AXIAL FOR CEOS

THE CEO'S GUIDE TO

DEBT FINANCING
Table of Contents
Capital Structure......................................................................................................................................... 4

Equity vs. Debt: Which Is Better for Your Business? ................................................................. 6

Making Debt Work for You.....................................................................................................................8

4 Questions to Ask When Evaluating a Bank Loan ...................................................................23

How Talking to a Lender Is Different Than Talking to an Investor ................................... 24

Why You Should Review Your Debt Regularly ...........................................................................26

5 Pieces of Advice From Lenders to CEOs .................................................................................. 28

Don’t let debt scare you.
:3

When it comes to running and growing a successful business, debt can be a healthy
and helpful way to finance operations and new expenditures. The key is to take on the
amount and type of debt that’s right for your business’ goals at a given point in time.

In this ebook, we’ll provide first-hand advice from lenders about how to find debt
options that work for your business’ needs, and explain some of the most common
types of loans available.
You’ll learn:
ɚɚ How debt and equity fit into the capital structure
ɚɚ When to turn to the bank, and when to consider alternative lenders
ɚɚ Types of loans available for your business
ɚɚ How to talk to a lender
Capital Structure :4

A company’s capital structure is arguably one of its most important choices.

From a technical perspective, the capital structure is defined as the careful balance
between equity and debt that a business uses to finance its assets, day-to-day
operations, and future growth.
From a tactical perspective, it influences everything from your firm’s risk profile,
how easy it is to get funding, how expensive that funding is, the return its investors
and lenders expect, and how insulated your company is from both microeconomic
business decisions and macroeconomic downturns.
What Is a Company's Capital Structure?
By design, the capital structure reflects all of your firm’s equity and debt
obligations. It shows each type of obligation as a slice of the stack. This stack is
ranked by increasing risk, increasing cost, and decreasing priority in a liquidation
event (e.g., bankruptcy).
Senior debt is the lowest cost and lowest-risk form of financing — holders of
this form of financing have first dibs on a company’s assets in a liquidation event.
Because of the minimal risk that accompanies this block of the capital structure,
senior lenders loan money at lower rates (i.e., lower interest payments and less
restrictive debt covenants) relative to more junior tiers. Examples of senior loans
include bank loans and debt secured by collateral.
More junior forms of debt include no collateral business loans and mezzanine financing,
First and foremost, the capital structure is effectively an overview of all the claims
that different players have on the business. The debt owners hold these claims in
the form of a lump sum of cash owed to them (i.e., the principal) and accompanying
interest payments. The equity owners hold these claims in the form of access to a
certain percentage of that firm’s future profit.
Secondly, the capital structure is heavily analyzed when determining how risky it
is to invest in a business, and therefore, how expensive the financing should be.
Specifically, capital providers look at the proportional weighting of different types of
financing used to fund that company’s operations.
 :5

For example, a higher percentage of debt in the capital structure means

increased fixed obligations. More fixed obligations result in less operating buffer
and greater risk. And greater risk means higher financing costs to compensate
lenders for that risk (e.g., 14% interest rate vs. 11% interest rate).
Consequently, all else equal, getting additional funding for a business with a debt-
heavy capital structure is more expensive than getting that same funding for a
business with an equity-heavy capital structure.
 Equity vs. Debt: Which Is :6

Better for Your Business?

By Ami Kassar, Founder and CEO, MultiFunding
For business owners, the decision to finance a company via debt or equity can be a
crucial choice for the direction and future of the company. Both options have their
pros and cons, so it’s important to carefully weigh the benefits and downfalls of
each and determine how it will impact your business and personal life before signing
on the dotted line.
Equity Investment
Equity investment is when a business raises money by selling interests in the
company. Investors, who could be as close to you as friends or family or as removed
as angel investors or venture capitalists, take a percentage of your company when
they agree to fund the business.
With equity financing, the investor is on the hook for the majority of the risk. If your
business fails, you do not have to pay the investor back the money that was invested
in the company. No out-of-pocket payments mean that you will also have more cash
on hand to invest in the business upfront. This can be a huge relief for start-ups or
In addition to small businesses that are just starting to turn profits and gain market leverage.
giving up some However, the downside of equity financing is enough that many small business
of your future owners to shy away from this option. Understandably, investors in your company
profits, you're will share your profits and benefit from your successes. As the owner of the
also giving up company, you will reap a smaller portion of the rewards for your hard work, a hard
some of your pill to swallow when the time comes to pay your investors.
control of the
company whe In addition to giving up some of your future profits, you’re also giving up some of
you bring on your control of the company when you bring on investors. Before making decisions
investors. that will affect your business, you’ll need to consult with your shareholders and
keep them abreast of company actions.
Debt
Just like taking out a loan for a car or a mortgage for a home, taking on debt
for a business involves borrowing money to be repaid to a lender, plus interest.
Businesses may be eligible for an SBA-backed loan, a private loan, a line of credit
from a bank, or a personal loan from friends or family.
Unlike with equity financing, the lender in a debt financing arrangement has no :7
control over your business. Once the loan is paid in full, your relationship with the
lender is over. A lender is only entitled to the agreed-upon principal plus interest of
the loan, not any future profits of the company.
Other advantages of debt are that interest paid on the debt is tax deductible, and
that the regularity of loan payments makes them easy to forecast and plan for out
of monthly cash flow in comparison to fluctuating investor payments.
The disadvantages of debt financing are likely well known to any business owner
who also has personal debt. Loan payments must be paid back on time, or the
consequences can be severe for your business. By taking on debt, you are taking
the risk that your company will be able to comfortable and confidently pay back
the loan. Many business owners find themselves in a situation where loan payments
hamper their ability to grow or stretch their funds too thin.
Although you won’t need to give up control of your company with debt financing,
you will need to pledge certain assets of the company as collateral. And, even if the
company is registered as an LLC or another type of business entity, lenders may still
require you to personally guarantee the loan with your personal financial assets.
Which Option Is Best For You?
For many business owners, equity financing can be more difficult to obtain.
Investors are hard to come by for businesses that don’t have a large reach or a
proven record of sales. I don’t think this is necessarily a bad thing.
Shows like Shark Tank, in which hopeful entrepreneurs pitch their business ideas
to a group of investors with the hope of making an equity financing deal, have a
tendency to glamorize the world of equity investing and make it seem like a reality
for all small businesses. The show would be vastly improved if there were a lender in
the group alongside the investors to present a different option for financing.
In my opinion, debt financing can be a great solution for small businesses in a variety
of different situations — starting a business, expanding a business, weathering a
financial storm or investing in sales or marketing. With the right education, the right
loan product and a clear path to pay back the loan, debt financing can often be the
best option for small business.
 Making Debt Work for You :8

