mezzanine-financing/
The business may also take on an equity owner at a sub-optimal valuation.
Sometimes based on SOFR, sometimes not.
Ballpark rates: 10-20%+
Invoice Factoring/Financing
Factoring firms front the company money to either pay for goods or services that business sells.
This can be by buying invoices from the company at a discount, or by lending the company money based on their accounts receivable.
In return, they will step in and do the collections of those invoices.
This means that the factoring firm is not only senior to the equity holders (they get their cut paid right away, and first), but they are also deeply ingrained in the business.
Rates: high
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