Case Study ABC Food Manufacturing Ltd Originally founded in the early 1990 s, ABC Food Manufacturing Ltd (ABC) is a family owned company that operates in the high value-added end of the food manufacturing sector. ABC s management team has changed significantly over the years as non family members were added and the family members themselves took a less active role. Recently the family indicated that it would be willing to sell the business to the existing management team for a cash payment of 5m. The management team has agreed that this price is acceptable. As the Financial Controller of the Company, the management team has tasked you with the job of obtaining the maximum level of bank debt that can be leveraged on the balance sheet of ABC. The balance of the purchase consideration is to be provided from privately raised funds but the management team is anxious to maximise the direct debt funding. A meeting with the Management team has been scheduled for early next week to discuss Bank financing possibilities and the submission to be made. Consider the following information in preparation for that meeting: 1. Industry Outlook o Traditionally, ABC has operated mainly in the domestic market, with any export sales being opportunistic and once off. Market research has identified that whilst there will be little immediate threat from new entrants, domestic sales growth will be modest but steady. o The management team believes that future growth will be export led and market research has indicated export opportunities particularly into the UK. 2. Brief Background on ABC o Over the last number of years, ABC invested heavily in the manufacturing process and equipment. This has resulted in a highly automated manufacturing process and consequently there are no immediate reinvestment requirements (i.e. Capex). o The business operates from freehold factory/office premises in a good industrial location within the greater Dublin area. Premises were very recently professionally valued at 1m. o Company has debtor insurance on all customers subject to an excess of 1,000 per customer. o There is no single customer that exceeds 15% of turnover o The 2009 Directors Salaries included a once off payment of 300,000 3. Existing Bank Relationship and Facilities o ABC have a good working relationship with their bank and have never defaulted on any commitments o Originally drawdown in 2006, there is a term Loan with a current balance of c. 925,000, secured on assets of the company including a specific fixed charge on the factory premises. Currently, this is being repaid at the rate 6,000 per month. o The current variable rate on this loan is 2.25%. This is based on 3 months cost of funds + 1.25% margin. o Company has no other borrowings or credit lines. The following Financial information for ABC Food Manufacturing is included: a) Appendix 1 - Profit & Loss for the financial years ended 31 st December 2007 to 2009 b) Appendix 2 - Balance Sheet as at 31 st December 2007 to 2009 c) Appendix 3 - Ratio trend analysis
Appendix 1 Summary Profit & Loss Profit & Loss Year End 31/12/07 31/12/08 31/12/09 000's 000's 000's Sales: 3,021 4,043 5,148 Cost of Sales: Opening Stock 35 77 127 Purchases 1,995 2,689 3,429 Depreciation 188 74 84 Closing Stock -(77) -(127) -(105) Total Cost of Sales 2,141 2,713 3,535 Gross Profit 880 1,330 1,613 Operating Expenses: Labour Costs 365 472 815 Selling General & Admin 127 143 173 Bank Charges 9 2 Bad Debts 1 1 1 Interest Receivable -(1) -(10) -(24) Interest Payable 48 47 46 Total Opex 549 653 1,013 Profit Before Tax: 331 677 600 Taxation 42 75 72 Profit After Tax: 289 602 528 Dividends 30 30 30 Retained Profit 259 572 498
Appendix 2.Summary Balance Sheet Balance Sheet Year End 31/12/07 31/12/08 31/12/09 000's 000's 000's Fixed Assets: Freehold Lands & Buildings 1,509 1,491 1,472 Plant & Machinery 165 122 64 Total Fixed Assets: 1,674 1,613 1,536 Current Assets: Stock 77 127 105 Debtors 717 811 1,206 Prepayments & Accrued Income 16 14 79 Bank Balances 315 764 1,065 Total Current Assets: 1,125 1,716 2,455 Current Liabilities: Trade Creditors & Accruals 401 361 505 PAYE/PRSI 17 16 137 Corporation Tax 17 55 Bank Loans 105 105 98 Total Current Liabilities: 540 537 740 Long Term Liabilities: Bank Loan 904 865 826 Total Long Term Liabilities: 904 865 826 Total Net Assets: 1,355 1,927 2,425 Shareholders' Funds: Share capital 750 750 750 Retained Earnings 605 1,177 1,675 Total Shareholders' Funds: 1,355 1,927 2,425 Appendix 3 - Ratio trend analysis Key Ratios Year End 31/12/07 31/12/08 31/12/09 EBITDA (000's) 566 788 706 Gross Margin 29.1% 32.9% 31.3% Wages as a percentage of Sales 12.1% 11.7% 15.8% Current Ratio 2.1 3.2 3.3 Quick Asset Ratio 1.9 3.0 3.2 Debtor Days 87 73 86 Creditor Days 73 49 54 Stock Turnover (Days) 13 17 11 Gearing 74% 50% 38% Interest Cover 11.8 16.8 15.3
