The Impact of Scale-up Timing on Your Growth Capital Pricing

Posted on: May 17th, 2021

growth capital

Growth capital in the form of structured debt or equity, involves a few timing variables that are important to understand. In these deals, high cash flow growth leads to future equity value, upon which the pricing of the deal is based. When the projected equity value is not realized within the investment horizon or is delayed, this can have a large impact on your growth capital pricing.

Conversion Feature in Growth Capital

The growth capital provider may have a conversion feature that allows them to convert their capital into shares, at a high price. Or a mezzanine lender may have set the principal repayment to the maturity date, assuming the company has the cash or ability to easily refinance them. In both cases, the achievement of consistent, multi-year growth creates a future value scenario, upon which the growth capital provider’s returns are based. Without steady and consistent growth over the hold period, the lender or equity investor has a starkly different return environment.

Companies and Growth Capital

The Company may have performed well, but if they miss one or two years of performance over a 5-year period, the investors will not realize their targeted returns, which can trigger a few unfortunate remedies. In the case of an investor with a guaranteed minimum return, they will receive more shares, diluting the other shareholders. In the case of a lender whose principal is due, they will usually charge fees and equity warrants to restructure the loan repayment.

Preferred shareholders usually have ratchet protection as well to ensure that future capital raises are at prices higher than the level, they invested in. If a company needs more capital than originally raised, but raises it at a lower price, the existing preferred shareholder will not be diluted from the decrease in value. Their stake in the company will increase to compensate them for the decreased value of the stock price. Each of these scenarios is reflective of pushed out timelines, the immutable law that things always take longer to materialize. This underscores the criticality of meeting timelines when scaling up.

All too often, companies overestimate their speed of growth and allow their investors to believe they can grow at faster rates than manageable. When structuring your deal, make sure you have built in cushion to allow for inevitable time delays, so you can avoid this negative pricing impact.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.