A Latin American company produces and distributes green household cleaning products. Investors have funded the company with a convertible loan that is repaid monthly through a percentage of revenues as opposed to fixed interest payments, allowing the company more flexibility for growth than with traditional debt.
The company had limited sales and marginal EBITDA, which made valuation challenging, so the investor designed a tailored senior convertible loan that would be paid back through an escalating percentage of sales.
Target IRR: 20-25%
Type of investment: Senior convertible loan to a non-US-based enterprise
Investor: An impact investment fund focused on supporting the early growth of social and environmental companies in Latin America. It invests in a wide range of sectors, such as education, sustainable consumer products, health, housing, organics and clean energy. It seeks to tailor its transaction structures to the needs of each portfolio company.
Company: A producer and distributor of 100% non-toxic and biodegradable household cleaning products. Company is generating revenues and is cash flow positive.
Revenue-based loan: The company’s total loan obligation is fixed, and repayments are determined as a share of revenue, escalating over time until the entire obligation is repaid.
Conversion option for investors, at investor discretion: The loan may convert into equity at a pre-determined multiple of trailing revenue or EBITDA, at the discretion of investors.
Investment amount: The investment was broken down into two tranches: (1) US$300k immediately, and (2) US$150k after 12 months, contingent on reaching predefined operating and financial milestones.
Repayment timeline: The target term is 5 years, with an 18-month grace period for both principal and interest.
Revenue share rate and repayment cap: After the grace period, the company pays an initial 3% to a maximum of 9% of revenues (escalating over 3.5 years) until the investor receives a total of 2.3x its original investment.
Conversion option: Convertibility provision allows the investor to convert into equity at its own discretion and at a valuation equal to the higher of 1x TTM sales or 5x TTM EBITDA. At the time of conversion, the investor can only convert the balance of the total obligation still owed calculated at 2.3x the total loan provided, less any loan repayments made up to that date. Conversion is only allowed after an initial 18-month lock up period.
Governance: The investor assumes one Board seat and has veto right over a number of pre-defined “Major Decisions”, including new share issuance, new debt issuance, CAPEX and budget decisions.
Tax considerations: The local tax regime does not have any special treatment for flexible debt schedules, so not a concern for the issuer in this case. For a U.S. lender, “original issue discount” tax implications could be significant given the grace period, variable nature of payments, and lack of”original issue discount” reporting by the company.
More detailed deal rationale and context:
- Company has to be close to profitable or already profitable, so that it can service debt at a % of revenue after about 12-18 months.
- Margins need to be strong, if investors are to take up to 9% of revenues by year 5.
- Company should not have significant prior debt.
- Company should not expect to have a large need for additional equity/debt requirements during the term of the investment.
- Structure appealed to investor over equity because it would allow the company to grow and thrive over the longer term without needing to be acquired in the short to medium term to provide a liquidity event, for two reasons: (1) It was not obvious that the company would appeal to a strategic buyer within the life of the fund, and (2) The investor was concerned that sale to a strategic buyer could compromise its mission.
- The structure also appealed to the company because the founders liked its equity-like alignment of incentives (the faster the company grows, the higher the IRR for the investor), however they got to retain more ownership than they would have under an equity deal and the investor’s returns are capped.
- Local business environment: local founders are often comfortable with the idea of building a company for the long-term, with potential generational succession plan. Therefore, the idea that they wouldn’t be acquired in the next 5-7 years was not off-putting.