We Don’t Know What We Don’t Know

So, your company is interested in buying a competing chain of gasoline service stations and convenience stores, dealer supply-only or commercial agreements, and/or you are considering building several new-to-industry sites.

There is a saying, "We don’t know what we don’t know" and in the case of financing growth opportunities, that is true for the owners of many midsized and small, privately held petroleum distributors that have not been active in the mergers and acquisitions (M&A) marketplace or added new-to-industry sites to their network for a number of years.

This statement applies not because an owner and/or his or her senior staff do not include many extremely smart and talented managers. Rather, in many midsized or small companies, the senior management team is primarily focused on the day-to-day operation of the company. They simply do not have the time to keep up on what’s happening in the M&A and capital markets.

Before any operator decides to launch any new or major growth initiative, there are several key financing issues your senior management team (CEO, chief financial officer, controller, etc.) may want to consider.

• How many different funding scenarios should our company review to determine its best return on investment (ROI)? 
• Has our company been tethered to only one senior lender for many years and can that source of capital really meet the company’s current capital needs? 
• Does setting up a separate special purpose corporate entity to facilitate the proposed acquisition free up existing cash flow and increase our current and future funding options?
• Will alternative financing actually increase our company’s ROI and allow us to expand more quickly and with less equity?
• What type of market feasibility study should our firm complete before committing capital to a new-to-industry location?
• Does my senior management team have the time and expertise to procure and analyze the various funding options available in the marketplace?

SENIOR SECURED FINANCING

Our firm focuses on helping operators analyze the various viable funding options available in the marketplace that can be used to fund any growth initiative that complements a company’s long-term strategic objectives. Listed below are several key issues that our firm normally reviews with each client when the final acquisition capital structure will ultimately involve some kind of senior secured financing. 

Senior Debt:

• Does it make sense for my company to use senior debt financing? 
• What are the current market rates and overall loan terms?
• Can you finance the opportunity exclusively with senior debt? If so, what limits, if any, will the senior lender’s loan documents place on other future investment opportunities?
• Will the senior lender’s financial covenants restrict the use of your company’s excess cash flow? 
• How many amortization and term structures will a lender consider?
• What is a reasonable equity contribution for this transaction?
• Should I refinance some or all of my existing debt as part of the overall transaction?
• Can I use my existing equity in my company as part of the required capital contribution? How does varying levels of capital impact the ROI?
• Do I need to provide the lender a personal guarantee? If so, can it be limited in nature or burn off over time?

Senior Bridge Financing:

• How does bridge financing work? Rates? Term?
• Does it make sense to use bridge financing for the retail assets my company plans to rationalize and quickly sell post-closing?
• Should the financing include any amortization?

ALTERNATIVE FINANCING

Many of the acquisition capital structures our clients have used in the past to complete an acquisition or fuel organic growth consisted of a combination of traditional senior financing and/or alternative funding vehicles, such as preferred, mezzanine or sale leaseback financing. 

It normally makes sense for any retail operator to at least consider alternative financing options for any acquisition opportunity or organic growth initiative. This is especially true if your company has a limited amount of capital to fund its expansion plans.

Listed below are brief descriptions of some of the important questions a company interested in expanding should investigate prior to making any final decision to use an alternative financing structure.

Sale Leaseback (SLB):

• What is the initial capitalization rate contained in the lease agreement and how quickly will base rent increase on an annual basis?
• Can a low-performing site be removed from the lease agreement in the future?
• How can our company finance a future modernization project on a leased site?
• What is the after-tax cash flow and ROI if our company uses SLB financing? 
• Any post-closing operational controls included in the lease agreement?
• Will the SLB capital provider offer your company an option to buy the properties at a set price and at a predetermined time in the future? 

Mezzanine Financing:

• When is mezzanine appropriate or really needed? 
• What rates and fees do mezzanine lenders customarily charge? 
• How about mezzanine lenders with predetermined return multiples? 
• What are our company’s investment returns with a senior/mezzanine capital structure? 
• Will my preferred senior lender agree to a senior/mezzanine capital stack?
• Will this structure impact senior loan proceeds?

Preferred Equity:

• What amount of current interest or monthly return can the acquisition pay to preferred equity investors? 
• How will this structure impact the company’s ownership structure?
• Who will control the day-to-day operation of the impacted assets?
• Will stock warrants be part of the overall deal?
• How will the investment be treated from a tax standpoint?

A company interested in expanding must also carefully consider its exit strategy before deciding on any financing option. For example, can your company’s projected EBITDA grow by the amount required to refinance the original capital structure or pay off any short-term financing, such as a bridge loan? What are the projected after-tax cash flow implications on each type of refinancing option? How much principal will be paid off over the term of the loan? What are the early prepayment terms?

Market conditions can quickly change in our industry and you may need the flexibility of revising your company’s capital structure to meet any new or material challenges.

Of course, every situation is different, and just as no two snowflakes are the same, neither are acquisition opportunities or expansion plans. Each warrants a closer look to make sure you have a fuller picture of your options, risks and projected financial rewards.

John C. Flippen Jr. and John Sartory are managing directors of Petroleum Capital and Real Estate LLC (www.PetroCapRE.com). The firm provides buy-side acquisition, refinancing, capital restructuring and select sell-side advisory services in the convenience and gas industry. PetroCapRE has assisted clients in completing transactions valued at more than $2.2 billion. They can be reached at [email protected] and [email protected].

Editor's note: The opinions expressed in this column are the authors’ and do not necessarily reflect the views of Convenience Store News.