Raising Capital In A Worsening Macro-Economic Environment
- Company: Sasfin Corporate Finance
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Uncertainty is nothing new to any business manager. This uncertainty essentially comes in two forms: Exogenous risks and Endogenous risks. A manager can control the internal risks in an organisation but exogenous risks are harder to control and these risks are linked to macro-economic events which are almost completely out of the control of a business manager.
One could try to rely on the views of economists but then again, as the age old saying goes: “The only way to trust an economist is to chop off one hand so that the economist can’t say ‘on the other hand…’.”
The key to managing ever-changing external influences on a business, is to constantly evaluate these influences and remain adaptive. This often leads a business manager on the path to raising capital.
Quite often, and particularly during challenging macro-economic environments when a business manager needs to keep a close eye on the operations of the business, they may need to seek assistance from advisors to conclude not just a ‘life-raft’ capital raise, but rather a bespoke capital raise, to ensure the economic storm is weathered and the business is poised to continue growing and capitalising on the opportunities presented by difficult times.
The source of capital is dependent on numerous factors, such as the cash-generating ability of the business, business sensitivity relative to the business cycle, health of the balance sheet and the management team/shareholders’ ultimate objectives.
Cash-generating abilities of the businesses
A cash-generative business is any investor’s dream. Obviously the ability for the business to raise capital is dependent on existing debt obligations and how amenable the shareholders are to the type of capital injected into the business.
Raising capital for a profitable business that has a consistent track record, even during poor macro-economic environments, is usually doable as it offers a positive return for investors and financiers.
The question is whether to raise equity or debt? To answer this question, one would first need to assess the current and target capital structures of the business. It is advisable, where not clear-cut, to engage with a professional advisor to assess your business’s capital structure.
Should this exercise indicate a need for equity capital, for a private business, the most efficient way to raise equity would be through a structured process designed to attract potential investors with the right pedigree and access to capital to enable your business to exploit opportunities.
Listing your business
A further option, which may be viable for some companies, would be to pursue the option of listing on a recognised stock exchange. This has the benefit of either raising capital on listing or post-listing, and being able to access public capital markets more frequently than when a company was privately held.
Business’s sensitivity relative to the business cycle and health of the balance sheet.
Should this exercise result in the answer that debt is the most appropriate form of capital to raise, it would be important to consider the key characteristics of debt: Debt can be cheaper yet potentially more demanding on cash resources that the business may want to hold onto during tough times e.g., by way of contrast, although more expensive, equity requires no interest to be serviced or capital to be repaid and constitutes a more patient type of capital.
Most businesses are sensitive to a business cycle, but on the odd occasion there are businesses that are agnostic to the business cycle. The reason for this is either that the underlying business is relatively indifferent to the business cycle or the manager of the business has structured a business that has a diverse income stream coupled with an entrepreneurial mindset.
Debt versus equity capital
Usually during times of poor economic growth a business may experience an environment of low interest rates. Therefore, raising debt through either a credit facility or an existing note programme is less expensive than raising equity capital from investors who expect higher returns. Furthermore, where debt is raised in the production of income, the interest incurred on this debt would normally be fully deductible in terms of South Africa’s income tax legislation.
That said, there is an old joke about bankers: “A banker is the type of person who will lend you an umbrella when the sun is shining and demand it back when it starts raining.”
Consequently, during times of poor economic growth, a bank’s willingness to extend new lines of credit is often restricted. That’s why being able to access alternative debt sources or ensuring that the business has excess capacity in terms of its existing credit facilities with a bank is important.
A proven track record of being able to service a debt obligation goes a long way when applying for new facilities. An important consideration to note is that a bank or a funder may enforce stricter covenants in an environment of poor economic growth if new debt is raised (and sometimes even on existing facilities).
An alternative to debt or equity is preference shares. The problem faced by companies accessing the South African preference share market is that investors are still mindful of the fairly recent demise of African Bank. That said, we have noticed renewed demand in this market and, for the right types of business, this is a very attractive alternative to raise quasi equity finance.
The main alternatives would be issuing perpetual (i.e. non-redeemable) or redeemable preference shares. This decision, taken in consultation with a company’s advisors, will need to be carefully assessed depending on the company’s needs.
Finally, the key to any capital raise during trying times ultimately rests with the management team. A good manager with an adaptive and positive attitude, and supportive shareholders will make the process of raising capital in times of economic stress easier.