LBOs via CID – a few lessons learnt

In the last six months I have completed two acquisitions using Confidential Invoice Discounting (CID) as part of Leveraged Buy Outs (LBOs). Invoice discounting can also be called invoice financing, debtor financing or (incorrectly as a 3rd party typically collects the debt) factoring.

The key advantage of using CID is that the debtor book is a very secure asset for lenders to lend against. Typically, a lender will lend 60-90% of the value of a company’s debtor book and when the invoice is paid, it pays off the debt. For example, if a company’s debtor book was ￡200k, then a lender willing to lend 80% of this will pay out ￡160k. A nice pot of cash and assuming the company can carry on sending out new invoices, these invoices can be financed to provide ongoing working capital for the business.

This sounds great and is a well-trodden LBO route but there are a few lessons and top tips to consider:

How seasonal is the business?

If you are looking at buying an ice cream manufacturer, then their debtor book is likely to be higher in the middle of a nice hot summer than in the depths of winter. If you agree a deal in August and need to raise the finance from the debtor book, you might not be able to raise enough funds once the deal is ready to complete in November as the debtor book will be a lot lower.

Top tip – when agreeing a deal structure, agree to pay a percentage of the debtor book at completion as opposed a flat figure.

How often does the target company invoice?

Leveraging the debtor book to pay the target’s former owners takes a big lump out of the business’ future cash flows. I.e. those debtors were going to be paying cash into the business over the next 30 to 60 days but that money has now been spent on the seller’s new Ferrari. This won’t be a problem however if the business invoices regularly (say daily or weekly). These invoices can be financed to provide ongoing working capital. If the business invoices infrequently (say monthly or even less frequently) then you could be giving yourself a cash flow issue, which isn’t the best start as a new owner.

Top tip – as part of your due diligence, review the order book to get a feel of how regularly the target invoices and produce a cash-flow budget to make sure there will be no cash flow issues post-completion. Most CID lenders will require you to do this anyway as part of their due diligence. ?

How diverse is the debtor book?

No, I’m not going woke here but if your debtor book is made up of a good spread of customers (with good credit ratings) and isn’t made up of one or two customers who account for most of the debtor book, then you should be fine. I ran into an issue whereby shortly after completion, we received some very large orders from a single customer. This was great on the one hand, but we had a clause in our CID contract that the lender wouldn’t fund any one customer’s debt that accounted for over 50% of total debtors. This meant that we couldn’t finance some of the invoices which resulted in a short-term cash squeeze.

Top tip – Review the lenders terms of lending with regard to concentration limits and see if this will give you a problem.

How do you get out of a CID arrangement?

Normally, once you enter into a CID agreement with a lender you will be tied in for several years. Three is fairly standard. At the end of this term, you can either renew, refinance with another lender, or pay back the outstanding debt. If you are going to repay the outstanding debt, you will need to have generated sufficient operating cash flow to be able to do so, which could be a challenge. You may have to take steps to increase profits/cash flows or reduce dividends to achieve this, but it is worth it. CID facilities can be expensive, so it is a nice overhead to be rid of and it is difficult to sell a business with a CID facility because lenders are unwilling to transfer the facility to a new owner, so being debt free is a big advantage here.

Top tip – plan to repay the CID facility as soon as possible and budget your cash flow around achieving this as soon as possible.

I hope you found the above useful. No doubt there are plenty more key issues that I have missed but these are the things that I have had to consider recently.

About the Author

Having previously worked as a Charted Accountant in Corporate Finance before running and then selling his family business, Daniel is now building a portfolio of businesses through acquisition. Typical target companies are in the manufacturing and wholesale sectors with turnovers of between ￡1 and ￡5m.

If you want to discuss selling your business, or know someone who does, you can contact Daniel via LinkedIn.