Remember that first time, when you stepped from the ramp and onto the plane…and looked down over the gap?
That is how many business owners feel now. Many in the executive suites have not been through an increase in interest rates such as the one we are having in 2022. As we said last in our last post, “Careers and fortunes are made during these transitional times.”
The Federal Reserve is using interest rates to lower nominal GDP (i.e. GDP unadjusted for inflation). As we said last post, “2023 will be ugly but with huge potential. We’ve mentioned how many businesses are unprepared.” It is not too late to prepare.
Modern marketing science has shown that people do not like to pay to wait; however, they will pay to receive an opportunity. Put differently, it is how you ask the question. Here at the Diamant Carré, our job is to increase the certainty of you getting a loan funded when you want it. However, want to know what one of our most common hurdles is with clients? Getting them to pay to wait. They don’t want to pay a commitment fee for an unused line of credit. “Oh, but I’m losing money on this!” they always say…
That couldn’t be farther from the truth
They are actually paying money to be ready for an opportunity…they are paying a monthly premium to be prepared to buy when another company cannot. When they take out a loan, they are also receiving an option to buy something when they want it.
Let’s do the math:
They pay 0.25% a year to have a $5 million line of credit. If the line is unused, that is $12,500 a year or $1,042 a month.
A typical business should be able to have profits on average of 5% of revenue, based on a five year average.
If the business is bought at two times revenue by using the loan, (i.e. revenue of $2.5 million. 5% of that is $125,000. If you can return the company to normal (or better) profitability, then that becomes $250,000 (but for this example, we’ll assume it is not possible). The $125,000 average cycle annual profit from the acquired company is ten times the commitment fee.
But wait, you have overlapping overhead, which can be reduced without changing the acquired companies business model. That profit, let’s say is 1% of revenue, further reduces your costs by $25,000 (twice your commitment fee).
Next, your new acquired competitors can be upsold to your better or more efficient products & services. Let’s use 0.50% of revenue for that gain in year one (which is very conservative for a broad client base). This will add another $12,500 to profits.
Lastly, you will have to pay interest on the $5 million. Based on a 7% rate, that will be $350,000 without counting principal payments. 1st year principal payment deferrals can be negotiated into loans, so we’ll just use the $350,000. In the first year, can you reduce costs by $175,000 at each company? That’s about the cost of two medium level employees. Their functions could be replaced by using marketing or operational automation. Have you examined the SAAS models out there for each department recently?
All of these add up to buying expansion capacity and new clients for relatively little in the first year.
In our prior post, we said “Inflation will also stay high, though not as high as it is now. Supply chain problems have been fixed as demand has slowed. The inflation for the next two years should see it 1/3 lower than recent levels. The next thing to fall is per-unit prices. Unfilled orders have already dropped to eleven year lows, and product deliveries times have shortened with them.” Ask your vendor about introductions to companies who have seen abrupt falls in orders.
Tell Your Bank “Help Me, Help You” (We can help you with this)
We said in our last post that bank financial levels for liquidity and capital appear reasonable, even when compared to the likely 2023 environment. That doesn’t mean they don’t have problem loans out there. Talk to you the loan person you work with about speaking to the special assets department head at the bank. Take a problem off their hands, and get a good deal at the same time.
What does that mean for a California business owner?
Design and other so-called creative employees will probably stay here, as will companies with asset-light business models (such as services i.e. accounting and legal). Trade/Export services will also stay. Both will also increase in size and employee count, as young people continue to be attracted to the coast. But the cost of manufacturing will be high relative the Midwest, so smaller/low volume operations can make it but not the large/more price sensitive ones.
It will be a very interesting time to watch, and for us to fund it. Keep your communication lines with your friends open and ready.
“Her insight and pulse on financial information influences my decision-making.”
~ Daniel Stover – Founder & CEO at Ensight Partners
Climb the Wall of Fear
Education is the enemy of fear. Let us know if we may educate you and your staff in a Zoom meeting, with suggestions on who to approach and how to finance it. You can use our ideas to get conversations going. Our pre-qualification process can help you know how much to bid and get you to where you need to be with the acquisition…much faster. Click here to learn more
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Photo Source: Pexels by Johannes Plenio