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Delayed IPO? Prepare your capital structure
Capital structure is a key factor in navigating life as a public company. With the IPO market slowly improving, management teams should revisit their capital structure to prepare for an open market window to go public.
As a first step, management teams should align their capital structure to the company’s growth plan, equity story and long-term objectives. Every company is different, and every financing option has benefits and potential challenges based on strategic goals. A thorough self-review should be considered to analyze seven potential focus areas, in addition to an evaluation of alternative strategies to secure funding.
Debt maturity profile
Try to eliminate near-term maturities for outstanding debt (either by pushing out debt owed through a refinancing or paydown) and improve the manageability of your maturity profile by staggering when debt is due. This eliminates near-term refinancing risk for equity investors.
Cost of capital
Even if interest rates are elevated, there may be opportunities for a company to optimize the cost of capital. Issuers can look to place senior debt or debt secured by collateral (if available). Secured and senior debt can typically yield cost savings for the issuer as opposed to junior or unsecured paper. Companies also may be able to raise hybrid capital which offers equity-like upside for investors and lower interest costs for borrowers.
Leverage profile
Companies that are highly leveraged may face skepticism from equity investors as financing costs divert free cash flow. Management should assess its leverage profile against a peer set of public companies via a benchmarking exercise. This can provide insight into market expectations regarding leverage and allow you to rightsize ahead of or at IPO. Going forward as a public company, management will need to communicate — and work to attain — a target leverage range with equity investors.
Liquidity profile
The working capital requirements of a business and the industry in which it operates often dictate liquidity needs. Is there a minimum cash balance needed to run the business? In today’s market, revolving credit facilities or securitizations can augment potential working capital needs or deficits. In an uncertain and volatile financing market, companies often look to secure a revolving credit facility as rainy day capital.
Cash flow forecasts and capital expenditure expectations
Management should assess the company’s cash flow forecasts and capital expenditure needs to determine how to finance growth. To the extent that operating cash flows are insufficient, it may need to look to the capital markets. Understanding the timing of financing needs will be important to potentially align with open window periods in the market.
Credit rating
Management teams in the pre-IPO planning phase can either revisit or build their relationships with credit rating agencies. A favorable credit rating can be useful with suppliers and other parties who look for third-party verification of a business. Equity investors use ratings as a barometer for credit quality and therefore incorporate it into their investment decision-making process.
Pre-IPO monetization strategies
Can the company support incremental leverage? Raising incremental debt to monetize an investment in the form of a dividend may provide greater certainty to return capital to investors. A dividend recapitalization is not for every company and generally requires positive sentiment in the market, but if cash flows support additional leverage, it may be a useful tool for owners.
Incremental funding options
If incremental funding is needed prior to an IPO, there may be suitable alternatives. Market dynamics have changed due to factors including elevated financing costs and macroeconomic headwinds. Combined with the fallout of the regional banking crisis, lenders have become more rigorous in their underwriting and lending processes. Pre-IPO financing options will require an in-depth financial analysis of your business, but several paths may be considered.
- The syndicated debt markets are improving but remain largely confined to higher rated and familiar businesses. Institutional investors have become more focused on interest coverage and leverage ratios as economic headwinds persist.
- Private credit is a growing asset class and may be another option. Private credit can be advantageous to businesses unable to access syndicated or public markets as structure can be more heavily negotiated among a single lender or small lending groups. A high growth SaaS company with strong annual recurring revenue but limited EBITDA, for instance, may find a financing solution in private credit.
- To the extent traditional markets are not available, creative financing solutions may represent an alternative path to capital. These include hybrids, convertibles, structured debt, paid-in-kind (PIK) debt and venture debt. These solutions allow borrowers to minimize cash outflows early on and compensate lenders with an equity-like upside. PIK notes allow the borrower to accrue principal as opposed to making cash interest payments for all or part of the time the instrument is outstanding. Convertible notes offer lower interest payments than traditional debt because of the option to convert the debt into equity at a predetermined strike price. Venture debt has become an asset class utilized by many high-growth companies looking for bridge financing before an IPO or subsequent equity financing round. Several of these solutions require a greater certainty of a near-term IPO as tenors may be shorter than traditional debt and run the risk of adverse features kicking in over time.
The bottom line
While there isn’t a one-size-fits-all solution, the market remains resilient. The first step to any financing plan should incorporate a thorough analysis of your business, including its financial profile and long-term growth strategy. Market opportunities can open and close quickly, so it’s never too early to prepare for the next stage in your company’s growth.
Learn more about how our debt advisory services can help your organization raise capital and prepare for life thereafter.
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