Leverage is defined as a company’s debt divided by its cash flow or EBITDA.
The WSJ sticky leverage article discusses large companies and large buyout deals but the same is true for smaller companies. Many have been negatively impacted by the current economic slowdown, and their leverage is higher because their debt has remained the same or increased while cash flows have decreased.
Compounding the problem, lenders are making new loans but at lower debt to EBITDA multiples making it practically impossible for companies to get additional debt financing at this time.
So what does all this sticky stuff mean?
If your company is in that position, hunker down and cut costs. As long as you can service your debt, you will stay in business. If capital is absolutely required, then equity is likely the only answer – today, but not necessarily a year from now. A year from now – you’ll be able to prove you turned a corner and survived this credit crisis. Its important to really sell the future of your company, show its turned the corner and the less equity you have to raise the better.
If your company is one of those companies that is performing well (and there are many of them) take this as a cautionary tale to ensure you have adequate financing in place to grow your business. The thing about debt financing is once you have it its difficult for the lenders to get it back absent a disaster. However, underestimating your financing need then expecting to get additional financing later when the need arises can become nearly impossible when your company hits unforeseen challenges or the financing markets change.
Also its important to look at the TYPE of debt financing your company receives. Many entrepreneurs string financing together with various lines of credit, which have high maximum balances but the real borrowing capacity is driven by working capital assets such as inventory and accounts receivables. As a business contracts so do those accounts which reduce a company’s borrowing capacity. In theory, that’s exactly how it should work since those same assets consume cash. But when companies finance long term needs with short term assets, funding short falls can become exposed.