The Power of Incremental Liquidity – A Case Study

We recently were introduced to a prospective client that was seeking incremental liquidity to fund their increasing growth – a common encounter in our travels. This prospective client had promising opportunities to grow value on two fronts:

1. Grow sales faster – provided they had the liquidity to fund additional revenue opportunities, and,

2. Improve margins – by taking advantage of generous early pay discounts being offered by many of their vendors

In addition to all of the routine considerations that any prospective client takes into account when deciding whether or not to proceed with alternative finance, this prospective client wanted (very astutely in our judgment) to better understand the threshold required to make it work for them – from a value creation point of view. To answer this question, we developed a side by side and apples to apples comparison of the two scenarios they had in mind – namely:

A. An internally funded growth model (predicated on having no access to additional bank debt – which they report was the answer received from many banks with whom they had spoken) whereby all earned cash flow would be plowed back into to the business to support growth, and,

B. An alternative finance funding model – which offers greater access to capital, but at a greater cost

The questions they wanted answered were primarily twofold: (i) which scenario produces greater value, and, (ii) how sensitive is potential value creation to the two identified variables (#1 and #2, above). The answer was exactly what we expected, but was at some level a surprise to our prospective client – not so much a surprise of direction – but more so how low they judged the threshold to be to make the alternative finance model a better result for them.

The following table is the result of this analysis – exactly as presented to our prospective client. The x-axis variables being the amount of gross margin improvement they would have to realize from taking advantage of early pay discounts as compared to the y-axis variables – the amount of revenue growth they would have to generate incremental to the revenue growth supported by their internally funded growth model.

For scaling purposes it is helpful to note that the prospective client will produce ~$3.8 million in revenues in 2010. All figures presented in the table below are in 000’s and are the difference in total value created as compared to the internally funded growth model which was analyzed to be ~$2.8 million.

Total Value Created / (Destroyed) Using Alternative Finance Model – 000’s

(a) Incremental revenue growth (i.e. in addition to internal funding scenario)

After going through all of the detailed assumptions with our prospective client – the ones they specified that we use – and realizing that in every scenario where they produce incremental growth of 2.5% or greater (whether or not they realize any margin improvement from early pay discounts) – they requested a proposal.

The potential to create several hundred thousand – or even a few million more in value – which is potentially as much as 80% more than the base value of ~$2.8 million – was as compelling to them – as it was to us.