Financial Modelling For Private & Venture Debt

In this blog, we will review financial modelling in the context of Private & Venture Debt. Specifically, we will reveal how Fuse Capital's talents use its expertise to unlock growth debt facilities for its clients.

We will go over:

• Brief overview of financial models
• The Importance of Financial Modeling
• Building Comprehensive Financial Models For Debt
• The Difference between Debt and Equity Financial Modelling

Financial Models?

Our financial model is akin to a versatile and customizable tool, crafted to suit specific client or internal requirements. It plays a critical role in tracking business performance and key metrics at various intervals (monthly, quarterly, annually) for businesses of any size. Its adaptability and functionality make it an essential instrument for informed decision-making and strategic planning.

The Importance of Financial Modeling

Financial models are a crucial component in developing Investment Memoranda (IM) for our clients seeking to secure debt funding. We construct integrated financial models from the ground up, encompassing all three core financial statements (Profit and Loss, Balance Sheet, and Cash Flow) for our clients.

We then refine their model forecasts to align with lenders' preferences and requirements, ensuring that the numbers effectively convey what lenders need to see to make offers and grant credit approvals.

Recently, we've observed that some of our clients lack an integrated model with all three financial statements. Sometimes, they have no model at all. Additionally, certain clients possess highly intricate and detailed models that necessitate simplification before incorporation into our IM. This streamlines comprehension for lenders and reduces the number of initial inquiries, expediting the offer process.

Building Comprehensive Financial Models For Debt

We've faced a couple of challenging aspects with numerous clients. One of the most intricate and demanding model builds was for a particular client (NDA)  during the due diligence (DD) stage.

This client is a company that facilitates affordable access to smartphones, laptops, and other tech gadgets for businesses and consumers through rental services. The challenge they faced was high product demand, yet an inability to keep up with inventory due to significant prior cash burn. They required a lender willing to provide financing against these assets, coupled with equity infusion.

Fuse successfully secured a €4 million term sheet for them from an asset finance lender (NDA). However, this term sheet was intricate, coming with various conditions and riders before funding could be accessed.

These conditions need to be meticulously modelled:

1. ) Drawdown in multiples of €250,000 with a maximum drawdown of €1 million at any given time.
2. ) Equity funding as a condition precedent before unlocking two tranches of €2 million each.
3. ) Maintain a Loan-to-Value (LTV) ratio of 85% for B2B business and 75% for B2C business— a challenging condition to maintain with two distinct revenue streams.
4. ) Funds available for drawdown only in the first 18 months.
5. ) Reinvestment of received funds allowed after paying off all expenses and debt service from rentals, but limited to the first 24 months.
6. ) Maintain a cash reserve of 2% of the outstanding loan balance at all times.
7. ) Covenants to maintain—Minimum Tangible Net Worth of €2 million; Maximum Leverage of 3x; and Minimum cash of €0.5 million for Tranche 1 and €1 million after Tranche 2 is drawn.
8. ) Equity injection from the Operating Company (OpCo) required if cash goes negative.
9. ) Financial consolidation of two entities, SPV and OpCo, to assess the impact on covenants.

We utilized the existing client model for revenue and cost assumptions, even though it was in poor shape. We adopted a bottom-up approach to calculating revenues, determining the assets that could be purchased using the funding while complying with all terms and conditions, maintaining LTVs, etc.

The model presented circular references, and we used macros to resolve them. Each drawdown or change in assumptions triggered model checks, flagging any breaches of conditions.

We rigorously tested this model with various assumptions to optimize it, ensuring it met all conditions outlined in the term sheet while demonstrating substantial revenue growth for our client to sustain the business, comfortably service the debt, and meet other cost obligations.

While it's a client that necessitated high-echelon modelling, they are not alone in necessitating this sort of expertise to maximise their fundraising's outcome. In fact, we rarely have instances of "standard" approaches.

Each transaction is different and requires tailored advice.

Unsung Hero

Goonjit Sing Pahwa, our Senior Investment Analyst, has been at the forefront of this particular financial modelling. Props to you, Goonjit!

How do debt financial models differ from equity financing modelling?

Private debt models are tailored to balance lender and client needs, showcasing consistent and steady growth. The focus is on achieving profitability in the next 12-18 months while enabling clients to utilize funds for necessary growth and comfortably service the debt while upholding covenants.

In contrast, equity finance models prioritize driving top-line growth with a hockey stick-shaped trajectory, aiming to elevate equity valuation.

These models often emphasize substantial cash burn to acquire customers and propel revenue growth, prioritizing this over immediate profitability. However, this aggressive spending approach can sometimes fall short of generating significant revenue growth, leaving businesses cash-strapped when equity investors withdraw support.

At this point, they begin exploring alternative funding options, creating an opportunity for us to step in.