Growth Capacity

Businesses that borrow for the first time often follow the same path. The facility is signed, the first few quarters go well, and then a soft quarter arrives. Revenue dips, the covenant headroom narrows, and the finance lead looks for something to cut. Payroll is hard to cut, suppliers have to be paid and debt service is not optional, which leaves growth spending as the one large line nobody is owed: the new machine, the second location, the sales hire. It is deferred, just for a quarter, to protect the covenant. Then it is deferred again.

A year later the business has serviced its debt perfectly and stopped growing. An equity buyer sees a business that stopped growing the day it borrowed, and prices it that way. All the growth value the reinvestment register earned on the third bridge has been given up to the structure.

Growth Capacity prevents this. It redefines debt capacity as the largest debt the cash flow carries while still funding its own growth. It does that by showing a credit committee that the reinvestment plan survives the structure in the downside, and that the documents protect it, so it does not depend on the lender's discretion. It ranks first on the bridge.

Growth funded below debt service

The levered forecast has to fund the reinvestment plan after debt service, in both the base and the downside case, from retained cash or undrawn capacity, with no injection of new equity assumed and no covenant breached by funding it.

That starts with carrying the plan into the levered model as its own line. Growth capital spending and growth working capital come from the reinvestment register, year by year, and sit below debt service and above the covenant tests, where the model shows directly whether the plan survives the structure. Most levered forecasts bury growth spending inside total capital spending, where it looks like any other cost and is the first thing trimmed when the forecast is too tight.

The plan is then run through the downside before any term sheet. In each downside month, the gap between the cash the business keeps after debt service and the cash the plan needs is the amount the facility will have to cover. Because that number is known before any lender is approached, the business can ask for what it needs and does not find out later what it lacks.

Baskets that let the plan run

The loan agreement has to carry a capital spending basket, an acquisition or permitted-investment basket and any carve-outs the plan needs, each sized at or above the matching year of the reinvestment plan and negotiated onto the term sheet before signing. Adding them later by amendment means asking a lender who already has the signature.

A basket is a permission written into the loan agreement. Most senior facilities restrict what the borrower may spend, invest or acquire without the lender's consent, and the baskets set how much is allowed. A business whose baskets are smaller than its plan has to ask permission for every project above a token amount, and a permission that has to be asked for can be refused, delayed or granted at a price.

The work begins by mapping the plan onto the lender's standard covenant schedule, so that each year's growth spending and each planned acquisition is matched to the basket that would govern it and every shortfall is listed before negotiation starts. The baskets are then negotiated as a condition of the term sheet. The comparison of competing term sheets puts basket size beside price, and a lender whose baskets cannot hold the plan scores below one whose rate is higher. Finally, counsel checks the baskets in the executed documents against the plan and files a one-line finding per basket with the debt schedule, so a basket that shrank between term sheet and signing is caught before closing. With the baskets in place, the plan can be executed without the lender's consent, and growth becomes a right under the documents.

A line for the bad months

The facility also needs an undrawn line, an accordion or a committed line, sized to the largest cumulative gap between the reinvestment plan and retained cash in the downside. Every condition to drawing it has to be met in the downside forecast in the month the draw is needed, the commitment fee has to be paid, and the line must not have expired.

The line is sized from the downside funding gap with a margin for timing, never from a round number, and the model page that produces the figure goes into the lender pack. Every condition on drawing it, leverage, coverage and no default, is tested in the downside forecast in the month the draw would be needed, because the business will need the money in exactly the month those conditions are hardest to meet. A condition that would fail in the downside is renegotiated before signing. And the line is kept alive. The commitment fee is a budget line, the expiry date sits on the maturity ladder, and renewal starts on the same early schedule as every other maturity. With the money committed before the downside arrives, a downside does not stop the plan.

Growth that actually continued

The last requirement turns the claim into a record. For every year since the facility closed, the reinvestment register should show growth spending at or above plan, no project deferred or cancelled to protect a covenant or a distribution, and a return on reinvested capital still above the cost of capital.

Three habits keep it true. Plan against actual reinvestment is a page in every monthly lender pack, so a shortfall is visible to the lender and the board in the month it starts. Deferring a growth project is a board decision with a written reason and a date for it to resume, so the finance seat cannot quietly let a project slip to pass a covenant test. And every project's scheduled measurements continue after the facility closes, so the return reported is the return earned under the debt and not the one from before it.

That record is what removes the buyer's discount for growth. The buyer no longer has to take on trust that growth survives leverage, because the register shows it did.

What it does to value

Growth Capacity ranks first on the bridge because it is the only driver here that moves growth. Its value is the reinvestment the structure lets the plan keep in a soft quarter, multiplied by the spread of the register's return on new capital over the cost of capital, for each year of the advantage period, discounted and carried to the owners through the debt schedule. A plan the structure would force the business to cut is worth nothing at this anchor.

That spread compounds, which is why the driver outranks the tax shield. The shield is a fixed sum, earned once. Growth at a return above the cost of capital keeps adding value for as long as the advantage lasts. The driver is also cheap, since the baskets and the undrawn line are negotiated into documents the business is signing anyway. The seat paid for it is the owner's, jointly with the finance lead, against reinvestment at plan with the register's return above the cost of capital, and it is paid more for exceeding the plan only where the return still clears the cost of capital.

What has to be in place first

Four things come first. The reinvestment register and its return, inspected at the start of the bridge, matter because the plan this driver protects is the register's forward view. The levered forecast with its downside, from Levered Forecast, is where the funding gap, the drawing conditions and the basket sizes are all read from. Competing term sheets, from Facility Sizing, are needed because baskets and an undrawn line are negotiated, and negotiation needs more than one lender at the table. And counsel has to be briefed on the reinvestment plan before the term sheet, because a basket is a legal term and counsel has to know what the plan needs before reading the lender's draft.

Knowing that it works

The line has to cover the largest cumulative downside funding gap, in dollars, so that gap is recomputed each quarter. Basket headroom against the plan, per basket and per year, should never fall below zero. Reinvestment is tracked against plan since closing, year to date and cumulative, and the return on reinvested capital in the levered period is set against the cost of capital.

An owner who knows where the plan is tight can name the basket it hits first, in which year and by how much, without opening the loan agreement. They can also name the downside month in which the growth line would be drawn, and the condition most likely to block the draw, before a credit committee asks. And they should be able to explain the last deferred growth project from the register, with its reason, its board minute and its date for resuming.

Why it slips, and what holds it

Growth spending becomes the first line cut to protect a covenant. The undrawn growth line lapses, or is drawn for something other than growth. Or a basket is amended down at renewal in exchange for a lower rate.

Each has its safeguard. Reinvestment against plan is a standing page in the lender pack and the board pack, so a cut shows in both packs in the month it happens, and the board has to give a reason. The growth line's expiry sits on the maturity ladder with its own renewal date, and any draw for a purpose other than a registered growth project needs the same board minute as a deferral. And at every renewal and refinancing, the comparison that scored baskets at the first facility is run again with basket size beside price, so a lender offering a lower rate for a smaller basket is scored, not simply accepted.