Every business is different. We talked to Mike Richmond, Managing Director of The

DAK Group, to get insight into how working with an advisor can help companies find
the right type of financing for their needs.
Q: How can working with an advisor help business owners?
A: A business owner is an expert at running their business, and has probably had some
experience dealing with a local bank. For business owners that are looking to finance
a major capital expansion, acquisitions, solve working capital needs, or a combination,
working with an investment banker is a surefire way to secure funding, often at better
rates with better terms. The investment banker is an expert in knowing a variety of
funding sources (beyond the banks), and is knowledgeable about term options and skilled
at negotiating the best opportunity for their clients.
Often companies make the mistake of looking to solve only their immediate concerns,
and fail to consider what’s appropriate in the long term. We work with companies to
analyze their long range goals and to formulate a financing structure that best meets their
overall needs.
Q: What’s the first step when working with a business?
A: We analyze their business plan and financial statements to determine their long
Very often term capital needs and advise them on the optimum capital structure — one that
companies fail provides the most flexibility at the lowest cost. Because lenders often tie covenants
to consider to operating plans, we also advise business owners to create two plans: an
what's aggressive internal operating plan and a more conservative plan that will be shared
appropriate in with the lender.
the long term. Q: How do you advise a company to think about equity vs. debt?
A: The difference between the cost of equity and debt is significant. At the same time there
are risks when leveraging a company with too much debt. We look to create the optimal
structure that minimizes costs and meets the risk tolerance of the business owner.
Q: What’s one of the biggest misconceptions CEOs have about debt?
A: Many CEOs do not realize that they have to manage the process of obtaining
financing. The more work they do up front, preparing a strong package of
information, researching the appropriate lenders, and understanding the debt
market, the more likely they will be successful and at lower cost. In our experience
banks and various lenders are very different. Restrictions and requirements differ
from lender to lender, sometimes even within the different departments within the
same institution. CEOs often don’t understand that if they can satisfy a lenders :9
requirements, they will be sought after.
CEOs are saying they can’t get debt. Frequently they are looking in the wrong places,
or are not adequately prepared. CEOs considering debt should talk to an advisor to
help them navigate the variety of options and lenders, and to determine the optimal
level of risk at the lowest possible cost.

Debt Diaries: Sterling Commercial Credit

Karen Small, Credit Underwriting Officer
Q: What kind of debt do you provide?
A: We provide asset-based lines of credit and invoice factoring credit facilities. Debt is secured
by short-term assets which includes accounts receivable, inventory, and equipment.
Unlike a traditional bank or SBA loan we inject fresh working capital weekly based on sales and
cash receipts. We accommodate high growth without giving up equity.

Q: When do CEOs come to you?

A: Common scenarios include:
ɚɚ They cannot cover their weekly operating expenses such as payroll, vendor bills, rent
ɚɚ The company cannot take on new purchase orders to accommodate growth
ɚɚ Traditional bank or SBA lender response time is too slow for growth-minded business
owners
ɚɚ Current A/R level is $800k but Traditional Bank lender credit facility is capped at $250k
Q: What are your main considerations when evaluating a potential loan?
A: Some of the top qualifiers include:
ɚɚ High personal credit score
ɚɚ Growth minded business model
ɚɚ Undercapitalized balance sheet
 Types of Debt : 10

“The landscape of debt is diverse but very fragmented,” says Peter Capobianco, Director
of BPV Capital Management. “Traditional debt financing has become very difficult for
some companies to obtain but alternative sources have become prevalent from various
online opportunities to funds and family offices filling voids previously occupied by
more traditional/commercial banking institutions.”
Here are a few of the types of loans you might consider when thinking about
debt financing.
The First Step: Bank or SBA Loans
Within the senior debt class, there are different types of debt with different levels of
relative seniority. Nearly all organizations will make use of a line of credit provided by a
bank or a financial institution; this is usually secured by current assets or inventory and
is typically the first to be repaid.
Business lines of credit give you access to a specific amount of money and only require
repayments and incur interest if you use the money. These lines of credit are often
revolving, which means you don’t have to reapply once you’ve paid the balance down.
Bank term loans, which provide a lump sum of money which you pay back over a
certain period of time, are a great form of debt to consider as they’re relatively
cheap and low risk. However, bank loans can be hard for businesses to secure. In
order to qualify for a bank loan, business owners need strong personal and business
credit, a large asset base, a detailed business plan, and solid industry experience.
Small local or regional banks are more likely to be flexible in structuring a loan that
If your business
works for your business.
doesn't qualify
for a bank loan, If your business doesn’t qualify for a traditional bank loan, the Small Business
the SBA may be Administration (SBA), a government entity, may be able to help you bridge the gap.
able to help you According to MultiFunding's Ami Kassar, the SBA “partially guarantees traditional bank
bridge the gap. loans (between 50-85% of the loan amount) to lower lender risk and reduce interest
rates on loans up to $5 million in value.”
Don’t expect the process to be seamless. Kassar says that “the SBA has a reputation
of being laboriously measured and overly bureaucratic” and that “for business owners
seeking quick capital, the turn-around times and legwork for an SBA loan are often
prohibitive, even if the money is available at a lower rate and with more attractive
terms than its competitors.” But he adds that with the right guidance, the process can
run smoothly. “In most cases, I recommend bank loans and SBA loans as a first step. : 11
Many clients mistakenly believe they’re not eligible, but there’s no harm in at least
exploring the option.”

