Managing Debt Versus High Interest Rates
By Victor S. Parra, Contributor
Running a private motorcoach company is a capital-intensive business. Balancing the need to upgrade your equipment to meet customer demands against high interest rates while still keeping debt under control, is always a major challenge for our industry.
Recently, the Wall Street Journal ran a front-page piece entitled, “Bankruptcies Increase for Small Companies.” It blames this development on high interest rates, tighter lending standards and higher operating costs…all factors that severely affect our industry. Plus, it doesn’t seem the Federal Reserve is ready to lower interest rates any time soon. This is largely because the current inflation rate is running 3.7%, above the Fed’s target of 2%. That leaves the current benchmark short-term rate at 5.25% to 5.5%, a 22-year high! In addition, this limits the option of refinancing debt since you’re likely carrying a better interest rate than what’s currently available.
Some Good News!
This past year has produced record revenues and profits for most in the private bus industry. In fact, it looks like many businesses are returning to pre-pandemic levels. The demand for motorcoach transportation is exceeding the industry’s capacity to service this unprecedented growth. Albeit, much of this is due to the fact there are more than 50% fewer registered private bus companies today than before COVID so dramatically devastated our industry. Nevertheless, the private bus industry has not seen this level of demand since the advent of de-regulation in the early 1980s.
What Is Debt-To-Equity, And Why Is It So Important?
Simply put, it’s the financial ratio indicating the relative portion of equity used to finance a company’s assets, total liabilities/total equity. This information can be found on your balance sheet. Fundamentally, this is the percentage of investment in a business that comes from your creditors — banks, finance companies, and other types of lenders — versus your own equity you may have in the company.
The lower the ratio (ideally less than 1 to 1) the stronger financial position your company has. This gives you better leverage in negotiating more advantageous interest rates when borrowing money. Conversely, if your debt-to-equity ratio runs above say 5 to 1, your business is in a more volatile position (at greater risk) and susceptible to creditor control. Moreover, long-term debt carries more risk than short-term obligations. Not a position you want to be in!
Data received from all Spader 20 Group members showed improved debt-to-equity ratios were most common among smaller operators when ranked by annual revenue. The group of operators with annual total revenue up to $7 million averaged 2.1/1 compared to 4.1/1 when comparing YTD August 2023 to YTD August 2022. The group of operators with annual total revenue of $7 million and above showed no change at 0.8/1 during the same period. Plus, Spader reported that overall, the industry went from 2.4/1 year-to-date August 2022 down to 1.5/1 year-to-date 2023. This means the industry overall is taking advantage of higher customer demand to bring debt in line with equity.
You’re most likely thinking you have a lot of cash on hand and are better prepared should a COVID-like tragedy strike again and motorcoach travel slows or comes to a screeching halt as it did in 2020. On top of that, you’re probably carrying a lower interest rate which you secured before interest rates started to rise over the past two years. On the surface, a 5/1 debt-to-equity ratio may appear more palatable. So, it doesn’t feel like having high debt is really a problem. Not so!
But there’s another important reason to keep your debt under control, especially if you’re thinking about selling your business. Buyers — private equity groups and other strategic buyers (i.e., other bus companies) — typically do not buy debt!
Corporate Finance Associates have seen some companies back away from selling their businesses to willing and financially able buyers because their debt loads cut so deeply into the selling price of those companies; and some companies cannot sell their businesses at all, because the debt exceeds the cash received for those companies (better known as the sales price). Debt needs to be satisfied, or at least in line with your equity position, before the sale is completed. Debt reduces dollar-for-dollar what you put in your pocket after the sale.
(Author’s caveat: Debt-to-equity ratio is not the only important metric against which you measure the management of your business, but it should be near the top of your watchlist!)
What Do You Do If Your Debt Is Still High?
First, target paying down your debt each month. Plan and set goals. Dedicate an amount over and above your monthly debt payments to accelerate your debt reduction. If you’ve been to a restaurant lately, you’ll notice either on the menu and/or on your bill, a surcharge over and above the cost of your meal to help cover costs incurred during the pandemic. Many businesses are doing this because everyone experienced the pain of the pandemic. I’m not suggesting you broadcast the surcharge on your invoices, but at least account for it in your pricing.
Lastly, don’t cheat! Don’t say, “Oh, I’ll skip this month and make it up next month.” You won’t. Remain disciplined to applying the income from this surcharge to paying down your debt each month. What I’m suggesting can be hard, especially during lean months. But you’ll feel and sleep better knowing that albatross hanging around your neck is getting smaller and easier to carry around.
If you’d like to discuss this issue further, feel free to reach out to me at email@example.com. I wish you the best as you continue the battle of maintaining a financially healthy business!
Victor S. Parra is a retired President and CEO of the United Motorcoach Association (UMA) and currently is Managing Director of Strategic-Focus Advisors, LLC, a consulting firm that works with Corporate Finance Associates (CFA) — a 60+ year old investment bank, providing M&A guidance in the transportation space. Concentration is in the middle market.