As a banker, Charles J. Bryan feels comfortable with things he can touch, like the wall of a building he can run his hand over or the edge of a truck tire he can kick. Bryan can grasp a hold of these things both literally and figuratively; they are assets he can imagine being valuable collateral to a loan he might make. "I like to kiss buildings, kiss the ground, or kiss machinery," says Bryan, a senior vice-president at Nashville City Bank & Trust Co. "Kissing air doesn't give me as much security."
But every now and then, a banker is faced with something to finance that is less tangible than a piece of equipment or an office building. It might be a game plan for a young business, a successful network of franchise agreements, or a radically new piece of software.
It is at times like these that bankers realize they need to consider more than the fixed assets of a company in deciding how much to lend. When it came time to lend beyond the tangible assets of Ecovar Inc., a $15-million LaVergne, Tenn., company, Bryan's confidence came from his knowledge that Ecovar's customers depend on the business to supply a gel that is the vehicle for a key ingredient in the manufacture of printing ink.
Ecovar had gotten started in 1978 with the help of venture capitalists and other outside investors. But over the course of several years, the investors' interests leaned toward high-technology and service businesses. In late 1983, Bob Mueller, Ecovar's chief executive officer, began actively to seek a way to buy out the interests of his passive investors, and he quickly came to the realization that a bank-financed leveraged buyout of the original investors was the answer.
Bryan's bank had extended revolving credit of about $2 million to Ecovar after reviewing the company's fixed assets, machinery, physical plant, and inventories.But those assets weren't sufficient to support the kind of loan Mueller needed both to finance the buyout and to provide working capital in the future.
To make up the shortfall, Ecovar turned to a Nashville venture capital firm that put up around $2 million in debt and equity capital in exchange for a third of the company. At this point, Mueller assumed Ecovar would go public in the spring of 1984, thereby providing the venture capitalists with their payoff. But a sour market for new offerings left Ecovar looking for a way to pay off its debt and obtain refinancing.
With Nashville City Bank already committed to a credit line of $2 million, Bryan wondered how much further his belief in Ecovar could carry him. One attraction in financing the buyout through the establishment of an employee stock ownership plan (ESOP) was that 50% of any interest payments Ecovar would make to the bank would be tax-free to the bank under current Internal Revenue Service rules. Mueller would have an opportunity to sell his stock back to the company and translate some of his years of sweat equity into cash. But still Ecovar lacked any unsecured hard assets to float the kind of loan it would take to finance the ESOP.
"I've already loaned negative tangible net worth," Bryan said as he prepared to extend his relationship with Ecovar. "Let's assume that they want to keep the existing revolving credit. To fund the ESOP, I'm really going to have to loan on goodwill. How do I know what goodwill is worth? That's the question."
Bryan may never know the answer to that question, but for now he is content to put about a $2-million price tag on it. In exchange, Bryan is asking Mueller to sign a management contract under which the CEO agrees to stay with Ecovar during the life of the bank loan. Bryan is also taking out a life insurance policy on Mueller because, after all, that makes Mueller less of an intangible asset. Finally, Bryan plans to have Ecovar guarantee the debt of the ESOP.
The changing climate of business in America, particularly the trend toward entrepreneurism, has presented banks and commercial finance companies alike with new opportunities for risk and reward. Citicorp Industrial Credit, in Harrison, N.Y., has lent money to companies in which assets have ranged from a confectioner's trade name to an Oklahoma mud hauler's state license.
"The asset-based lender must look beyond traditional assets" in making loans, says Frederick S. Gilbert Jr., executive vice-president of Citicorp Industrial Credit. The mud hauler had nothing in the way of fixed assets besides his trucks, Gilbert explains, but a closer look at the company revealed that in Oklahoma, a permit to haul fire-retardant mud is as valuable in the oil patch as a cabbie's license in on the streets of Manhattan. "You look first at your hard assets," Gilbert says. "Then if there are any soft assets, you appraise them, too."
In evaluating intangible assets, lenders look for elements of a company's success -- its patents, trade names, dealer agreements -- that contribute to cash flow but often don't appear on the balance sheet. In a worst-possible-case scenario, these intangible assets might become very tangible items that could be sold separately from the business itself. Not that such thoughts are on the minds of lenders. "We look at intangibles primarily as a hedge, but not as a substitute for a viable business," says Gilbert.