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Comfortably Numb in the Lower End of the Middle Market

Date: Aug 23, 2016 @ 07:00 AM
Filed Under: Current Environment

Said James Darnell, MD at KLH Capital, a Tampa-based private equity fund, “As an equity group, our intention is grow the top line and EBITDA by reinvesting profits in the three to seven years that we typically own a business. Our investment thesis does not work with a three to four year amortization period that asset-based lending might require. We prefer an amortization period of seven to ten years.”

With regards to those who are active in asset-based lending, we see banks such as PNC Business Credit, Wells Fargo Capital Finance and The PrivateBank active and aggressive, along with non-bank financing from the likes of Monroe Capital and Madison Capital.

Recommendations for ABLs in Lower Middle-Market Transactions

First and foremost, if your bank is not deep and committed to asset-based transaction lending, don’t bother pursuing transaction related asset-based deals, but be ready for the relationship based “blue bird” (that comes in from out of the blue).

Situations where ABL makes sense include corporate divestitures where the division or product line has high working capital and has not performed well with muted historical EBITDA. This pushes the cash-flow lenders out of the mix.

Similarly, in situations where a company has come out of bankruptcy or a troubled situation and is in the “rehabilitation phase,” asset-based lending could be a strong solution and the pricing can be attractive for a lender with expertise in the industry. Industries undergoing this level of change include capital equipment manufacturing, oil & gas-related, consumer goods, and  commodity-based businesses.

Furthermore, given our survey results, the importance of strategic acquirers, and the prevalence of add-on acquisitions, look to your existing client base and talk with them about their acquisition strategies.  There may be substantial opportunities associated with working with them early on transactions and understanding how they can more fully leverage the parent company’s assets with the target’s to provide ample cash to close the deal at relatively low, ABL-based pricing. Remember unitranche and mezzanine are priced in the mid-teens. Some acquisitive clients within your portfolio might be interested in having you prepare high-level pro-forma term sheets to fund portions of potential acquisitions.

Less likely, but possible, scenarios include situations where acquirers, whose primary source of funding is mezzanine or unitranche, need asset-based lines of credit at a transaction close in businesses with seasonality, where the accounts receivable and inventory balances shift meaningfully throughout the year.

Finally, we believe the Fed will do nothing on interest rates until the middle of 2017, and barring any major political events, we see a flow of deals consistent with the cadence of the first half of 2016 through this time period.

Thomas Bonney, CPA
Founder & Managing Director | CMF Associates, LLC
Thomas Bonney, CPA, is founder and managing director of CMF Associates LLC, a firm that delivers transaction- and transition-focused financial, operational and human capital solutions to private equity-backed companies across North America.
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