Anatomy of a Deal: Finance Growth with Debt
One of the beauties of the private-placement financing market is its almost infinite variety. So when Leonard Milberg, the chairman of Milberg Factors, a New York City-based factoring firm, needed to raise new capital in 1993, he "naturally turned to this market.
"It's the nature of our expanding business always to need more money to purchase other companies' receivables," he explains. "Raising funds through a private placement is quick and cheap and offers us a great deal of flexibility."
Every couple of years Milberg sells some form of subordinated debt, usually with a 10-year maturity. (Quick explanation: If the debt-issuing company goes bankrupt, its subordinated, or junior, debt is paid off only after the bank loans -- the senior debt -- are. Because of the additional riskiness, subordinated debt pays a rate of return that is higher than the interest rates paid on bank loans.)
Companies can sell debt, equity, or any combination of the two through private placements. But Milberg prefers debt-only deals because, as he stresses, "we have no interest in bringing in outside investors." For Milberg, subordinated debt is doubly beneficial: the cash that goes directly into the company's coffers also enhances its credit line. "Bankers," he explains, "consider subordinated debt part of our capital base. The bigger your capital base, the more you can borrow."
Milberg's financial condition is strong, and the company has a history of numerous private placements. Neil Powell, chairman of SPP Hambro & Co., the New York City-based investment-banking firm that handled Milberg's debt-only private placement, emphasizes that "many other private companies -- especially smaller or younger ones -- need to include some equity enhancement for investors. That might take the form of stock warrants that would gain value after an initial public offering or would be bought by the company itself at a later date."
The Milberg deal, $7.5 million in subordinated debt and an additional $2.5 million in senior debt, took four months to complete. One final twist: interest rates were initially fixed at 9.09% and 8% respectively, but soon the CEO executed an additional transaction to "swap" the fixed rates for variable rates linked to the prime rate. "The one thing I wanted to avoid," says Milberg, "was paying 9% interest and watching rates drop so low that I'd have to charge clients only 3% for our money. We'd lose the spread." Rates have risen, though, and, he notes, "we're sheltered by being able to raise prices to clients. The variable rates were best suited to our needs, so I'm pleased with this deal."