10 Apr AGRICULTURAL DEBT FUNDING BEYOND THE BANKS
Causes and Reasons for Alternative Agricultural Funding
Let’s get straight to the heart of the matter. From our extensive engagement with the agricultural community, the motivations to seek alternative debt capital are as follows;
- SPEED TO MARKET. Needing to take advantage of an opportunity that carries a wealth creation matrix which exceeds the additional cost of capital. Timing here is critical and fast-moving funding arrangements is more essential than the cost of capital.
- EXPANSION CAPITAL. Taking on an acquisition for growth may push the limits beyond what the banks can accommodate (or accommodate but with unsatisfactory terms and conditions). To take the business to the “next level” may require a more commercial lending regime to accommodate the growth. Once the growth has been consolidated and proven, the borrowing can move back into mainstream banking. Developing land for intensive irrigation is an example.
- ADDITIONAL LEVERAGE against assets. Banks generally take a full grip on security and servicing on a conservative lending policy regime. To borrow beyond these boundaries, especially if strong balance sheets are available, requires moving along the risk curve to acquire additional debt capital.
- SUCCESSION: the need to pay out business partners or passing the business (assets) onto the next generation may require a more bespoke borrowing strategy to accommodate all the funding requirements.
- NEW MARKETS: opening new markets may present challenges in proving up concepts. Regional green field projects may fall below the spectrum of compatibility with the banks. Aggressive vertical or horizontal expansion may push Loan to Valuation Ratios too hard.
- FINANCIAL DURESS: A business may undergo temporary financial duress either because of unfavourable seasonal or commodity price events, or one-off events like divorce, litigation or health. If the event triggers an unfavourable position with the bank, then a more strategic funding solution may be required to lengthen the runway.
- LIQUIDITY: Either from growing pains, enterprise expansion or cash flow challenges (tax liabilities). Additional liquidity may be required to keep the business solvent.
Agricultural Debt Funding Options (Non-Bank Lending)
What alternative debt funding arrangements are available to agricultural borrowers and what can they expect?
Capital ranges from traditional senior debt (banks) from one end of the spectrum to equity at the other. There are many shadings in between as you move along the risk / reward curve of borrowing.
Non-bank lending can either be institutional (for more corporate sized funding deals > $20m) to private lending for smaller to medium enterprise farmers (less than $10m of borrowings).
There are many permutations to this question depending on the characteristics and parameters being sought, but in general the following characters will apply;
- More lenient covenants. This may be very applicable and strategic if the reporting covenants or terms required from the traditional banking create a high risk of “technical” default within the funding arrangements. This itself could be more adverse than paying a higher rate of interest to circumvent these issues.
- Speed to market. Alternative non-bank lenders can generally move a lot quicker to settlement (or unconditional approvals) if the situation warrants it.
- More commercial due diligence. Non-bank lenders look at the commercial elements of the transaction to create a view on its fundability. Traditional banks must adhere to a credit policy that is designed to protect the mum and dad deposits, hence banks apply a very conservative and protocol driven approval process. Many of the deal breakers for traditional banks can be acceptable for non-bank lenders.
- Short term tenures available. Funding for less than 12 months tends to be for more private lending operators given the high overheads banks needs to endure to recover profitability.
- Can be secured or unsecured (cash flow) lending.
- On or off-balance sheet structures.
- Structures can be arranged to meet the circumstances. Example is a lower annual coupon to manage the cash flow position then a PIK (payment in kind) upon exit to capture or share in the appreciated growth of the business.
- Higher cost of capital. The cost of this capital will generally always be higher than that of the senior debt within the traditional banking circuit. This is because it is more strategic capital that requires a higher return for a higher risk.
What are the key attributes required?
Once again, this various depending on the scope and funding requirements. In general, the following are some guidelines;
- Trading history for at least three years.
- Risk mitigation around any trading anomalies.
- Defined growth / exit strategy.
- Management and structuring.
Please contact us anytime should you wish to discuss these options in more detail.