Building a capital stack to build for future growth
You can’t build wealth without debt. Being able to borrow money is a major part of the business game. This fundamental concept applies equally in personal wealth and business growth. A strong, nimble and flexible capital stack is a key success factor for every Canadian automotive dealership. Here are some things to consider:
Understand your credit score and how its calculated
Your financial history is the primary indicator of your future credit success. This includes knowing the types of debt you’ve had (credit cards, loans, mortgages) and your payment history (on-time or late payments).
Any bankruptcies, liens or other public collection records will naturally negatively impact your score so do everything you can to stay on the right side of this equation.
Credit unions use a scoring model, usually a FICO score, to establish an independent metric on your credit worthiness.
The weighting system for this model is broken down as follows: 35 per cent based on your historical ability to pay on time; 30 per cent based on your utilization, how much debt you have vs available; 15 per cent based on how long your accounts have been open; 10 per cent on your mix of credit cards vs long term debt; 10 per cent on whether you’ve applied for a lot of new credit recently.
Each of the above elements are used to determine a score between 300 and 900, where the higher the score indicates the better your credit worthiness.
Subordinated debt will be more expensive. These lenders take on a bigger risk as they don’t have a direct line to secured assets if default occurs. Accordingly, they will demand a higher interest payment to offset this risk.
Structuring the layers of financing
After concluding on your ability to borrow, you need to establish sources of capital for future real estate projects, start-up ventures, dealership acquisitions, or other business investments.
Consider risk and repayment requirements when establishing your order. Follow these steps to ensure the success of your strategy:
Calculate the total amount required and your investment objectives. For example, I need $40M to acquire a dealership that will return 10 per cent net to sales.
Or, I need $1M to fund the expansion of our service department that will generate 40 per cent-70 per cent gross profit over the next five years. Be specific and honest as this will be key to determining the right funding partner.
Build your strategic layers:
- Senior debt, normally provided by banks and other financial institutions, offer the lowest interest rates and are the easiest to obtain. They are usually secured by property of business assets;
- Subordinated debt will be more expensive. These lenders take on a bigger risk as they don’t have a direct line to secured assets if default occurs. Accordingly, they will demand a higher interest payment to offset this risk;
- Equity, either preferred or common, offers your last line of capital. It generally presents itself via investors looking to make a return to participate in your business. Repayment can be fixed in nature or result from residual profits at the end of the year;
- Match debt to the right project. Low risk project should source from traditional financial institutions whereas high risk project should consider more equity type funding; and
- Model out your repayment cash flow stream and exit strategy while building in your investor returns. Assuming long-term business plans and the correct market conditions exist.
It’s clear that today’s dealership groups require a vast capital stack to succeed. Cash alone won’t be enough to take your group where you’ll want it to go. Think long and hard on how you want to structure your debt. Don’t do this based on gut feel. Have a plan and stick to it.
Balance risk with reward, and lenders with projects. You’ll be better off in the long term for it.