TYPES OF SBA LOANS:

ɚɚ 7(a): 7(a) loans are the most common type of business loan guaranteed by the
SBA covering a broad range of collateral and business types.
ɚɚ CDC/504: CDC/504 covers real estate and equipment loans.
ɚɚ SBA Express: The SBA can expedite the borrowing process for a higher
premium on smaller loan amounts (under $350,000).
ɚɚ CAPLines: SBA’s CAPLines program helps small businesses borrow for short-
term and cyclical working capital needs.
ɚɚ International Trade Loans: The International Trade Loan offers loans up to $5
million for fixed assets and working capital for exporting businesses from small
to mid-sized.
“Over the years our firm has had tremendous luck working SBA lenders to create
positive outcomes for our clients,” says Kassar. “In one example, we recently helped
a trucking company obtain a $5,000,000 SBA loan. They used the proceeds to
refinance their building as well as about $2,000,000 worth of their truck fleet. They
were able to obtain a 25 year amortization on the loan, and improve their cash
flow by hundreds of thousands of dollars a year, which was critical for a major new
project they are undertaking.”

USING SBA LOANS TO FUND ACQUISITIONS

According to Kassar, “the SBA can be a literal godsend” for any small business
thinking about making an acquisition.
The SBA provides loans up to $5 million which can help buyers fund the remainder
of the sale price. “For one thing, the repayment periods for SBA-backed loans are
exceedingly long,” says Kassar. “If real estate is involved, you might have up to 25
years to repay. And the usual 7(a) loan when other assets aren’t involved generally
has a 10-year payoff. In either case, you may well be able to pay off the loan through
your earnings.” Compare that to a traditional bank loan, which would likely have an
amortization period in the five to seven-year range.
“As an added bonus, if you’re able to pay off a 7(a) loan more quickly than expected,
banks generally aren’t allowed to impose prepayment penalties,” says Kassar. And
 although a buyer’s savings are typically a crucial component in an acquisition, “If : 12
your finances are strong, there’s a chance you can obtain 100 percent financing,
making your savings a moot point.”
Kassar also notes that SBA loans can be used to finance a collateral shortfall, unlike
banks, who require collateral to bank the entire loan and don’t take into account
intangible assets. “As always, SBA loans are ideal for companies that have not only a
good credit rating, but also strong cash flow, which makes a collateral shortfall less
damaging to lenders.”
Drawbacks to SBA loans include the complicated, bureaucratic process and the
need to research lenders — “remember, the SBA itself doesn’t make loans (it only
insures them),” notes Kassar. The SBA also requires owners with more than a 20
percent stake to personally guarantee the loan.
Regardless of how much cash your company is carrying, as a CEO, you should
consider acquisitions an option when looking to accelerate growth and expansion.
Payment plans, LBOs, and the SBA are all financing options with flexibility that
demand little-to-no cash commitment on your part and grant you access to a
wider variety of potential targets. While each carries its own risks, those pale in
comparison to the future rewards that the right acquisition can bring your business.
Putting Up Collateral: Asset-Based Loans
Typically, banks Asset-based loans are, as their names suggest, loans provided by banks against the
will be willing value of a company’s assets. Relevant assets include: accounts receivables, inventory,
to lend 50-70% and even fixed items like equipment and physical buildings. Typically, banks will be
of the value of willing to lend 50-70% of the value of the agreed-upon assets.
the agreed-upon
assets. FINANCING RISKIER PROJECTS
Since banks providing asset-based loans have collateral to call in the event that
the loan is not repaid, they may be willing to offer this type of financing for riskier
projects. For instance, if your company is looking to start a new line of business,
you may be able to borrow against the assets of your existing line to finance the
development of your new line.
Also, assuming your company is in good financial health and that you have a steady
stream of receivables, asset-based loans can also be among the easier types of debt
to secure. As with any attempt to secure financing, it is important to be able to
show the long-term viability of your business when pursuing asset-based financing.
STRONG ASSETS : 13
Naturally, to pursue asset-based funding, a company needs to have strong assets
against which to borrow. As a result, SaaS and other web-based companies are
typically not ideal candidates for asset-based loans.
Companies considering the possibility of borrowing against their receivables must
also consider the strength of those receivables. Receivables with uncertainty of
being repaid are unlikely to be accepted by banks as collateral in a loan agreement,
and it is possible that a bank will want to audit the firm on the paying end of an
A/R to evaluate its likelihood of repayment. Thus, it is helpful to have long-standing

Debt Diaries: Gibraltar Business Capital

Heather La Freniere, EVP, Head of Originations
Q: What kind of debt do you provide?
A: At Gibraltar Business Capital, we primarily offer asset-based revolving lines of credit. We
provide greater liquidity, speed, and certainty of close to prospective borrowers, as compared
to a commercial bank option. CEOs typically come to us for growth financing, such as sales
and marketing staffing, and plant or factory expansion.

