"The Pulse" -- #124 / Off-Balance Sheet Financing

Recruiting Timeline:

Banking:

Where We’re At:

• SA 2027: PMCF opened its application this week. 2 banks are actively recruiting for SA 2027

• FT 2026: HSBC, Howden, and MUFG opened their apps this week. 65 firms are actively recruiting for FT 2026  

• If you need some interview support or just need a place to vent, check out our Coaching Program: Coaching for banking, consulting, and buyside recruiting | The Pulse. 95%+ of those coached for the summer 2026 recruiting season received offers!

New SA 2027 Applications:

• PMCF: Boutique M&A (SA 2027)

New FT 2026 Applications:

• HSBC: Large, full-service bank (FT 2026)

• Howden: Boutique, insurance-focused advisory (FT 2026)

• MUFG: Large Japanese bank (FT 2026)

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Consulting:

Where We’re At:

• A few application releases this week. As mentioned in previous newsletter editions, most releases going forward will be for smaller firms.

SA 2026 released apps:

• Cicero Group - Associate Consultant Intern (SA 2026)

• Activate Consulting - Summer Analyst (SA 2026)

SA 2027 released apps:

• None

FT 2026 released apps:

• Cicero Group - Associate Consultant (FT 2026)

• Activate Consulting - Business Analyst (FT 2026)

• Alpha Financial Markets Consulting - Strategy & Deals Associate (FT 2026)

• Hidden River Group - Public Sector Strategy & Innovation (FT 2026)

• Vantage Partners - Associate (FT 2026)

Buyside:

Where We’re At:

• SA 2027: Weiss Asset Management opened its resume drop this week. There are currently 7 buyside firms actively recruiting for SA 2027

New SA 2027 released apps:

• Weiss: Multi-strat HF (SA 2027)

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Market Update: 

Off-Balance Sheet Financing

With all of the chatter about the First Brands bankruptcy and the older news about the Tricolor bankruptcy, we find today to be a great day to walk through off-balance sheet financing.

Off-balance sheet financing starts with a quick trip to SPV hell.

SPVs are ‘Special Purpose Vehicles.’ They’re typically created to facilitate off-balance sheet financing or manage a select group of assets. In the case of First Brands, they were creating layers upon layers of SPVs to factor receivables.

-Factoring-

Factoring is a popular form of off-balance sheet financing and involves the sale of receivables at a discount to receive a lump sum of cash today. This can be very helpful for managing working capital.

Imagine you’re a company who needs to pay suppliers in 30 days, but only receive payments from customers after 60 days. This dynamic creates an inherently poor cash conversion cycle because you’re always paying suppliers before receiving funds— which stymies growth. A way to solve this problem is by factoring your receivables (payments due from customers) in order to receive a lump sum of cash today to a). pay suppliers and b). pursue growth initiatives.

Various investors and lenders will typically serve as the factoring counterparty to provide cash in exchange for the receipt of the future stream of income from the factored receivables. As I mentioned, receivables are effectively factored at a discount so that the counterparty can be compensated for fronting the cash.

These investors typically only have recourse against those receivables and do not have a direct claim to the company’s corporate cash flow. Therefore, the company shouldn’t have to consider this factoring activity as corporate-level debt and will opt to place this activity in a separate SPV beneath its operating entity ‘Opco.’

I’ll discuss more about what can go wrong with off-balance sheet financing as well as the recognition of SPVs from an accounting perspective towards the end of the write-up.

Some other popular forms of off-balance sheet financing include asset securitizations and sale-leasebacks.

-Asset Securitizations-

Ahhhhh securitization ahhh 20088 ahhhh GFC. Securitization has a bad connotation because of its relation to the GFC, but securitization itself is one of the greatest financial inventions.

Many financial companies, especially those with “liquid” assets such as mortgage companies, are heavily reliant on securitization markets to efficiently operate their business. These companies originate loans or financial products but do not have a deposit base to rely upon for funding. So, they securitize their loans by bundling them into tranches and selling them to investors. In return, these businesses receive a lump sum of cash to originate more loans and keep the engine running.

Just like factoring, the goal is to speed up your cash conversion cycle and separate asset-level activity from corporate-level activity.

-Sale Leasebacks-

Sale leasebacks are another popular form of off-balance sheet financing where a company literally sells an asset to a counterparty and leases it back to retain the use of the asset. Instead of periodic, large capex needed to recognize the purchase of new equipment, a company could just purchase it, immediately sell it to a third-party, and lease it back over a few months / years to continue using the asset while smoothing out the cash outflows. As a lease payment, there is only an impact to the income statement and the asset is not recorded on the balance sheet.

