MA Financial investment specialists, Amelia Hill Salter and Alex Mount contributed to this article which was originally published on Listed@ASX.
A rising number of high-quality, listed and private Australian businesses are opting to incorporate alternative sources of debt into their funding mix. This is being fuelled by challenging equity market conditions and a desire to limit shareholder value dilution through an equity raise.
It can be challenging for small- and micro-cap companies to raise funds in the current market climate, with share price, required equity raising discounts and lack of investor demand often hurdles to an ordinary equity raising.
Listed company access to capital from high net worth investors is constrained, with private client advisers focused on diversified asset allocation, apportioning up to 50 per cent of clients’ portfolios to alternative asset classes.
Furthermore, traditional bank lenders are generally unable to provide credit unless it’s secured by a significant asset such as a property, which can be a challenge for some businesses.
Combined, these factors can constrain ordinary capital raisings by smaller or growth-led ASX-listed companies. However, there are opportunities to explore alternative capital solutions.
A case for growth credit
Given present market conditions, alternative capital solutions such as growth credit, often referred to as growth debt, venture debt or private debt, may represent an attractive funding option for boards and management teams.
- Growth credit is often used to finance product development, capital works and acquisitions
- Instruments are typically secured-term loans or hybrid credit, with fixed maturities of three years or less
- Loans are interest-bearing with some amortisation for longer maturities
- Credit instruments incorporate customary contractual protections, including security, covenants, undertakings and enforcement rights
- In addition to the credit instrument, the lender may receive upside exposure such as equity warrants, participation rights or conversion rights.
For boards and management teams that have strong conviction on their potential to grow and succeed, growth credit can offer a less-dilutive and lower-cost financing alternative to issuing new equity.
Growth credit provides capital to progress a company’s present and medium-term objectives. This is particularly relevant where an ordinary equity raising may be challenging, undesirable or incorporate significant execution risk in volatile markets.
Growth credit can be used as a bridge to a future equity raise. It is typically more flexible than traditional bank credit and warrant or conversion pricing at a premium to current market pricing can send a supportive signal to equity markets.
Some important considerations
Growth credit is typically only appropriate for companies at, or with a pathway to, cash flow break even, or with a clear pathway to refinancing by traditional lenders or equity capital raising.
Any framework for reviewing growth credit alternatives should consider multiple business scenarios, with different funding requirements. It is also essential to define objectives, such as dilution of shareholder value and certainty of funds. Think through shareholder approvals and implications for existing funding arrangements.
It is also vital to determine the boundaries of acceptability for terms. Remember to review and rank potential alternatives against equity raising structures, based on the defined objectives, including execution risk. Then, identify preferred lenders with relevant credentials, industry experience, funding capacity and capability to execute on the preferred alternatives in the desired timeframe.
In the current market environment, boards should consider all funding alternatives alongside ordinary equity raisings to pursue an optimal capital solution. Given its characteristics and advantages, growth credit could be a beneficial option.