Q: What are your main considerations when evaluating whether a business is

a good fit your services?
A: We review the collateral — specifically, accounts receivable and inventory — to see if there is
enough collateral to support the requested leverage or loan. In certain cases, there may be things
that we cannot finance, such as progress or milestone billings, or percent of completion contracts,
but we always take a 360 approach to see how we can help.

Q: Why is it beneficial to consider a commercial lender instead of a bank?

A: More flexibility. We can work with a borrower to determine exactly what the needs are, and
develop the best solution. Typically, banks are more willing to lend to those companies that aren't
in such dire need, as they are considered more risk averse due to regulatory restrictions.

Q: Tell us about a success story you’ve had with a business owner.

A: We provided an accounts receivable revolving line of credit to an innovative start-up company.
They were serial entrepreneurs, had a strong business plan and executed exactly as planned —
using our capital to purchase inventory and grow sales. Ultimately, the company moved on to a
larger facility with a traditional bank because it became so healthy.
customers or large firms as clients if you are seeking to use receivables as collateral. If : 14
your primary customers are small companies or your client relationships are not long-
standing, you may need to borrow against other assets or pursue other types of debt.

RISKS
Any time an asset is being held as collateral, there is risk that the asset could be lost,
especially in cases where asset-based loans are being used to finance new ventures.
While banks may be willing to finance riskier lines of business with asset-based
loans, it is important that you be confident in your ability to repay the loan without
surrendering an asset.
In the event that you choose your receivables as the asset to back your loan, it is
very possible that the bank providing the loan to you will instruct your debtors to
pay them directly. While this situation obviously streamlines your loan repayment
process, it also takes a chunk of cashflow out of your hands, which can be an
uncomfortable feeling. The potential loss of receivables is one factor to consider
when deciding whether or not to take asset-based financing.
A drop in the value of the asset used to collateralize your loan can also cause
the bank to recall part, if not all, of your borrowed amount. This can throw the
operations of any business into turmoil. As a result, as mentioned before, it is
important to collateralize asset-based loans with stable, predictable assets.
For the right companies, asset-based financing can be an extremely effective
means by which to take on debt. It can be easy to acquire and simple to maintain.
It is important, however, that the assets underlying the loan are strong and stable.
Uncertainty with underlying assets can cause banks to recall loan amounts or
possess assets, scenarios that can do more to harm a business than the original loan
did to help.
Invoice Factoring
A type of asset-based lending, invoice factoring helps provide businesses with a
continuous flow of operating capital. Business owners might use this capital to pay
creditors or taxes, meet payroll, or alleviate financial stresses associated with growth.
Invoice factoring entails selling your company's invoices to a lender. On the day
the invoice is due, the factor pays the company some percentage of the invoice.
Later, when the factor collects the invoice, it pays the company back the remaining
balance, minus a fee. In essence, invoice factoring enables an organization's
accounts receivable to serve as working capital for the business.
Factoring doesn’t mean necessarily mean your business is struggling. Business : 15
owners may use factoring to increase working capital and facilitate growth.
Factoring provides an alternative to a traditional bank loan, especially for businesses
who can't currently qualify for a bank loan. Factors can provide a reliable, and fast,
source of financing for these companies.

Debt Diaries: CrestMark Bank

Ray Morandell, Senior Vice President, National Sales Director
Q: What kind of debt do you provide?
A: Working capital financing through asset-based lending, factoring, and add-on equipment
financing. We are an alternative for traditional non-bankable deals. Our clients are typically
going through some kind of circumstance or transition, and we meet those needs for
companies with sound management and a good vision and business plan.

Q: What are your main considerations when evaluating whether a business is

a good fit for your services?
A: Company focus and plan, management capabilities, strength, and character. We also look at the
company’s customers, i.e., the level of companies they sell to. We are collateral-based lenders so
having sufficient current asset collateral (accounts receivable, inventory) and/or equipment is the
foundation of our solutions. Our focus is the lower middle market so the majority of our client base
is companies from startups to about $50 million in annual revenue.

Q: Give us an example of the most common circumstances under which a

CEO might shop around for debt.
A: CEOs might come to us if their current financier is not meeting their growth needs or
comfortable with turnaround dynamics. Our customers typically look to us to meet needs that
traditional lending approaches do not fulfill. We are able to leverage assets for working capital
even if the equity base of the company is strained.

Q: What’s a common misconception CEOs have about debt financing?

A: Not fully understanding the opportunity costs for lack of liquidity deployment. We typically
look at our solutions not as a cost of capital but a return on investment. We are focused in
how the liquidity we create is deployed within the company and the level of return CEOs may
realize through appropriate use of leverage.
Debt Diaries: 12Five Capital : 16

