Having Strong Balance Sheet Pays Off When Seeking Loan
Old-fashioned business caution made Phil Harris a winner in the new game of business finance--an entrepreneur who can command debt financing from skittish lenders.
Harris is president and chief executive of Signature Theatre Management Co., an Oakland-based owner of movie houses in small and mid-size towns in California, Montana and Hawaii where they don’t compete with megaplexes. He says he has always run his business conservatively--minimizing debt and maximizing cash flow.
The result: When he needed debt financing for a big acquisition a year ago, he got it, buying up 41 theaters in the Mann chain in Northern and Central California solely with borrowed money.
How? Harris’ balance sheet showed so much equity and so little debt that his lenders didn’t balk. In addition, he followed an unusual strategy in his industry, buying not the leaseholds of his target properties--customary in the business--but rather the land and buildings, bringing the number of theaters under his control to 214. Thus, he targeted more than just the cash flow of the theaters, giving his lenders even greater comfort.
“We purchased the real estate as well as the business interest,” he said, “and that opened up a new and different avenue for putting together our financing, which we would not have had if we were simply acquiring the leaseholds. It made it a little easier because we had hard assets--land and buildings.”
Harris’ experience illustrates an important truth about business finance: The new rules of business finance are really the old rules in the sense that lenders still back those who follow conservative, time-honored business practices. Thus, entrepreneurs like Harris get the debt financing they need by giving their lenders less to worry about.
“We have seen a contraction in the capital markets; there’s no doubt about that, and it’s tied to the general slowdown in the economy,” said Johnny O. Lopez, executive vice president of mergers and acquisitions for Platinum Equity, a Los Angeles investor firm that typically operates the firms in its portfolio, which includes extensive holdings in information technology companies.
“We publish a daily recap of merger and acquisition activity, and nine to 12 months ago it was always two and three pages long. These days, it shows barely one page.”
Selling prices for healthy mid-size companies reflect the decline, Lopez said, having fallen 15% to 20% in recent months, and the deals that reach consummation typically involve less debt and more equity than they did a year ago. As a result, most entrepreneurs can’t float their acquisition campaigns on debt financing and instead must dig into their own pockets for more equity than they might have had to put up a year ago.
But the marketplace presents many opportunities for buyers with cash to invest, Lopez said. His firm has done six deals since September, acquiring companies with revenues exceeding $1.5 billion in transactions involving more equity and less debt than those a year ago.
“There’s more equity and less debt in the marketplace, and that’s why we see this time as an opportunity.”
Lopez expects even greater opportunities to appear in the coming months as venture capital firms, reeling from the slaughter of the dot-coms, rid their portfolios of under-performing companies. The economic slowdown may push Fortune 100 companies to shed assets as well, he said, and these sellers will favor buyers with cash.
“Sellers don’t have a lot of sympathy for buyers who can’t deliver cash,” said Chris Britt, president of Marwit Capital, a Newport Beach private equity investor licensed as a small-business investment company, or SBIC, by the Small Business Administration. “Sometimes it takes sellers awhile to acknowledge this, but it’s a buyer’s market. You must have cash or access to cash.”
Even so, as Harris learned in negotiating the Mann deal, you needn’t always put up your own cash. Lenders had turned skittish at the time, but the bank and private lender that financed Harris’ deal saw so much security in his balance sheet that they lent him all he needed to close the deal. Under the terms of the deal, Harris did not disclose the dollars involved.
“We smaller exhibitors always had to finance our growth on a conservative basis,” Harris said. “Because we were successful and achieved our returns on investment, by the time we were ready to do the acquisition, we were in position to show our lenders cash flow not being used to service debt. That enabled us to entice the financing we needed.”
To solidify his position, Harris converted one of the properties into office space and sold another to generate cash to reduce his debt load. He also spun off some of the real estate into a subsidiary so as not to encumber Signature Theater’s balance sheet with debt.
“We were seeing skittishness in the marketplace even then,” Harris said. “Liquidity in general was drying up and people in a wide variety of businesses were finding it more difficult to get traditional financing.
“But we’re in a position where we’re still under-leveraged. I’m not in the market for expansion money right now, but I believe that within reasonable constraints, I’d have available to me just about as much capital as we might need.”
*
Juan Hovey can be reached at (818) 709-6420 or via e-mail at jhovey@socal.rr.net.