The Task: Prior to submitting a proposal to the Bank you must present the management team with a report outlining the following: 1. Identify the total level of debt funding you feel is realistically achievable in the current banking market? 2. Identify how you would want this debt structured 3. identify the security you consider will be required to obtain the funding 4. What, in your view, are the top 3 key risks that the Bank will focus in on? 5. What, in your view, are the top 3 pre drawdown conditions that the bank is likely to impose? 6. Consider 3 financial covenants that the Bank are likely to look to incorporate into the loan agreement and at what level do you feel they should be set at? 7. Outline what information you would include in your submission to the bank The Suggested Solution: 8. Identify the total level of debt funding you feel is realistically achievable in the current banking market? o In assessing the level of debt funding a bank would be willing to provide to any customer they will consider a number of factors including repayment track record, cashflow available for debt service, robustness of forecasts and level and quality of available security. Typically a bank would not lend more than the shareholders funds or total net assets in the balance sheet, however there may be some instances in which debt may exceed net assets The actual value of the fixed assets is greater than the book value. Guarantees are provided by a 3 rd party e.g. holding Co, Promoter, related Co. In this scenario it is likely that the maximum funding that would be provided is approximately 2.5m. A key issue here is that the leveraging of the balance sheet must not create a negative net worth situation. 9. Identify how you would want this debt structured In this case we would suggest: o 5 Year Straight Line Amortising Term Loan - 1,000,000 o Invoice Finance Facility - 750,000 (based on 75% discounting of all eligible debtors, assumed to be 1m) o 15 Year Commercial Mortgage - 750,000 (based on 75% of the market value of Factory Premises) 10. identify the security you consider will be required to obtain the funding Security would include o First ranking fixed and floating debenture over all the assets of ABC Food Manufacturing Ltd, to include a First Legal Charge over factory premises. o Full subordination of any(i) shareholder loans, and other forms of equity financing (if applicable) o Assignment of Debtors Ledger together with standard indemnities from the Directors o Keyman Cover of at least 1m o Personal Guarantees, again of at least 1m. 11. What, in your view, are the top 3 key risks that the Bank will focus in on? o Ability of the management team to maintain and grow the business, particularly if the departing shareholders were the driving force behind the business. o Sustainability of the cashflow particularly over the 5 year period of the 1m loan. o Any important skill gaps that might result from the management changes. 12. What, in your view, are the top 3 pre drawdown conditions that the bank is likely to impose?
Standard for a facility of this type to include but not limited to Bank satisfaction with:- o the make up of the management team & Board, and future business strategy o Valuation on the factory premises o Satisfactory Debtors Survey in respect of the Invoice Finance Facility 13. Consider 3 financial covenants that the Bank are likely to look to incorporate into the loan agreement and at what level do you feel they should be set at? Standard for a facility of this type (levels to be agreed for quarterly testing) and to include: o Total Debt/EBITDA 2.5/1 o Interest Cover 5 times. o Repayment Cover 2.5 times. o Directors Remuneration Restrictions As per Business Plan but subject to review if in the event of the Business Plan forecasts not being achieved. o Capital Expenditure Restrictions No capital expenditure, excluding normal replacement, in excess of 20,000 per item or 150,000 in total to be undertaken without the prior approval of the Bank. 14. Outline what information you would include in your submission to the bank a) Background history b) Trading and financial position analysis. o 3 years historical accounts. o Recent management accounts, aged debtor & creditor analysis. o Compare actual results versus forecasts. o Trend analysis of all key P&L and Balance Sheet areas. o Comment on variances and trend movements, positive and negative. o Provide a historical Funds Flow Analysis. Cash is King. o Independent confirmation of overall tax position. o 12 month Bank statements c) Business Strategy and Operations: o Outline of the strategy for the business. o Description of the business model and products/services produced. o Marketing plan including analysis of key markets. o Competition and competitor analysis. o SWOT analysis to include commentary on important SWOT areas. o Any other relevant information d) Management & Staff: o Include formal structure chart (with photograph). o Comment on management skills and experience, include CV s if appropriate o Industrial relation history. o Staff turnover. e) Banking Requirements: o Clearly set out what facilities are being sought Existing and New. o Include FX lines and Contingent liability lines. o Include a funding table if appropriate. o Include repayment proposals and support with a funding analysis. o Support request with Monthly Trading and Cashflow forecasts & key assumptions f) Security on Offer: o Details of what security is on offer to the bank. o Support with valuation reports.
o Consider if Personal Guarantees are going to be provided. Support with Asset & Liability Statements. g) Bank Covenants: o Interest cover 2-3 times. o Repayment cover 1.5 times. o Debt to EBITDA 2-3 times. o CAPEX. o Loan to Value. o Borrowing restrictions h) Ongoing Information Requirements: o Quarterly management accounts within 30 days. o Quarterly aged analysis of debtors and creditors. o Annual audited accounts within 90 days. o Annual Tax Confirmation. i) Connected/Associated Exposures: o Associated borrowings, common shareholder companies. o Personal borrowings of the main shareholders/directors j) Any Additional Relevant Information: