“I like my players to be married and in debt. That’s the way you motivate them.”

-Ernie Banks

Debt securities have always played a major part in financing a company’s growth and maintaining cash flow in times of growth as well as retraction. During this time in the pandemic, our government is starting to play an even larger role in getting companies to increase their debt loads through programs like PPP and the Mainstreet Lending Program. As of mid-2020, interest rates, both for these government programs as well as with bank-financed and venture capital, are historically low. It’s easy — maybe inevitable? — to add low-cost debt to your company’s balance sheet and capital structure. But at what level does debt become detrimental to the immediate future of your company?

Contrary to many businesses, a few of our clients are actually paying down existing debt on their books. One business owner is selling more of their product online and experiencing a major shift in their business model. As a result of stronger cash coming in, management is electing to pay down debt to make her company more available, i.e. creating potential for equity or securing a larger debt offering with more attractive lending terms.

What is the right approach for your company?

As you might expect, our answer is it depends. It’s really important that, even in this uncertain time, companies make sure that the operating performance of their business will withstand the impact of our pandemic.

The government programs under the CARES Act and other pending Acts will not last forever — and there will likely be higher inflation and/or tax rates in the next three to five years because of the increased amount of government funding.

Here are two schools of thought for companies to consider:

Lock in lower interest rates today so you can take advantage of available money in this environment, especially if inflation continues; or
Increase your company’s flexibility for future recapitalizations and debt-refinancings by paying off debt today.

When evaluating which path to choose (expanding debt or paying down existing credit lines), each business owner needs to ask themselves these three questions:

Is your customer experiencing growth at this time? If you feel like your end user is not as impacted or is starting to recover more quickly than consumers of other product lines or industries, this might be the opportune time to slim down your balance sheet and start considering potential acquisition opportunities. If the opposite is true, you should conserve cash and analyze your cash-burn rate.
Is your current ratio 1.0 or greater? Current ratio is calculated by dividing current assets by current liabilities. A number of one or greater indicates a company with enough resources to settle its immediate obligations. If your current ratio is less than 1.0, it’s a strong indicator that there is a near-term cash flow issue that needs to be addressed in the next 3-6 months. If this describes your company, consider cutting back on purchases, getting rid of excess inventory, and finding potential opportunities to refinance debt that you took on prior to Jan 2020.
Are all your partners/significant stakeholders on the same page? All entrepreneurs devote much of their personal fortune to their business, and this could impact your ability to make decisions in the near term. If all partners do not agree on whether to obtain financing to support the business, difficult conversations need to happen. These challenging talks will help determine whether existing owners will provide additional capital to maintain market share or if it is time to buy out partners who do not share the same vision for the company. These conversations will ultimately determine the strategic path for your company — and whether it will survive and thrive in the future.

Takeaway: Businesses often need an outside perspective to help analyze and interpret the best path for their company’s future strategies and objectives. For a free assessment of your financial situation and potential path to follow, please contact us at info@acceleratingcfo.com.

Brian Califano