Ryan Jaskiewicz, Founder and CEO

Q: What kind of debt do you provide?
A: Factoring. We are a lender of first resort for our clients. Most of our clients are newly
established companies that are growing, but not ready for bank financing. We are the bridge to
that place. We are all about cultivating the passion of our clients and we do that through learning
about our clients and providing them with the best team to guide them along that track.
Q: What do you look for when evaluating whether a business is a good fit for
your services?
A: Our main considerations are debtor credit and character. The unique thing about factoring
is that the credit risk shifts from our client specifically, to the customers they are selling to.
This is why it is important that our client is taking on good clients, so they can access the credit
against that. We also look heavily at the character of our client. We want to see that they fit
with our core values and our mission as a company.
Q: When do clients come to you for help?
A: Typically, our clients come to us when sales are great, but there never seems to be enough
money in the account to pay their people. They sometimes come to us when they are
frustrated that they went into their bank and the banker told them they didn't fit into their box.
Finally, most clients come to us when they are just tired of being held back from growing their
businesses due to lack of cash flow.
Q: Is it more beneficial for a CEO to go to an institutional lender as opposed to
a traditional bank?
A: I think they both have their place. Businesses are just like people and have cycles they go
through. We all started as babies, then toddlers, then children...you get the idea. A business
is much the same. When the business is still in the early stages, it needs someone like us to
nurture it. Once it is self sufficient, it can be more comfortable moving on to traditional banking.
Q: What are some of the most common misconceptions of CEOs seeking debt?
A: They are under the misconception that debt should be cheap. At some stage debt can be
less expensive, but early debt is not like a home mortgage or a student loan. There is a lot of
risk to the lender and thus, there is a higher investment for that. They also don't understand
that not all credit is equal. I like to say that some people buy Apple computers and some
people buy Dells. They both get you online and check your email, but one of the companies
charges triple what the other one does. There is a reason for that and the key there is that not
everything is about price.
Between Debt and Equity: Mezzanine Financing : 17

By Ami Kassar, Founder and CEO, MultiFunding

In the architecture world, a mezzanine is described as an intermediate floor of a
lesser width that’s positioned between two main floors, while theater buffs know
the mezzanine is the lowest balcony or forward part of a balcony.
A mezzanine seat often is considered second rate — although some mezzanine
views actually offer the most-coveted sightlines.
In the financing world, so-called mezzanine debt also often has a so-so reputation
— a reputation that isn’t necessarily deserved. In fact, it’s been used successfully
for years.
“Mezzanine debt gets its name because it blurs the lines between what constitutes
debt and equity,” the Motley Fool writes.
For our purposes, mezzanine debt is cash flow that sits in the second lien position
behind asset-based lenders; in return for their risk, lenders often incorporate an
equity kicker such as stock warrants or bonus payments tied to company valuation.
Typical loan lengths are three to five years.
That sounds troubling, but it’s not necessarily a bad thing for the right company.
Mezzanine debt can be put to good use, especially for companies that have a
strong cash flow to support the debt. It’s not generally tied to secured assets, but is
lent based on a company’s repayment ability — also known as free cash flow. And
mezzanine debt allows a business to obtain financing without having to issue equity
and dilute ownership. That increases leverage.

Know Your Lender

“No one knows their business better than the CEO or owner. Our experience is that
most CEOs of small businesses treat their companies like their children. They will
do anything and everything to protect their business, employees, and assets, from
potential harm and destruction. As such, the best advice I can give to a CEO is to be
sure you know who you are getting into bed with as a potential new lender. Not all
lenders are alike. It is important to find the right lending partner for your contemplated
needs/situation and understand the basic terms that lender may require.”
-Seth I. Friedman, Managing Director, RLJ Credit
Corporate expansion projects, acquisitions, leveraged buy-outs (LBO), management : 18
buy-outs and recapitalizations may all be financed by mezzanine debt. It’s often used
for smaller LBOs that otherwise don’t have access to the junk bond market.
One catch, however, is that pricing can be across the board. Given its subordinate
position, interest rates are going to be relatively high to start, so be sure to shop
around for the best deal.
But why would borrowers want to pay those higher rates, which might be 20 percent or more?
For one thing, smaller companies often have limited options.
And remember that the IRS considers the interest on debt a tax-deductible expense,
which bring the effective interest rate way down.
Mezzanine lenders may also include features that can make payments more
management. PIK toggles — where interest is added to the loan balance — are one
example. Thus, if a borrower can’t make a normally scheduled payment, the interest
(or at least part of it) can be deferred.
Firms that are growing quickly won’t need a mezzanine loan for too long. That’s
because as the company grows, its value increases as well. At that point, you could
be able to refinance all debt into a single senior loan at much more palatable terms.
So, who exactly invests in mezzanine debt?
Large institutional investors such as commercial banks, insurance companies,
private equity firms and mezzanine funds are common investors.
“In an ideal transaction, the mezzanine fund hopes to make a profit through a
combination of current interest, the exercise of warrants, the sale of the underlying
equity upon a sale of the business or by requiring the company to repurchase the
warrants after a period of time,” states the law firm Duane Morris. “Most mezzanine
lenders are not interested in becoming long-term shareholders in your company
because they need to make distributions to their own limited partners.”
All of this begs the question, “Is mezzanine financing right for you?”
That depends on how aggressive you want to be, but it should be a real consideration if the
cash infusion would bolster your revenue growth far beyond what you could do organically.
The same is true if you want to boost company valuation in advance of a sale or going public.
WHEN TO USE MEZZANINE DEBT : 19
Mezzanine debt can fill the space between a senior bank loan and available equity to fund
the cost of a transaction. It is commonly used for acquisition financing and ownership
restructuring (such as in a leveraged buyout), although it can also be applied to growth
opportunities or to finance dividend payments for company shareholders. Deciding when
to use mezzanine debt can be tricky as there is no standard transaction where it is deemed
appropriate. However, for a business that needs to grow above and beyond what other
forms of financing can support and is confident in its ability to generate returns beyond
the higher cost of this form of capital, the answer may be yes.
No Collateral Needed: Unsecured Business Loans
Unsecured business loans provide companies with financing without the need to

