Financial indicators

Feedback from interview participants revealed that corporate strategy influences financing strategy (section 5.2.4) and research proposition RP3b stated, that indicators will influence the selection of the refinancing instrument. The results in section 5.2.1.4 showed that key performance and financial ratios are an element of the financing strategy, even though it was not seen as one of the most important elements. Therefore this section explores from document analysis (a) if the financial ratios have been a decision parameter of the management and/or (b) if they were a limitating factor from a bank perspective. Table 5.14 displays the financial covenants used in the existing financing contracts of the cases after the performed (or envisaged) refinancing:

Table 5.14: Refinancing Instrument and Financial Covenants

Case Primary refinancing

instrument(s)

Financial covenants in the existing/new financing contracts

1 Syndicated loan Leverage (Net financial debt / adj. EBITDA)

2 Syndicated loan

Schuldschein

Leverage (Net financial debt / adj. EBITDA) Interest rate coverage

Minimum economic equity ratio

3 Retained earnings Leverage (Net financial debt / adj. EBITDA)

Minimum equity ratio

4 Extension of standard mezzanine

Bridge loan

Leverage (Net financial debt / adj. EBITDA) Minimum economic equity ratio

5 midcap bond Leverage (Net financial debt / adj. EBITDA)

6 Retained earnings

Bilateral loans

Leverage (various definitions) Minimum economic equity ratio

7 Syndicated loan Leverage (Net financial debt / adj. EBITDA)

Source: Own illustration.

A leverage ratio – defined accordingly with section 1.3.4 – was identified in every case to be included. A minimum economic equity ratio was furthermore included in four out of the seven cases. These two important ratios for financing contracts could not be identified in any interview but only in the supporting financing documents from the cases. No differences were observable between owner-manager and external manager cases. In addition, literal and theoretical cases did not differ in terms of financial ratios found in the documents.

However, these two ratios are named by banks and companies to be the most common financial ratio in financing contracts (Roland Berger Strategy Consultants, 2009, 2014). In particular, the leverage ratio was not only used as a limitation that could trigger an event of default in case the company would exceed the agreed level. This event of default could lead to a mandatory repayment of the financing. It was also identified in every case to be included in the documentation as a measure to calculate the interest margin of the respective instrument. This inclusion of a leverage to calculate a margin grid qualifies the instrument as performance sensitive debt corresponding to the investigation by Adam et al. in 2014. Case 5 and Case 6 must be differentiated from the other cases, since these used a midcap bond or bilateral loans respectively as primary external source of refinancing. However, even in these two cases, a leverage ratio was included as maximum level of indebtedness for the

company which would trigger a mandatory prepayment event in case of an exceedance.

Coming back to performance sensitive debt, it appears that the included margin grid might not be a result of management optimism or management behaviour, as indicated by Adam et al. (2014), but depending on the chosen refinancing instrument. Margin grids were included in every syndicated loan agreement as well as in the syndicated bridge loan in Case 4. However, neither in any of the Schuldschein agreements nor in a reverse factoring nor in a bilateral loan agreement, a performance sensitive component was identified. Leverage steps within the margin grid and step-ups per margin grid were also quite homogeneous.

By contrasting financial ratios used in the overall corporate strategy with ratios that were found in the existing financing strategy – or respective elements – it became obvious that in none of the cases financing ratios were included in the general corporate strategy. The general corporate strategy only includes performance ratios, whereas the three investigated financing strategies included ratios on financing, such as a minimum equity ratio to maintain, or liquidity ratios. Table 5.15summarises the ratios identified.

Table 5.15: Key Financial Ratios and Financial Covenants

Case Key performance ratios in

the corporate strategy

Key financial ratios in the financing strategy (or guidelines)

Financial covenants in the existing/new financing contracts

1 Profitability: Minimum consolidated EBITDA-Margin of 10.0%

Financing: Minimum equity ratio Leverage (Net financial debt / adj. EBITDA)

2 Profitability: Minimum ROCE of 18.0%

Profitability: Return on Sales (EAT / Sales): > 4.0%

Liquidity: Free cash flow / Sales: 3.5% to 4.0%

Liquidity: Minimum cash position of € 150 Mio. plus minimum undrawn revolving credit facilities of € 400 Mio.

Financing: Minimum equity ratio

Liquidity: Free cash flow / Sales: 3.5% to 4.0%

Liquidity: Minimum cash position of € 150 Mio. plus minimum undrawn revolving credit facilities of € 400 Mio.

Leverage (Net financial debt / adj. EBITDA)

Interest rate coverage

Minimum economic equity ratio

3 Profitability: consolidated ROCE of 9.0%

Profitability: Minimum EBIT level of € 70 Mio.

Financing: Minimum equity ratio of 30.0%

Financing: Leverage (Net debt / EBITDA) < 3.5x

Leverage (Net financial debt / adj. EBITDA)

Minimum equity ratio 4 Profitability: Minimum EBIT-

Margin

None Leverage (Net financial debt / adj.

EBITDA)

Minimum economic equity ratio 5 Profitability: Minimum EBITDA-

Margin

None Leverage (Net financial debt / adj.

EBITDA)

6 Not commented Not commented Leverage (various definitions)

Minimum economic equity ratio 7 Profitability: Minimum EBITDA-

Margin

Profitability: Minimum EAT- Margin

None Leverage (Net financial debt / adj.

EBITDA)

Source: Own illustration.

Comparing the financial ratios from the financing strategy with the financial ratios used as covenants to be included in the financing contracts, only Case 2 and Case 3 show a partial linkage between the two elements. In all other cases, financial ratios were used in the financing agreements as covenants without any feedback towards the financing strategy. This further indicates that these ratios are introduced by the financing partners rather than actively being used by the company to establish a direct connection between financing strategy and financing contracts. However, it must be recognised that such financial covenant would lead to a mandatory repayment event and represents an obligation for the company. In addition, the profitability ratios are indirectly connected to the financial ratios and the financial covenants. In Case 1, a reduced EBITDA-margin caused by a decreasing profitability would directly lead to

an increased leverage in the financing contract. Therefore, this is a limitation factor for the management as it is dependent from external partners in case the financial ratios are not met.

By exploring the determinants that drove the refinancing decision, an interaction with financial indicators was explored. Especially the leverage ratio was investigated to be included as financial covenant in every case and independent from the chosen refinancing instrument. Financial covenants serve as an instrument to mitigate information asymmetries, as these are reported on a regular basis to the lenders and many financing contracts include mandatory prepayments (see section 5.3.5) in case these financial covenants exceed certain levels. They allow banks to get information on deteriorating economic conditions earlier, as firms are motivated to enter into discussion with the banks prior to such incident.