Harbourline Foods: Financing a Capacity Expansion
Harbourline Foods is a family-owned UK chilled-food manufacturer with annual revenue of £42m and EBITDA of £5.6m. It wants to build a second production line costing £14m to serve a new supermarket contract worth £9m of annual revenue at a 6% operating margin. Existing debt is a £6m term loan at 7.5% (two years remaining) and a £3m revolving credit facility drawn to £2.4m. Net debt/EBITDA is currently 1.5x; the bank's covenant ceiling is 2.5x. The owners hold 100% of the equity and are reluctant to dilute, but the company has only £1.1m of cash. The new line would take 14 months to commission, and the supermarket contract begins in 10 months. The finance director proposes funding the project entirely with a new five-year amortising loan at 8.25%.
1. Assess whether the proposed debt funding is prudent, quantifying the covenant headroom and the timing risk.
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Headroom calculation. Current net debt is £6.0m + £2.4m − £1.1m = £7.3m, so net debt/EBITDA is 7.3/5.6 = 1.30x, not the stated 1.5x - the FD should confirm which definition the covenant uses. Adding £14m of debt gives net debt of £21.3m. EBITDA only rises once the new line runs, so on day one the ratio is 21.3/5.6 = 3.80x, far above the 2.5x ceiling. Even if the full £9m contract converted at 6% margin (only £0.54m EBITDA), the ratio would be 21.3/6.14 = 3.47x. The proposal breaches the covenant on drawdown.
Timing risk. The line commissions in 14 months but the contract starts in 10, so four months of revenue depend on existing capacity or penalty-bearing late delivery. Debt service begins immediately while cash inflows lag, worsening liquidity.
Conclusion. Full debt funding is imprudent. A blended structure - perhaps £6–7m debt (keeping the ratio near 2.4x once partial EBITDA arrives), £4m equity from a minority investor, and staged capex tied to commissioning milestones - better matches risk to funding. The FD should also negotiate a covenant reset or an equity cure before drawdown.
2. Recommend an appropriate financing mix and justify it against the owners' objectives and the company's risk profile.
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Objectives. The family wants control; the bank wants covenant compliance; the supermarket wants delivery certainty. These conflict, so the mix must trade dilution against financial risk.
Recommended mix. (1) £5m term loan at 8.25% over seven years with a two-year capital repayment holiday - keeps net debt/EBITDA at (7.3+5)/5.6 = 2.20x, inside the 2.5x ceiling. (2) £4m minority equity from a growth investor for, say, 20–25%, preserving family control while funding the gap. (3) £3m asset finance/lease on the production line itself, secured against the equipment, which lenders price more cheaply because the asset is recoverable. (4) £1.1m cash plus a £1m overdraft extension for working capital during ramp-up. Total £14.1m.
Justification. This keeps the covenant intact, spreads repayment across the revenue ramp, and limits dilution to a level the family can accept. Leasing matches asset life to funding life. The overdraft covers the four-month commissioning gap. Alternatives - a rights issue (too much dilution), mezzanine (expensive at 12–14%), or supplier credit (unsustainable) - are inferior. The plan should include a covenant headroom report to the bank and a contingency if the contract slips.