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Canada’s economy may still be struggling to find a higher gear amid slumping commodity prices and the downturn in the oil sector — yet enterprising private companies can still find ways to grow their business and strengthen their competitive position. There are opportunities to be seized by companies with realistic expectations, a well-crafted business plan, solid financial management and a willingness to invest and take smart risks.
However, raising the funds needed to drive that growth can be a challenge in the current environment. The financing landscape has changed, and it can have surprising implications for companies that aren’t prepared.
Conventional wisdom holds that there’s an abundance of funding available, with investors and lenders eager to put their capital to work and searching for superior returns in a world of rock-bottom interest rates. The reality is rather different. As many companies are discovering, getting growth financing can be difficult and costly.
Canada’s banks continue to provide a significant proportion of lending and other financial services to the country’s private businesses, such as operating lines of credit. However, the banks are conservative and highly risk-averse, which inevitably colours how they determine and hedge risk and make lending decisions. With oil and other commodity prices dragging on much of the country’s economy, banks’ risk aversion will likely grow as their business lending activity may fall.
Indeed, access to capital, whatever its form — senior bank debt, junior capital, equity or equity-like capital — has become much more restricted, especially for companies involved in the natural resources sectors. Even companies in other sectors, such as manufacturing and transportation, may also find financing harder to obtain simply because of their exposure to the natural resources downturn. These issues and concerns are weighing on the minds of lenders and equity investors alike and some are responding by not funding anyone. Those that are providing funds are doing so on stricter
terms — terms which could actually be detrimental to some businesses.
Lending terms have grown stricter because the market has recently undergone a major recalibration of relative risk-adjusted returns.
Up until just a few months ago, investors frustrated by the low-interest environment were willing to accept higher risk in exchange for higher potential returns. But now these same investors, stung by defaults and concerned about the impact of the slumping natural resources sector, have greatly refined their view of risks. They’re adopting stricter investment criteria, insisting on more rigorous covenants, conditions and oversight, and demanding higher returns. Sub-investment grade debt that yielded 6% to 8.5% in the fall of 2015 is now yielding significantly higher returns, as investors demand better compensation for the perceived higher risk. 2016 default rates on sub-investment grade debt are forecast to spike to 5% of all publicly issued bonds; this will likely translate to higher borrowing costs for private mid-market corporate and commercial businesses seeking funds from banks and similar providers.
However, growth financing is available for companies with good track records, a healthy balance sheet, a strong management team and a solid business plan. It may just take an unexpected form, such as trading a stake in the business and a seat on the board in exchange for an injection of private equity or setting capital equipment against an asset-based lending arrangement.
Financing terms and conditions will vary depending on a company’s specific situation, of course. For companies that need capital — perhaps because they’ve suffered a setback, breached loan covenants or lost a source of funding — lenders will typically apply must more defined risk parameters. The cost of accessing that new financing can be significantly higher than owners expect, potentially including a higher monthly coupon and dilution of equity. Owners may also find investors demanding more oversight and increased governance as a condition of financing. Not that this is necessarily a bad thing: many mid-market companies will actually benefit from having more sophisticated, more professional governance structures in place. But owners should brace themselves for “sticker shock.”
Owners searching for growth capital, whether to pursue an acquisition, accept a large contract or expand production, will also find themselves facing a higher cost of capital. It’s important that owners factor this into their decision to pursue a growth opportunity, because the higher capital costs and other covenants may actually counteract any growth potential. Unfortunately, it can take two or three years after the decision is made for owners to truly know whether they lost an opportunity — or dodged a bullet.
Even in a low-growth economy, well-run companies can find or create new opportunities to achieve revenue and margin growth — from acquiring a competitor or expanding into new markets to investing in productivity-boosting machinery or other technology. No matter the path or paths chosen, business owners can improve the odds of success by building a solid foundation for their efforts.
Your business doesn’t have to be held back by a low-growth economy — you can still pursue opportunities to expand, grow revenues and improve margins in today’s business environment. Our Corporate Finance professionals can help you access new and innovative financing sources. Whether you want to invest in additional assets, increase your working capital or refinance debt, we can identify and help you access the right capital that will allow you to reach your business goals.
If you’d like to discuss how your company can achieve its growth ambitions in a low-growth world, please contact Dan Porter, Senior Vice President and Director, Corporate Finance at 416.596.1711 or [email protected]
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