Small- and middle-market companies have many promising growth opportunities, despite the clouds hovering over today’s economy. Organizations can still find financing to fund expansion, a capital investment or an acquisition. But what’s a business owner to do once his or her company’s credit lines have run out?
Institutional capital, which includes subordinated debt and preferred equity, could be the answer. It can be used for making acquisitions, buying out partners or obtaining working capital. Let’s look at this financing option for companies whose spirits are willing but whose bank lines are exhausted.
What’s Institutional Capital and How Does It Work?
Institutional capital is an unsecured debt that is subordinated to a company’s senior bank debt. It can be supplied by numerous institutions, including insurance companies and pension fund providers, and is generally used to fulfill long-term capital needs. Also, redemption or amortization usually doesn’t happen until five years after the debt is issued. In exchange for taking a bigger risk than secured lenders, institutional investors assume minority ownership positions and become investment partners with business owners.
Institutional capital has some important long-term implications. For example, it’s only cost-effective if it helps your company significantly improve profitability. It should also help drive the value of your stake above what it would be if you hadn’t taken on a new investment partner.
Who Qualifies for Institutional Capital?
The best candidates for institutional capital need at least $3 million in funding, have annual sales of at least $10 million and earnings before interest, taxes and depreciation (EBITDA) of at least $2 million.
On the other side of the table, institutional investors are looking for companies with a diversified customer base, favorable industry growth trends and barriers to entry – or more simply put, a solid infrastructure. They will require audited financial statements that show a stable earnings record, and they will want to monitor progress. So their potential clients should have information systems that can generate timely, accurate financial statements. Finally, investors plumb for evidence of managerial depth, including a succession plan that ensures smooth operational continuity.
Matchmakers Can Make It Happen
Because institutional investors – like the companies that seek institutional capital – can be located anywhere, an intermediary usually brings the two parties together. It’s much like an arranged marriage in which the parties meet beforehand to see whether they get along before a union is finalized. Many intermediaries have access to myriad investor groups, allowing them to determine the best fit.
The intermediary visits the capital-seeking company, observes its business operations and prepares a comprehensive operations memorandum, which becomes a marketing tool for prospective investors. Then, the intermediary contacts investors it believes best suit the company’s circumstances. They all meet and decide whether a business relationship is viable. When the match is made, the intermediary helps negotiate agreement terms and conditions.
Proceed With Caution
Institutional capital can be an excellent way for your company to expand or make an acquisition. But before pursuing this financing route, thoughtful analysis is necessary. Taking on an investment partner will affect your company’s operations and goals, so institutional capital isn’t simply “about the money.” Before taking this leap, give us a call; we’ll help you map out the best route between your company and the capital it needs.
Sidebar: Good Intermediaries Attract Excellent Capital
Institutional capital can help you create significant long-term value you might not have achieved otherwise. Getting the best deal means putting your company’s investment considerations in the best possible light. A key step in securing institutional capital is a high-quality offering memorandum that lists your pertinent assets. An intermediary can help you prepare your documentation and contact investors best suited to your company’s circumstances – so choose this consultant wisely. To do so, ask questions, such as:
- What’s your track record on prior offering memoranda?
- How frequently have you raised capital for a project like the one we’re pursuing?
- Have you previously worked with our investor candidates?
- Do you have direct access to the decision-makers?
The answers to these questions should help you choose the right intermediary.