However, assets eligible for sale leasebacks are often critical equipment. For example, a ferris wheel for a themepark company. The critical nature of this equipment means that this lease deserves greater payment priority than returning capital to shareholders. In that regard, it acts more like a loan because the company will not be able to stand on its own if it is unable to pay its lease.

Sale leaseback structures are different from factoring and securitization because an investor is not selling a future stream of cash flows, instead they’re just selling an asset. The true sale of the asset means that the company does not even need to create an SPV to control the sale leaseback activity. However, the goal of a sale leaseback remains the same: optimize cash flow at the corporate-level.

-Off-BS Financing Accounting Recognition-

Off-BS financing is a double-edged sword. Regulators and maybe some investors want to see companies clearly identify their off-balance sheet financing activities. However, companies don’t recognize this activity to be corporate-level business. Companies want separation of asset and corporate treatment so that investors are not misled to think their company is significantly over-levered when 90% of the debt has $0 of recourse to the corporate entity (the entity they want to issue equity or raise additional financing).

Today, companies need to consolidate all SPVs where they have a). majority voting interest and / or b). are a primary beneficiary of the SPV activity. So, most of the time these SPVs are consolidated and the full picture of a company’s off-balance sheet financing activities are included within their consolidated financial statements.

This can be misleading because investors may wrongfully assume that a company is entitled to the cash flow of billions of dollars of SPV assets or is significantly overlevered due to the consolidation of the SPV liabilities.

-When Off-Balance Sheet Financing Goes Wrong-

Off-balance sheet financing sounds sketchy, but there is nothing wrong with these structures when there is no fraud or misconduct present. As an investor at the corporate-level, you should want your businesses to pursue off-balance sheet financing to optimize corporate-level cash flow and therefore maximize returns to shareholders.

However, the complexity of off-balance sheet financing opens up the doors for fraud and misconduct. A malicious management team can double-pledge collateral within layers of SPVs and intercompany transactions (Tricolor and First Brands). This means that the same $1 of assets is being used to raise multiples of leverage by convincing collateral investors / lenders that they’re the sole entity entitled to the same stream of cash generated by that $1 of assets.

A management team may also be able to bury bad collateral within a bucket of “good” assets to raise preferable financing terms (GFC). In this case, investors underwrote a risk profile of X, but really received the risk profile of Y.

Given the recent events involving off-balance sheet financing, we wanted to shed some light on how these structures work and why companies opt to use them. Most businesses are simply looking to optimize cash flow and do not want to defraud investors. However, fraud is a permanent feature of investing. All you can do is know where to look and what to look for to try and detect it before getting screwed.

Disclosure: Nothing written here is financial advice or should be used for investment decisions.

WACC

Today we are going to discuss the Weighted Average Cost of Capital.

The weighted average cost of capital (WACC) is core to every job that involves valuation. Specifically, you'll be applying a WACC as the discount rate in a DCF. Think of the WACC as more or less a hurdle return rate a company needs to meet when investing in a project.

Calculation: ((cost of debt x (1-tax rate) x % debt in the capital structure)) + (cost of equity x % equity in the capital structure) 

^sounds complicated, just memorize it

Inputs:

-Cost of Debt: interest rate of the debt

-Tax Rate: whatever tax rate impacts the given company. This is applied because interest expense is tax deductible

-% Debt in the Capital Structure: See image above for a visual. It is the proportional amount of debt a company uses to fund its business

-Cost of Equity: risk-free rate + beta x the market risk premium

^will touch more upon this next week

-% of Equity in the Capital Structure: See image above for a visual. It is the proportional amount of equity a company uses to fund its business

Now that we dropped a few equations and definitions, we can move on with our discussion.

We can’t understand WACC without understanding capital structures. A capital structure is essentially the composition of the right side of the balance sheet. A capital structure is a breakdown of the tools (debt and equity) used to fund the purchasing + maintenance of the assets for a business.

Capital structures look very different across different industries. Check out "The Pulse" --#74 / Different Industries, Different Profiles. 

-Different companies within an industry have a similar capital structure, but companies within different industries often have very different capital structures.

So, a WACC is really just a blended average of the costs of the different tools used to finance the assets of a company.

Therefore, it serves as the minimum rate of return a company needs to generate on its investments/projects. WACC is famously used in a DCF as the discount rate applied to the projected cash flows.

A good-looking WACC from my experience is anywhere from 7-15%.

I challenge you, if the corporate tax rate is reduced from 21% → 15%, will WACCs increase or decrease?

Going Forward:

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“The Pulse” #124