When Does Mezzanine Make Sense?

by Seth Friedman, Managing Director, RLJ Credit
Mezzanine or subordinated debt can be used in many instances, but the most common uses of
mezzanine debt capital are for shareholder liquidity, an ownership transition, acquisition financing,
and for strategic growth capital. In today’s private equity marketplace, we are seeing purchase price
expectations from sellers at near record levels. In those situations where a business is being acquired
by a private equity firm, that firm will look to partially fund the purchase price with debt capital. In order
to achieve their targeted returns, PE sponsors will generally look to place between 4.0x – 5.0x of the
purchase price with debt. Typically, a senior lender will provide the first 3.0 – 3.5x in 1st lien debt, and the
remaining 0.5x – 1.5x will be in the form of mezzanine debt. The remainder of the purchase price will
be funded with a combination of cash equity from the sponsor as well as rollover equity (non-
cash) from the seller.

Outside of control buyout transactions, mezzanine debt tends to make sense for a business
that is looking for a source of flexible, long-term capital that is flexible in terms of coupon
structure, terms, and amortization as compared to banks and other senior debt providers.
Generally speaking, mezzanine debt is non-amortizing, but is more expensive than senior
debt. We pitch our mezzanine product as an alternative to equity, not to a senior lender as
we are less dilutive and cheaper than equity. If a business owner is able to attract senior debt
financing for a contemplated transaction, we would never try to compare our mezzanine
debt product to that senior debt product unless the owner is looking for flexibility and
patience. Only at that point can we compare our solution to a senior debt product.
Debt Diaries: RLJ Credit : 20

Seth I. Friedman, Managing Director

Q: What type of debt do you provide?
A: RLJ Credit is a collaborative, decisive, and patient lending partner to U.S.-based small
businesses. We provide flexible capital (including senior debt and subordinated debt investments)
to the lower middle market to help a CEO take his or her business to the next level.

Q: What are your main considerations when evaluating a potential loan?

A: We generally are focused on U.S-based small businesses defined as companies with minimum
revenue and EBITDA of $10 million and $2 million, respectively. We are generally industry
agnostic, but focus broadly on Business Services, Consumer, Manufacturing/Industrial, and Value-
Added Distribution. We look for businesses with a defensible market position; experienced
management; and diversification of its customer base, products, and markets.

Q: What are some of the most common circumstances under which a CEO
will shop around for debt?
A: Add-on acquisitions, recapitalizations, growth capital for expanded product/
service offering, and other strategic initiatives.
Q: What are some of the most common misconceptions CEOs have about
debt when you begin to work with them?
A: Most CEOs who have not historically used debt to support the growth of the business may
not realize that this type of capital comes with certain restrictions that a lender may likely
impose upon the business. A CEO must refer to their loan agreement with their lenders when
considering using cash generated by the business. Cash flow is what an institutional lender
depends on for loan paydown/payback. As such, an institutIonal lender will clearly define what
that cash flow can and cannot be used for in the business.
Q: What’s the best piece of advice you can give to a CEO when it comes to
thinking about debt?
A: When a CEO considers a debt partner, he or she should be sure they are comfortable
with the terms that are associated with the contemplated financing. Our firm takes a
collaborative approach with our owner/entrepreneurs. As such, we spend significant sums
of time with the management team (including the CEO) while conducting our due diligence
on the company and gauging how comfortable we are in working with him or her.
 pledge hard collateral. These loans are often used to cover gaps on a short-term : 21
basis or provide working capital to businesses who don’t qualify for traditional
bank financing. They can also be used in conjunction with bank financing as
subordinated debt.
Though costs can be higher than other alternatives, these loans can come in handy
to fix a cash flow crunch or any other immediate need.
(Though these loans are commonly referred to an unsecured loans, they do typically
require a UCC, or Uniform Commercial Code, filing, which indicates lenders have a
secured party interest in your business, albeit on a subordinated or junior basis).
Merchant cash advances are when you sell a portion of your future sales in
exchange for immediate cash. Lending companies in the space also offer true
business loans with daily or weekly payments. Both types can be funded within 24-
48 hours, but loans are preferable since they are fully tax deductible.

The Importance of Being Honest

Peter Capobianco, Director, BPV Capital Management
“The relationship with a debt provider will be much better if you approach it is as a
partnership. However, lenders are not equity holders and there are key differences; they do
not have the same upside potential and therefore expectations will be different.
“Also, once the relationship is commenced, be open and honest to your lenders and let
them know about issues as soon as possible. Most lenders don’t expect their borrowers to
be perfect. However, if a lender doesn’t know about the problems they can’t help solve the
issue. Most issues can be solved; however, small problems can become huge issues without
the proper amount of time and attention. Lenders value relationships where they trust the
borrower and are not consistently surprised with issues.”
Debt Diaries: Noble Funding : 22

