Priming Your Upside

Posted: 05/1999

Priming Your Upside
–A Guide to Raising Private Debt
By Bryan Mitchell and Salman Tajuddin

As any telecom insider would tell you, telecommunications is a capital-intensive
business. The ability to execute on a business plan is predicated not only on raising the
appropriate amount of capital, but also on raising the appropriate type of capital from
the appropriate financing source.

Capital markets offer a range of financing sources, each one corresponding to a unique
risk-and-cost profile. This article is the second in a three-part series that will cover
capital-raising options available to telecommunications companies. Last month, in Part
One, we discussed the general differences between debt and equity solutions. This month,
we’ll take a look at raising private debt. In June, we’ll take a look at when to raise
equity from venture capital (VC) firms and the public.

Borrowing money implies you have arrived at the following conclusions about your
business plan:

* Your plan involves manageable risk. Your funding needs may involve the
acquisition of a single asset or business, expansion of an existing business, or the need
for working capital. Whatever the use of proceeds, the plan provides sufficient protection
of principal and does not jeopardize the core business. The limited risk involved in this
course of action qualifies your company for debt’s lower cost of capital.

* Your plan has a definable capital requirement. Your funding requirements are
temporary, existing only as a bridge to a foreseeable event. Alternatively, your capital
needs compared to your overall capitalization may be so minor that debt is preferable to
the dilution and higher-return requirements associated with raising equity.

* You desire to minimize control dilution. You would rather operate within the
parameters established by lender covenants than cede any measure of control to an equity
investor.

* You desire to leverage invested equity. Required annual rates of return for
equity in telecommunications are viewed to be approaching 30 percent. Debt capital with
interest payments between 8 percent to 15 percent reduces the overall cost of capital,
increasing your business’s present value.

Doing the Deal

With clarity of purpose ahead of you, the next step is to put together your proposal to
the lending community. Your proposal will explain why you need capital, what you intend to
do with it and how you intend to return the principal plus make interest payments on a
regular basis.

The plan you put together will be no ordinary business plan. A smart debt investor will
question the strategies of the company and the tactics that will create revenue growth and
profitability. Present a plan that addresses those questions head on. Communicate the
impact that new capital will have on key functions:

When lenders pursue due diligence on your company, they will focus on your historical
performance to date and your plan for future growth and profitability. Potential lenders
will focus on a number of financial and operating criteria that they will use to assess
that performance. Some financial criteria that will be assessed include:

Certain operating criteria include:

Pick Your Partner

The next step is to find your potential debt partners and get your deal done. As
discussed in Part One, there are many alternatives for debt financing, each with varying
levels of flexibility and risk tolerance. Assuming that your capital needs are strategic
in nature, you should be seeking a credit facility that will be long-term and flexible
enough to facilitate multiple operating objectives. With these credit needs, your
prospective partners include commercial banks, commercial finance companies and specialty
finance companies.

To whittle down the list of potential debt providers, look for lenders that appreciate
the particular capital needs of competitive telecommunications providers. Just because a
lender has asked the least questions and is the quickest to offer a proposal does not mean
it has listened to or understood your business plan. Business is volatile, and high-growth
industries such as telecommunications are even more so. It is imperative that your debt
provider has the knowledge, capacity and interest to be able to respond intelligently to
this volatility. A lender that understands the plan will probe for the business
"pressure" points, because greater returns can be realized by understanding
those points and using capital to exploit them. A partner who shares your vision for value
creation is willing to take on a greater degree of risk and be more flexible during and
after the deal.

Finally, as the principal of your company, you should make sure you understand the
institution’s decision-making process regarding your transaction. Make certain that you
deal with the decision makers. Make sure that the decision maker hears firsthand about
your company’s plan.

The Trouble with Lawyers

Once you have landed your deal with the lender you want, the time will come to codify
the terms of agreement. For beginners, the documentation process can be a frustrating,
antagonizing and expensive process. With a little preparation and advice, however, you can
close your transaction with a reduced level of hassle.

The first thing you should keep in mind is to focus on the business issues. Make sure
that you have a clear understanding with your lender as to what really matters in the
transaction. Integrity of systems, collections, network redundancy–these are risk factors
that are the responsibility of a lender’s underwriting process, not the lawyer’s
documents.

Another item that will remove a lot of aggravation from the documentation process is
keeping your organic documents in order. These include your shareholders agreements,
corporate by-laws, resolutions, material contracts and existing loan documents. Have these
items available early, even during the underwriting if necessary. It is time-consuming to
review these items, so it is best to get them out of the way early to keep things on
track.

Finally, take an iron-fisted approach to your lawyers. Know when the risks that they
are trying to protect you from are monetarily less significant than the hourly fees you
are incurring. Know that your negotiation efforts are better spent in fine-tuning ground
rules for the lender’s behavior while your loan is performing. A lender will not be
inclined to deal on its rights to protect a nonperforming investment.

Happily Ever After

After the last cigar has been smoked and the last glass of champagne has been thrown
back, you can look forward to a happy, healthy relationship with your new financial
partner, right?

Hopefully, but things do not always go as planned, which is why it is important to keep
an open dialogue with your lender. Include him or her in the decision-making process to
keep surprises to a minimum. Keep up your end of the bargain by providing accurate and
timely management reports. Prove that you are an effective steward of the lender’s
capital.

Doing a leveraged debt transaction is a big step for many companies and entrepreneurs.
Debt can be a powerful tool in the execution of your business plan. If used wisely, debt
can maximize your returns on equity by lowering cost of capital and helping you retain
control of your business as it grows. Debt is not for everybody, but successfully raising
and repaying debt will go a long way toward demonstrating your credibility in the capital
marketplace.