Take Five #112: A 9-point inventory due diligence process to find flaws that could sink a deal, and more
Take Five #112: A 9-point inventory due diligence process to find flaws that could sink a deal, and more
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Take Five #112: A 9-point inventory due diligence process to find flaws that could sink a deal, and more
1. Is it better for businesses to hold cash or pay off debt?
Strengthening the balance sheet can come in two forms:
Increasing the level of cash held on the balance sheet
Reducing the level of debt on the balance sheet
Holding Cash vs Paying Down Debt
The choice between holding cash and paying down debt is one of flexibility vs cost. Cash is flexible, but holding cash has a cost.
You can always use that cash later to pay down debt if you want to. But once you’ve chosen to pay down debt, getting that cash back is harder. Unless it’s revolving debt, but that’s for another time.
So it’s a trade-off… but unlike most other cost of capital decisions, fortunately it’s simple to quantify.
You will earn interest on your cash at a rate (S) and pay interest on your debt of S + a spread (2% to 5% for good credits).
So ‘S’ nets off and you are left with the spread as the cost of holding cash vs paying down debt.
The extent to which you want to use debt in your business will depend on lots of things, but notably:
Shareholder risk appetite/expectations
Strategy and strength of investment opportunities
Cost of current debt
Cost of new debt
Expected shifts in interest rates
Lender appetite
Liquidity requirements
Leverage targets
Collateral requirements
Covenant expectations
We will run a separate series on raising debt and managing lenders in the future. For now, we will focus on the capital allocation considerations with debt and cash.
The key question here is when to prioritize debt reduction.
Find the rest of the CFO Secrets post here.
2. Thread details some of boring-business billionaire Brad Jacobs’ best advice after 500+ acquisitions
3. Top types of debt used to finance SMB purchases
Bank debt and mezzanine debt (or “mezz debt” for short) can be broadly compared on a spectrum of pricing (i.e. the rate of interest), risk tolerance, and flexibility.
Though bank debt tends to be the least expensive option, it also tends to be the least flexible, often with well-defined covenant packages, repayment schedules, reporting requirements, and approval processes.
Mezzanine debt, on the other hand, tends to be much more flexible, with fewer covenants, more flexible repayment schedules, and less onerous reporting requirements. However, in return for all of that flexibility, the rate of interest charged by mezz funds tends to be significantly higher, often 2-3x the rate of interest charged by a commercial bank. Mezz lenders often get introduced into processes when borrowers either:
1. Can’t get bank financing at all; or
2. Can’t raise their desired quantum of debt from a traditional lender alone; or
3. Require significant flexibility from their lenders on covenants or repayment schedules. For example, consider a company that’s planning to meaningfully decrease profitability in the first few years after acquisition to make necessary investments in growthBelow I attempt to summarize some of the major differences between these two common sources of debt capital.
Read Mineola Search Partners’ post here.
4. A 9-point inventory due diligence process to find flaws that could sink a deal
5. Why asset lists should be broad, not detailed in an asset deal acquisition structure
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