Case 066Private credit and direct lendingWarm up

Case interview: a fast-growing pet food company asks for a loan that takes leverage to 3.0x EBITDA. Is it a good business to lend to, and what would you check first?

The situation

Kivrani Pet Foods makes dry and wet food for dogs and cats, sold through pet shops, supermarkets and online. Revenue has grown 18% a year for four years to Rs 300 crore, with an EBITDA margin of 16%, so EBITDA is Rs 48 crore. It has no debt today.

The founders want to borrow Rs 144 crore, 3.0x EBITDA, at about 11%, to buy out an early investor. Capex is about 3% of revenue, depreciation Rs 6 crore, tax 25%, and working capital runs at about 15% of each extra rupee of revenue. You have 30 minutes with an associate.

Your task

Would you lend, and what are the first things you would check before saying yes?

Quick check

Kivrani grows 18% a year. What does that growth do to the cash available to service the loan this year?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Kivrani is lendable at 3.0x if its demand is as stable as it looks, but the cushion is thin: interest cover is 3.03x and free cash flow only about Rs 8.5 crore a year, because growth ties up working capital. Check first customer concentration, gross margin against input costs, and whether growth converts to cash. If those pass, lend with amortisation and a leverage covenant.

Step 1What three questions decide a quick lend or pass?

Before lending money to a friend, you ask three things without thinking: is their income steady, is it enough to pay you and still live, and what happens if they lose a chunk of it? A credit screen asks the same three things of a business: stability of cash flow, coverage of the debt, and the downside. Kivrani's numbers: EBITDA of Rs 48 crore, debt of Rs 144 crore, interest of about Rs 15.8 crore, cover of 3.03x. That is a normal level for a stable consumer business and a stretched one for anything cyclical, which is why the stability question comes first.

A quick lend or pass rests on stability, coverage and downside1 Is the cash flow stable?Pet food: repeat, non-discretionary purchaseGrowth 18% a yearCheck: top customers,input costs, channel mixProbably,if not concentrated2 Is it enough?EBITDA 48, debt 144 (3.0x)Interest 15.8: cover 3.03xFree cash flow 8.5 a yearGrowth eats 8.1 ofworking capitalThin,because growth eats cash3 What if it falls?EBITDA down 25% to 36Leverage 4.0x, cover 2.27xFree cash flow 5.4Slower growth releasesworking capitalSurvives,with no room leftLend at 3.0x only if check 1 passes: stable demand is what makes a thin cushion acceptable.
Kivrani passes the stability test if its customers and input costs check out, covers interest 3.03x but generates only about Rs 8.5 crore of free cash flow because growth consumes working capital, and in a 25% EBITDA downturn reaches 4.0x with cover of 2.27x.
Step 2Why is free cash flow so small for a business growing this fast?

Start from EBITDA of Rs 48 crore, take off interest of 15.8, tax of 6.5 and capex of 9, and you have about Rs 16.6 crore. Then growth takes its share: Rs 54 crore of extra sales at 15% working capital ties up about Rs 8.1 crore, leaving about Rs 8.5 crore to repay debt. Fast growth is good for the equity and neutral to slightly negative for the lender's cash in any one year. The useful twist for the downside case: if growth slows to 5%, the working capital need drops to about Rs 2.25 crore, which cushions the fall in profit, so free cash flow falls only to about Rs 5.4 crore even with EBITDA down a quarter.

Step 3What would you check first, and why those?

Pick checks that could each turn the answer, and say why. First, customer concentration: if one supermarket chain or online platform buys a third of the output, the stable-demand story rests on one contract. Second, gross margin against input costs: pet food is made from meat meal, grains and oils, whose prices move, and a margin that has never been tested by an input spike may not hold. Third, cash conversion: are receivables days rising as Kivrani pushes into new channels, which would mean the growth is being bought with credit? Fourth, the use of proceeds: the loan buys out an investor, so it adds no EBITDA, and the lender should see the founders' own stake after the deal.

The view to give: yes, subject to the checks, with a structure that protects a thin cushion. Amortise part of the loan, set a leverage covenant around 3.75x with a step-down, and ask for a cash sweep once growth slows. If the first check fails, the right answer is a smaller loan, perhaps 2.0x, not a higher price.

Where candidates lose it

The common miss is being impressed by 18% growth and a 16% margin and forgetting that growth consumes working capital. The lender is paid from cash, not from growth rates.

The other is listing twenty diligence items. An interviewer wants the two or three that could change the answer, each with the reason it could.

What the interviewer asks next

  • The top customer is 35% of revenue. What does that change in the structure?
  • Would you rather lend to Kivrani or to a slower-growing competitor with the same EBITDA?
  • How would you size the loan if the founders wanted it to fund a new plant instead?

Company names and figures are illustrative.