FINANCING GROWTH IN UNCERTAIN TIMES
By Steve Woods, EVP and Head of Corporate Banking at Citizens Commercial Banking
Corporate leaders today sit at a crossroads. Continued economic prosperity has led to favorable business conditions, which has many companies poised for growth.
On the other hand, speculation that the business cycle may have hit its peak – coupled with talk of an economic downturn on the horizon and political uncertainty heading into an election year – has even the most optimistic CEOs and CFOs carefully weighing any expansion plans.
The No. 1 question many business leaders are facing: “Is now the time to take on debt to finance growth?”
Given the cost of capital and the still-strong U.S. economy, there has rarely been a better time to implement a well-thought-out strategic growth plan.
Reflecting on the current situation, interest rates and the cost of debt are still near all-time lows if you are looking to borrow to expand your operations or make a strategic acquisition. The market is awash in cash looking for places to invest. Company valuations are still at record levels if you are looking to sell or divest part of your business. Furthermore, overall economic activity remains strong despite slowing global growth and trade uncertainty (which has impacted the manufacturing sector in particular).
The bottom line is that there’s a window of opportunity, over the next 6-12 months, to lock in a capital structure while rates are still low and there is still access to both credit and the broader capital markets.
Looking to the future, the first thing company leaders should do is assess their strategic growth plans and ask some tough questions. Where do you want to be in five or 10 years? How can you get from here to there in terms of future revenue growth? Does this need to be organic or inorganic growth or some combination of both? What will be the gross margin implications? Do you need equipment and technology upgrades? Increased R&D spending and staffing? And then there’s the big question: How will a growth strategy be financed?
Here are three suggestions for corporate leaders as you develop your strategic growth plans based on debt and equity:
Review your current cash flow – realistically and thoughtfully
Cash flow is the first item commercial and investment bankers, private equity and other financiers will look at when assessing the growth potential of your company moving forward.
Among other things, potential financial partners will be examining the predictability of cash flow, the ups and downs, and whether strategic growth is both realistic and sustainable.
In evaluating cash flow, differentiate between maintenance expenses and future growth expenses
Maintenance expenses deal with how much is currently spent just to maintain the status quo. Growth expenses are all about how new capital spending will specifically lead to revenue growth (or margin expansion) via new equipment purchases, technology upgrades, R&D expansion, and possible staffing and real-estate investments.
It can’t be stressed enough: Maintenance expenses and growth expenses are two entirely different things – and they will be carefully scrutinized by potential financial partners.
It gets trickier for future growth plans based on merger-and-acquisition strategies. In assessing the pluses and minuses of an acquisition, for instance, one needs to differentiate between expense (or cost) synergies and revenue synergies.
Expense synergies are the opportunity, as a result of an acquisition, to reduce costs tied to the new operational structure of a combined company – whether it’s overlapping equipment, staffing, real estate holdings and other expenses that can be cut to achieve efficiencies and savings while not harming growth. You have to be very careful not to overestimate the potential expense-synergy savings, a common mistake when mapping out an M&A growth strategy.
Revenue synergies are the opportunity for a combined company to generate more revenue from non-overlapping operations and product lines, leading to higher overall sales than if the two companies had remained separate.
Recognize the strengths – and weaknesses – inherent in your industry
Not all industries are created equal. Some companies are in industries that can sail through downturns with relative ease, while others traditionally face strong winds and choppy waters. Remember: The more predictable the cash flow, the more attractive a company becomes to potential financial partners – and potential partners will want to know the true peaks and valleys that a firm might endure during a downturn. Diversifying your revenue streams can help make your cash flow steadier during a downturn. It is also important for you to think like a disruptor. Your competition may not be coming from the usual places, so it is important to think about how new technology, for example, could be changing the game.
So, is now the time to take on debt to finance growth?
You can’t really answer that question without following the process outlined above. However, after doing that analysis, you will likely find that you are in a much better position than you might have first thought to pursue your strategic growth plan. Given the current economic climate and the low cost of capital, there may be no better time than the present to put your plan into action.
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