Posted on: June 4th, 2019
Gap financing also known as stretch financing is that hard to reach part of your capital raise. It is that extra piece of capital needed after you have brought in your senior loan. While the gap may be small in size relative to the entire capital stack, it plays an inordinate role in closing your deal.
Funding this gap is a critically important task, one that few acquirers appreciate on the front end of the deal process. The occurrence of a gap is often a sign that the capital raise may be ill conceived and not properly structured in the first place.
Most deals with gaps are heavy with senior bank loans which may give them 80% of what they need, but still fall short of the additional 20%. The risk to not filling the gap are not to be taken lightly. Without 100% of your capital raised, you won’t be able to close. Even if you are able to shoehorn your closing proceeds, you may not have money needed to integrate or invest in the newly acquired business, placing strain on your internal liquidity. Not to fill the gap is to go into a risky endeavor – an acquisition – without all your financial resources available to you.
This gives you little cushion for underperformance, so if you hit a tough quarter or two, it’s harder to get the business back on strong financial footing. Raising the gap or stretch financing is best handled through adopting an approach that will eliminate the gap altogether from occurring. Through embracing the different loan structures available in the market, you can raise all the capital you need without having to worry about pesky gap or stretch financing. Here are the 4 tips to raising stretch or gap financing;
- Do a holistic review of your debt capacity – most gaps result from using just one approach to lending – asset based. Learn the other ways to measure debt capacity using cash flow. These structures will provided larger loans and will handily cover any perceived gap or stretch piece.
- Understand the power of pro forma EBITDA adjustment – talk to an advisor and learn how you can adjust historical profits with normalized expense adjustments. This allows you to increase your debt capacity and quality for larger loan sizes that will eliminate the gap.
- Work the lower part of the debt stack first – gaps result when banks come up short. It makes more sense to first understand how much junior capital you can raise and then back into the amount of bank loan. Junior capital such as mezzanine, unitranche, and unsecured loans bring more value to your debt stack. Better to scale that layer of your debt stack as the first step in your capital raising process.
- Highlight the Growth Story – Gap funding is repaid through future growth, through the business generating significantly more EBITDA down the road. Cash flow lenders need a strong, well-conceived growth story to sink their teeth into, in order to make the loan.