Tag: Investment

Debt funding covenants – What you need to know

Posted on by Rory Moynagh
Fiona King HNH
Fiona King, Debt Covenants: What you need to know

What is a Debt Covenant?

A Debt Covenant is simply an agreement made with your funder to adhere to certain financial and operational measures until the debt is repaid. They allow your funder to monitor its investment in your business and are set out in your funding agreement.

In understanding funding covenants, it is important that business owners know what to look out for in order to assess what impact they may have.

The implications of triggering a funding covenant can range from an uncomfortable conversation with your funder, a fee becoming payable or a renegotiation of terms in full or part. At HNH, our debt funding experts work with clients and funders to ensure that covenants strike the balance of allowing the funder to monitor its investment whilst not restricting the ability of the management team to run the business effectively.

Debt covenants typically fall into 3 categories:

  1. Financial

Your funder is focused here on the ability of the business to continue to service debt. As such, covenants are designed to give an early warning indicator that a business may struggle to service debt in the future.

Financial covenants tend to measure key metrics such as cash generation available for debt reduction (sometimes called EBITDA – Earnings before Interest Tax and Depreciation, adjusted for business specific items such as promoter drawings and working capital).

What to look out for:

  • Ensure the covenant has sufficient headroom to allow normal fluctuations in activity;
  • Timing of measurement – especially if you have a cyclical or seasonal business. 

  1. Information provision

This usually relates to the provision of financial information, typically audited financial statements and management accounts but can also include business specific items such as debtors’ ledgers or stock information.

What to look out for:

  • Format, frequency and deadline for submission – Do you prepare the information requested as a matter of course or will you have to employ someone to do it (and hence incur a fee)? If you outsource the preparation, will it be available within the covenanted 30 / 60 / 90 days after period end?

  1. Restrictive

This category contains covenants that are designed to protect your funder from a change in the risk profile of the business, unexpected calls on cash or diminution of assets.

Restrictive covenants typically relate to: dividends, drawings, capital expenditure, changes in shareholding, raising additional debt, providing security to another funder, making loans to third parties or directors’ remuneration.

What to look out for:

  • Restrictive covenants should not prevent the normal running of the business. It is therefore critical at the outset that provision is made within the funding covenants to for example, pay a certain level of dividend or permit capital expenditure, if that is what the business needs to do to continue its normal operation.
  • Restrictive covenants should also not penalise or discourage out-performance. For example, if covenants include a directors’ remuneration cap and the business wishes to reward employees for out-performance, it is important that provision is made within the funding documentation to permit this.

When selecting the most appropriate debt funding partner, it is therefore imperative that covenants and specifically the extent to which they impact upon your business is given equal priority to pricing.

Should I stay or should I go?

Posted on by Rory Moynagh

The forthcoming Christmas break is, for many business people, the one time of year they can enjoy a proper break, away from the constant interruptions of emails and deadlines, and spend some quality time with friends and family, reflecting on the year just passed and the challenges that lie ahead.

This period of reflection is often the catalyst for change and we frequently find ourselves spending much of January meeting prospective clients who have expressed a desire to sell their business.

There are a number of valid reasons why someone may come to this decision including:

  • I have taken the business as far as I can.
  • My attitude to risk has changed.
  • The economy/competition/technology is a threat to me.
  • My team doesn’t have the ability to develop the business.
  • I want to capitalise on entrepreneur’s relief while it is still available.
  • Multiples are strong in my sector and I want to get out at or near the top of the market.
  • I had an approach it has got me thinking.
  • I can’t work with my co-shareholders anymore and we need to go our separate ways.
  • Personal reasons such as a health scare or simply a desire to spend more time with family.

A key part of our process is to look beyond the headline reason for the decision and understand the underlying motivation.

We have bad days, or weeks, when work isn’t going well, the pressure is building and it just isn’t enjoyable.

However, for most business owners the decision to sell is a once or twice in a lifetime moment, so it is crucially important that proper consideration is given to the following thoughts:

  • Why now? What has changed in the business or personal circumstances?
  • What position is the business in? Does it need investment, new people, new systems, etc.?
  • What are the alternatives? Can something be changed that would take the pressure off and make work enjoyable again?
  • What could someone else do with the business? Are you selling an opportunity or a risk?
  • What will you do next? Even if the sale of a business yields a life changing amount of money, many sellers soon find themselves bored and seeking a new challenge.

It may sound counter-intuitive coming from a firm that ultimately gets paid when people sell their business, but we would much rather potential clients wait and sell for the right reasons, at the right time, rather than rush into a process which can be time-consuming, emotionally draining and indeed costly.

There is a high correlation between poor planning and aborted transactions; a failed process can linger over a business for years, putting doubt in the minds of employees, investors and potential acquirers.

Once the underlying reasons for wanting to sell are understood, only then should you look at the options, which may include:

  • A trade sale i.e. to another company.
  • A partial exit, achieved through selling a stake in the business to an investor, which would be a private equity fund, HNWI, family office, etc.
  • MBO, MBI or BIMBO.
  • Putting in place an exit readiness plan for a sale in the medium-term.

We will address these options in the weeks ahead, but in the meantime, here’s a link to our first blog in this series, ‘Why is succession planning crucial for your business?‘ .