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Businesses should get advice before borrowing

The issue for many businesses is knowing how to navigate the changed market

Just about every business needs to borrow from time to time. Sometimes it’s just a bank overdraft or short-term loan to tide it over periods when cash flows are tight and in other cases it might be to fund or part-fund the purchase of a new premises or the acquisition of another business. The questions tend to centre on where to get it and how much to borrow.

And when it comes to the where, the market here has changed considerably in recent years.

“The number of banks has thinned out and the number of alternative lenders and peer-to-peer lenders has increased,” notes Naoise Cosgrove, managing partner and head of corporate finance with Crowe Ireland. “The problem for a lot of businesses is knowing how to navigate the changed market. It’s difficult. There is no ready-made roadmap. There is a challenge for lenders to reach their target market as well. That’s where professional advisers come in.”

The main banks should still be the first port of call for most businesses seeking debt capital, according to Shane O’Neill, who runs the Davy Corporate Finance debt advisory business.


“Businesses with a good banking relationship should still prioritise their bank for debt funding but alternative providers can provide a wider product offering with more flexibility, for a price,” he says. “The traditional banks have an established suite of products across commercial property and SME funding, targeting overdrafts and revolving credit facilities, term financing, invoice discounting, asset finance, etc. The lending product suite of credit funds are similar but often more flexible.”

Credit funds are typically backed by pension funds or private-equity funds. They are not governed by the same prudential rules as banks and can be more flexible in their lending practices. “They may lend more money, can offer interest-only periods, and over a longer duration,” says O’Neill. “But they will price up the risk and charge more for the flexibility.”

Robert Adams, managing director of Focus Capital Partners, notes the growing importance of these lenders. “Alternative lenders have developed quite a big presence in Ireland over the past six or seven years with firms like Finance Ireland, Beechbrook Capital, Earlsfort Capital and Bain Capital all active in the market.”

At the highest level, the biggest corporates now borrow directly from pension funds. “The pension funds will deal with unrated companies and will do their own ratings before lending to them,” O’Neill points out.

Of course, not all debt is the same. “The most common forms of debt capital available to businesses are term facilities with regular principal repayments over the life of the loan; revolving credit facilities in which the drawn amount rises and falls in line with a business working-capital profile; asset-backed loans, which are generally secured against a company’s assets, be they accounts receivables, inventory or machinery and equipment; and unsecured overdrafts,” explains Jeremy Hoare director, debt advisory, corporate finance at KPMG Ireland.

Hoare says it is important to ensure there is alignment between the form of debt utilised and the proposed use of the funds. “For example, the acquisition of a fixed asset, such as a new factory, should ideally be funded via a facility with a longer term so that the repayment of the facility can be spread out and the ultimate cost met by the anticipated returns generated by the asset. Similarly, short-term or ad-hoc funding requirements should be met using sources of finance which are flexible and able to be drawn on short notice and on multiple occasions.”


Then comes the question of how much debt to take on. And businesses may not have a lot of choice in this due to the rules and guidelines applied by the credit institutions.

“There are two main types of lending,” Adams points out. “Secured lending and cash flow lending. Generally, cash-flow lending is calculated on a multiple of ebitda [earnings before interest, tax, depreciation and amortisation], usually around three or four. You can get mezzanine funding on top of that up to a multiple of twice ebitda. Unitranche lending is a blend of the two, giving between four and six times earnings.”

Those rules don’t necessarily apply to secured lending, which is usually repaid over a long term. “In asset-backed businesses like hotels or nursing homes which own real estate, the level of gearing can be higher,” says Cosgrove. “Loan to value is king in those cases.”

“There is no magic formula in establishing the correct level of debt,” says Ciaran McAreavey, managing director Ireland with Close Brothers. “The appetite for increased financial risk associated with the proposed level of leverage will differ from one business to the next. Fundamentally the business needs to assess the impact the repayment schedule of the debt will have on its projected cash flow. The assumptions around the projected cash flow need to be subjected to intense scrutiny and sensitivity analysis.”

He also points to another key measure of gearing, the ‘debt to equity’ ratio, which is calculated as the gross financial debt divided by shareholders’ equity. “A typical rule of thumb used by banks and lenders would be that a ratio of less than one is low and above two is high, with a ratio above 1.5 starting to make the lender consider whether the level of leverage is justified by the business.”

And those limits may be academic in any event. “Poor recent historic trading has become a significant factor for companies seeking to borrow at present as Covid-19 impacts their credit profile even if the business has bounced back,” O’Neill explains. “Combined with reduced asset prices and a weaker economic outlook, this makes debt raising more challenging.”

Interest rates

The increase in interest rates is also having a negative impact. Adams explains that the interest rates being paid on loans will have effectively doubled by the end of the year as a result of the increase in European Central Bank base rates. This will affect a business’s debt service cover ratio — the level of debt it can afford to service.

“This will significantly reduce the amount of loan capital available to businesses,” he adds.

Cosgrove advises businesses to get professional advice before borrowing. “Find out what lenders will and won’t do,” he says. “It might be better to use a mix of funding types. There is a lot of work involved in raising funding. It’s not a quick process. Professional advisers can help with that.”

“This will significantly reduce the amount of loan capital available to businesses,” he adds.

And it won’t end there, according to O’Neill. “Interest rates will continue to rise during 2022 and into 2023. Coming from a prolonged period of interest rates being close to zero, many companies will experience a doubling or trebling of their interest bill next year. Companies should be modelling these impacts now and setting plans to ensure that the balance sheet of the company, that has been passive for a number of years, doesn’t get in the way of day-to-day operations by choking cash flow.”

Of course, fast-growing businesses may be in a position to negotiate deals with lenders which allow them to draw down debt capital as they grow and can service the debt. However, as Adams notes, there are also equity options in the market which may be more appropriate for fast-growth businesses.

Cosgrove advises businesses to get professional advice before borrowing. “Find out what lenders will and won’t do,” he says. “It might be better to use a mix of funding types. There is a lot of work involved in raising funding. It’s not a quick process. Professional advisers can help with that.”

Barry McCall

Barry McCall is a contributor to The Irish Times