This guest post is written by David Pritchard, a principal and founding partner of Aequitas Advisors LLC, a capital markets consulting/advisory services firm. The firm seeks to put its extensive experience with the structuring and execution of capital markets initiatives to work exclusively on behalf of corporate clients, helping them more effectively and efficiently navigate the process. For more information, visit www.aequitasadvisorsllc.com.
In the context of business, “risk” truly is a four-letter word. It encompasses everything from liability exposure to supply chain issues and concerns surrounding credit exposure, cash flow needs, vendor delivery, business execution and the like. But among these, the risks related to financing your business, which determine “all-in” cost of capital, efficiency of access to such capital and the flexibility with which your firm is able to operate, may well be the most profound. It’s accurate to say far more companies have gone out of business as a function of unhealthy balance sheets, unmanageable fixed-costs and/or limited operational flexibility, than lawsuits or the failure of vendors.
Public companies typically access capital through either commercial lenders or the capital markets. Commercial borrowing is a relatively straightforward process whereby terms and covenants for a senior, generally secured loan facility are negotiated directly with one or several lending institutions. Accessing the capital markets, however, involves a much broader range of alternatives. Each of these — from permanent equity to equity-linked/structured instruments to non-bank debt — has its own unique characteristics, investor base and balance sheet implications, and can fundamentally affect the operational and return profile of a business. Additionally, because each affects a company’s leverage, dilution and financial flexibility, their appropriateness of structure and efficiency of execution should be considered of utmost importance to management and directors.
Among the best places for public companies to focus their efforts to optimize the fit, flexibility and cost of financings is on the deal process itself and the investment banks that structure and place them. Genuine risks to a company’s capital efficiency (and potentially even long-term health) lie within the dynamics and competing interests of this process.
The conventional framework for a securities offering involves the following steps:
- Internal identification of a financing need — capex, refinancing, acquisitions, etc.
- Bank interviews/presentations (the “Bake Off”)
- Deal manager/syndicate selection & fee negotiation
- Determination of offering structure
- Deal launch/roadshow/bookbuilding
- Negotiation of final terms/pricing
Through this process a company charts its financial and operational future. The company initially benefits from strong competitive dynamics, with the banks putting forth their best ideas in an effort to win the financing mandate. Once a deal manager is selected, these competitive dynamics fall away, and the company is left to rely on the input of a single financial institution which, per language in engagement letter, owes it neither a fiduciary nor agency obligation. And once marketing begins, the material risks of the conflicts inherent in the investment banking model, in which this single entity represents both buyers (through its sales force) and seller (the corporate client) introduce themselves.
Perhaps the best means of managing these risks, as with other exposures, is the use of experienced, unconflicted advisers to approach the market as an informed purchaser of its services. The right advisers for such circumstances are not conventional investment bankers with industry expertise, but rather transaction specialists who can help management teams navigate each of the steps outlined above, identifying points of exposure (again, read: risk) and monitoring their client’s interests throughout. Such specialists understand the informational advantage the deal managers hold in this process and balance it with greater transparency and a clear commitment to their single client, the corporate issuer.