Asset Based Lenders Must Analyze Their Borrower’s Expansion Strategies

By Freed Maxick ABL on November, 18 2013
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Freed Maxick ABL

Author: Paul Muldoon, CPA, CIE, CFE, Senior Manager

Be the voice of reason when it comes to customer growth.

ABLWhether a client’s business growth happens through internal expansion or external acquisition, they share certain denominators. Borrowers usually need more capital — either private equity or debt — to achieve their objectives. And these entrepreneurs tend to overestimate how they will perform while underestimating timing and financing constraints.

Asset based lenders often serve as the voice of reason by 1) reviewing expansion plans skeptically — that is, by asking key questions — before approving an expansion or acquisition loan, and 2) requiring borrowers to provide financial statement projections and other analyses.

Clients have several expansion strategies from which to choose. And lenders should analyze these tactics carefully.

Build from within

Clients can take the slow and steady path by stepping up sales themselves. Internal growth strategies might include building a new plant, developing a new product or service, purchasing new machinery or expanding into new markets.

But, building from within isn’t without its drawbacks. First, management must devote a lot of time to marketing and selling, which means there’s less time for normal operations. This scenario can be especially disruptive for a business that relies on just a few key individuals. Likewise, integrating new equipment or facilities can consume time at the expense of customer service and existing sales.

Moreover, new products may cannibalize existing ones, or a new target market might reject a product extension. Conducting preliminary tests via free trials, surveys and focus groups is an inexpensive way to avoid costly marketing miscalculations.

Consider an acquisition

Purchasing another business is the fast track for growth. An acquisition usually provides assets and an established track record, including a pre-existing client base, immediate cash flow, an assembled workforce and customer referrals.

Business combinations make the most sense so long as the value of the combined entity is greater than the sum of its parts. So, acquisitions should create value via operating synergies, economies of scale, and cross-selling opportunities. Your competitors will likely be the most obvious acquisition candidates.

Of course, acquisitions don’t always pan out. Some potential reasons for failure include seller misrepresentations and incongruent corporate cultures.

The most successful transitions require the seller’s ongoing efforts. In-depth due diligence can minimize acquisition risk.

Do it jointly

Joint ventures and other contractual relationships with other businesses, such as franchising and licensing, allow companies to grow with minimal capital infusion. By starting slowly, the two entities can test their congruence and, if they’re compatible, add incremental layers over time.

Develop projections

Clients face many growth opportunities but typically have limited resources to pursue all of their ideas. When you’re prioritizing and selecting expansion alternatives make sure you have projected financial statements.

Normally, projections begin with an expected percentage increase in sales. Then the growth rate flows through to other areas related to sales, such as variable expenses, inventory, receivables and payables. Thorough projections will depict all three financial statements: the balance sheet, income statement, and statement of cash flows.

CFOs and CPAs often use debt as a “plug” figure to balance projections. This figure is very helpful for lenders, because it shows how much, and when, the loan proceeds will be needed. Historic results offer an important frame of reference when reviewing the projections.

Don’t ignore the time value of money

One big problem with projections is that they often ignore the time value of money. That’s because they describe what’s likely to happen given a set of circumstances. Thus, it’s difficult to compare detailed projections against other investments that a business might be considering. As a result, other financial tools, such as internal rate of return calculations and a net present value analysis, generate comparative metrics.

Expect growing pains

Your clients’ expansions will likely come with growing pains. So, make sure their strategies are sound before issuing new loans.

Freed Maxick’s Asset Based Lending Team works with dozens of asset based lenders across the country. We can assist you in evaluating the merit and integrity of borrowers’ requests for expansion strategy funding.

For more information about our business advisory, audit, and other accounting services contact us here, or call me at 716-847-2651.

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