Smart Financing Strategies for Government Contractors

By Jed Fochtman, Capital Advisory Corporation

Access to the right type of financing for operations and contracts will play an increasingly important role in the future for tomorrow's government contractors. Government contractors face unique challenges in today's marketplace with the federal budget tightening and increased competition on existing contracts. Larger federal government contractors need to acquire smaller contractors to enable them to increase revenues. Smaller government contractors need to innovate by developing new products and services at lower costs to remain competitive.

In this article, we'll discuss smart ideas that you should consider.

First, a federal government contractor should to take a financial inventory of their existing assets and liabilities. Start with a detailed review of the existing assets, including cash, accounts receivables, inventory, equipment, real estate, intellectual property and other corporate assets. Next, review the present debt including supplier credit, bank lines, term debt, officer loans and any other debt. Consider the importance of these assets and liabilities as they relate to the present and future corporate mission and the core business.

Refinancing debt at today's low interest rates may be advantageous. Sell any assets that are underutilized or arrange a sale and leaseback on equipment or real estate to right size the balance sheet and streamline the company financial statements to reflect the future management goals. This review process will enable the company to be best positioned to grow and support new acquisitions as well as improve the balance sheet presentation and profitability. The overall financial leverage, asset vs. liabilities and the available working capital, current assets vs. current liabilities are balance sheet presentation issues that can be improved with the proper financial engineering.

In addition to refinancing existing debt, there are a number of financial remedies and solutions to consider. Proper cash management includes maximizing the interest income on savings and operating accounts. Alternatives available to improve the returns on idle cash, include money market accounts, laddering CD's and interest bearing deposit accounts from traditional banks, credit unions and investment banks.

Some government contractors may consider establishing a separate entity to hold corporate assets and renting them to the operating company. By transferring existing assets to a separate accounting entity to own assets like equipment, intellectual property or real estate, the contractor will reduce balance sheet leverage and allow for additional flexibility with the future potential sale of the company. This technique will enable the company to be best positioned to grow and support new acquisitions as well as improve the balance sheet presentation, profitability and tax planning ability.

Traditional bank financing for working capital needs may be sufficient in some cases. Typical bank financing terms include loan covenants restricting leverage, additional debt and regarding profit ratios. As an alternative, asset based lending is available which may allow access to more working capital than banks allow and without restrictive loan covenants. Asset based lenders can leverage unbilled contract expenses as well as billed accounts receivables resulting in a loan advance rate approaching twice the available amount that a bank may offer.

Credit insurance can be secured to reduce the credit risk and account concentration risk with US and International accounts receivables. Independent insurance companies and the Export Import Bank offer a variety of credit insurance options.

Equipment leasing should be considered when purchasing equipment and computer software. Normally, equipment leasing provides for financing of up to 100% of the cost of the assets, thus conserving cash for the contractor and allowing for the assets to be paid for over time and as they earn income. An operating lease or off balance sheet financing can be used to minimize financial leverage. Software acquisitions for operating and application software can be leased as well. This is accomplished by financing the license rights to the software over a period of time.

If you are considering an acquisition of another company or in need of financing to buyout an existing shareholder(s), than there are several options available to finance the transaction. Sources of capital to be considered are asset based lenders which provide more working capital than traditional banks. Mezzanine debt can be arranged which is primarily based upon the cash flow of the company and not the assets. Mezzanine debt takes a second lien position on the existing assets leaving the senior lender in control with a first lien position on corporate assets, although an inter-creditor agreement is required. These financing alternatives may be more attractive than diluting the ownership interests of existing shareholders with additional equity.

Lastly, corporate financial planning and the right lending products are critical to success and should involve your attorney, banker, CPA and investment banker.

Jed Fochtman is the president of Capital Advisors Corporation which develops strategic financial plans and secures various required types of financing to implement financial plans for fast growing middle market businesses, including government contractors. He can be reached at jed@capitaladvisorscorp.com.