Matthew Cohen, President, Noble Funding

Q: What type of debt do you provide?
A: We provide no collateral business loans from $25,000 - $2 million. Our loans are fully
subordinated debt to senior secured lenders such as banks, asset based lenders, and
factors. We furnish loan offers within 24-48 hours of submission, and fund in 3-4 business
days. Our working capital loans are generally repaid within a year. However, our clients
may re-borrow once their loan has been paid down to half. For example, on a $100,000
loan, once the loan has been paid down to $50,000, clients may re-borrow $50,000 over
and over like a line of credit. This feature provides ongoing working capital to satisfy
growth initiatives beyond what a senior lender can offer.
Q: When might a CEO consider your loans?
A: A CEO should consider our sub debt products when they are in growth mode or
have seasonal inventory requirements. They may have a bank line or asset-based line
of credit, but they require additional liquidity above and beyond what a formula based
borrowing base can provide. For example, let’s say they have an 85% advance on accounts
receivable, and 50% against finished goods inventory. If they are maxed out, they cannot
take advantage of seasonal inventory purchases, or adequately ramp-up for their busy
season. Our capital will “prime the pump” so to speak, and once they sell the goods, they
can borrow against the fresh accounts receivables that now will be higher than before
taking our capital infusion.
Q: Tell us about a success story you’ve had with a business owner.
A: I would say we do our finest work when we refinance our client’s senior secured line of
credit and lower their rate or interest and provide more availability, while also providing
a sub debt piece. This structure provides the ideal solution. We completed several of
these transactions last year, and we are in the middle of one right now. We are replacing
a factoring line with a more traditional asset based line of credit. It’s a $7 million credit
facility and we are lowering their cost of capital from 23% per annum to 11.5% per annum.
We are also providing a $1 million term loan fully subordinated to the senior secured
asset based line. This will save the company over $500,000 per year in interest expense
alone, while providing a large amount of subordinated growth capital.
4 Questions to Ask When : 23

Evaluating a Bank Loan

By Ami Kassar, Founder and CEO, MultiFunding
When considering a business loan, the natural instinct is to ask “what will this cost?”
or “what is the rate?” While APR is an important consideration, it cannot be looked
at in isolation.
When it comes to a business loan, there are many factors to consider.
ɚɚ What will the monthly payment be?
This is impacted by the amortization of the loan and whether or not it is a revolver
or a term loan. You have to be comfortable that the loan will be able to work with
your cash flow. As an example, it might make sense to pay a slightly higher rate, in
exchange for a longer amortization and lower monthly payments.
ɚɚ Is the rate of the loan fixed or variable, and if it’s fixed how long is it fixed?
If it is variable are there caps on how high the rate can go?
ɚɚ What will it cost to get in and out of the loan?
Are their points up front and what are pre-payment penalties if you get out early?
Upfront points can dramatically increase the APR, and you have to think about the
flexibility on the back end. Entrepreneurs often don’t pay attention to pre-payment
penalties and the term of the loan.
ɚɚ What lien and personal guarantee is the lender placing on you?
If it’s a personal guarantee, are you comfortable with it and if you have partners are
you sharing the load equally? If the lender is taking a lien on your business, is it on
specific assets or is it a blanket on the company? If it’s a blanket lien, and particularly
if it’s the first lien make sure you are giving away your first position for the maximum
borrowing base possible. Remember that once you’ve given away your first lien, a
loan in second lien position will likely be more expensive.
When reviewing the issues above it’s important that you take some time to think
about a business loan decision. It’s smart to try to get a few different options, and
that the differences between them will help you make the best possible decision.
APR matters, but it’s not the only issue that counts.
How Talking to a Lender Is : 24

Different Than Talking to an

Investor
By Ami Kassar, Founder and CEO, MultiFunding
When business owners go out to meet a lender, they often go in with the
same mindset as a meeting with investors. This sabotages their chances of
qualifying for a loan. Lenders have very different priorities and look for very
different criteria in an applicant.
If you’re interested in taking out a business loan, it’s important to understand how
the process is different before you go out and speak to lenders.
The Mindset of a Lender
Lenders are primarily concerned with managing risk. If they’re going to give you a loan,
they want to know that you’re going to be able to pay everything back on time. Lenders
are less concerned about your vision or the future prospects for your company. They
are less likely to get excited about the potential behind your company; unlike an investor,
they won’t be sharing in your long-term profits. Instead, lenders just want to see that
your company will be able to safely handle paying back the loan.
What Lenders Look For
Lenders are more interested in your past and present financial situation than
investors. They want to see concrete information that proves you’ll be able to make
your immediate loan payments. This includes information like your credit score,
current incoming cash flow, and financial assets that you can use as collateral.
Lenders are less interested than investors in the future prospects of your company.
They won’t give you a loan just because you have an exciting product under
development or a solid expansion plan that will triple your profits in five years. This
information won’t hurt your loan application and could make your company look
a little better to a lender, but it won’t be the key to receiving a loan. Instead, when
meeting with a lender, focus on presenting financial information that shows you can
comfortably manage the loan payments and aren’t a default risk.
Tips for Speaking to a Lender : 25

Before you speak to a lender, get in the right mindset. Remember: lenders want to
see concrete financial information. Ground your presentation as much as possible in
facts about your business – these should be points that you can back up with hard
evidence. Stay away from vague promises for the future. You’re not trying to sell the
story or dream behind your company like you would with investors. Not only will
this information not help your application, it could make the lender uncomfortable
and distract from your relevant financial information, leading to a loan rejection.
Instead, put together a clear, straightforward presentation that has all your financial
documents in order. If your presentation is a little bit on the boring side, that’s
okay. You aren’t trying to get a lender excited. All you’re trying to do is show them
that you aren’t a risk and that they don’t have to worry about give you a loan. Be
prepared with documentation that emphasizes your financial reliability.
Save the excitement for your investors. When you’re talking with a lender, focusing
on the facts gives you the best chance of qualifying for a loan.

On Institutional Lenders vs. Banks

“I think they both have their place. Businesses are just like people and have cycles
they go through. We all started as babies, then toddlers, then children… you get
the idea. A business is much the same. When the business is still in the early stages,
it needs someone like us to nurture it. Once it is self sufficient, it can be more
comfortable moving on to traditional banking.”
-Ryan Jaskiewicz, Founder and CEO, 12Five Capital
“While commercial banks are a logical first option for a CEO, often times, these
banks may only lend up against assets (i.e., working capital and PP&E). Most
commercial banks are not interested in providing incremental debt capital to
support long-term growth of a business other than debt capital that is backed by
a borrowing base of assets. An institutional lender is willing to provide long-term,
patient capital to support the strategic growth of a business. Institutional lenders
tend to lend against the cash flow of a business and generally support a more
leveraged balance sheet.”
-Seth I. Friedman, Managing Director, RLJ Credit
Why You Should Review : 26

Your Debt Regularly

By Ami Kassar, Founder and CEO, MultiFunding
Most companies don’t like to think about debt.
Once a company lines up its financing, it tends not to think about it again outside of
paying it down.
And that’s a big mistake.
Every business should annually review its debt to ascertain if there’s a way to
improve the picture and not wait for a problem to develop.
Think about where your personal life was back in, say, 2011, and compare it to the
present day. Your marriage may have ended – or a new one was started. Perhaps a
parent passed away. That son or daughter who was a gawky middle school student
is now a confident young adult preparing to enter college.
Or consider the Philadelphia Phillies, who won the most games of any baseball team
in 2011 (although they didn’t win the World Series) and are now coming off a season
where they were the league’s worst team.
Your business has probably changed, too.
Maybe that product you launched has wildly succeeded. Could it be that your
chief competitor went belly up? Perhaps improved technology had decreased your
production costs – and increased your profits.
In other words, life is always changing, so what made sense then might not make
sense now. Interest rates may be different, there could be new incentives offered
by various levels of government and your business simply may be more appealing to
lenders because you’re generating higher levels of collateral, credit and cash flow.
Back in 2011 (or whatever year you choose), it’s possible you were rejected for
a loan backed by the federal Small Business Administration (SBA), forcing you
to work with an alternative lender who charged high interest rates and featured
unfavorable terms.
Today, you may well be eligible for an SBA loan or a conventional bank loan at much
better rates. Just the interest savings alone could sharply improve your financial picture.
At the very least, a debt review will push a business owner to at least consider loan : 27
options that hadn’t considered in the past.
That said, debt review isn’t for the faint hearted.
Your current lender isn’t going to be happy to see you go – especially if you’re paying
an exorbitant amount of interest – and may suggest that you risk running out of
money or losing your flexibility if you change lenders.
Don’t fall for scare tactics, which means you must be able to resist the pressure
to stay put, not to mention plain old inertia. Just remember that your primary
allegiance is to your business, not your lender.
There really is no downside to a debt review. If things haven’t progressed as much
as you had hoped, you can always stick with your current financing. The only thing
lost is a bit of time – and it’s certainly not time wasted since, at the very least, you’ll
know exactly where the company stands and what financial options you might have,
both now and in the future.

The Key to Debt

“Think about debt both offensively and defensively. Debt is something to be
respected, but not feared.
Debt almost certainly will be an integral part of your business throughout its
life cycle, especially in the early growth stages. But even mature and stable
companies obtain debt.
Sometimes it’s to grow (whether it’s infrastructure, buying inventory or
obtaining a competitor, to name a few examples), and sometimes it’s to deal
with pressing, often unexpected problems.
The key to debt is knowing all the options available to you and choosing the
one that works best for you. Usually, that means the lowest interest rate, but
not always – favorable other terms can sometimes trump a good rate.”
-Ami Kassar, Founder and CEO, MultiFunding
 5 Pieces of Advice From : 28

Lenders to CEOs
1 “My biggest advice, and this is an old adage, but one that is seemingly quite
ignored; debt is always cheaper than equity. Even expensive debt. When you
bring on an equity investor, you now have a new business partner. One that will
want to be involved in decisions, or if not, second guess decisions. Investors will be
paid every single year, and when the business is sold, receive exponentially more
money than interest paid on any type of debt, whether it be senior or junior. I would
suggest taking a long-term outlook when considering short-term debt. I would also
advise CEOs to speak with lenders. It never hurts to have a conversation.”
-Matthew Cohen, President, Noble Funding
2 “Do your homework and interview multiple lenders before signing a term
sheet. Obtain a clear understanding of fee structure and be aware of any hidden
fees. Build a relationship with new lenders on integrity and open communication.”
-Karen Small, Partner, Sterling Commercial Credit
3 “Read the fine print and find someone that is going to be there for you
when "it" hits the fan, because it inevitably will. This is not easy to find out,
but if you lean heavily on the culture of the lender and not price, you will learn a lot
about where they stand. Everybody is different. Most lenders look at themselves
as a lender of last resort. Choose one that looks at themselves as a lender of first
resort, hires people of first resort, and treats you like a customer of first resort.”
-Ryan Jaskiewicz, CEO, 12Five Capital
4 “Consider who you are working with — really get to know the financial
partner and understand how they operate. Don't let a few basis points lure
you into an inflexible situation that will inhibit your ability to do what's best for the
business, and not the bank.”
-Heather La Freniere, Executive Vice President, Head of Originations, Gibraltar Business Capital
5 “Have a plan beyond the obvious needs. Cost of capital is a component in
evaluation but in the final analysis, how capital is deployed through leverage has to
be within a plan that scales margin contribution for the business — ROI.”
-Ray Morandell, SVP - National Sales Director, Crestmark
Contributing Axial Members

12five.com

: 29

multifunding.com

crestmark.com

gibraltarbc.com

rljcredit.com

bpvcapitalmgmt.com

dakgroup.com

sterlingcommercialcredit.com

noblebusinessloans.com