The consistent surge in economic and business risk over the past two years has largely normalized uncertainty, but it has also inspired ingenuity. Organizations that are surviving and thriving are consistently analyzing ways to mitigate risks while focusing on growth by exploring innovative capital restructuring solutions to strengthen their financial foundations.
When it comes to financial risk, companies today face the following challenges, among others:
- Tax increases
- Steep inflation
- Higher interest rates
- Shareholder uncertainty
- Political risk
- Accounts receivable bottlenecks
All these factors have elicited proactive and creative financial rebalancing to hedge against new risks and safeguard capital.
4 approaches to post-pandemic capital restructuring
Here are four of the most significant solutions we’ve seen in working with clients who are seeking to minimize financial risk during these tumultuous times.
1. Fine-tuning credit terms
Access to credit remains a significant factor. Companies are choosing to fine-tune their capital structure by testing the flexibility of credit terms and reassessing their credit options. Some are even choosing to issue high-yield bonds and swap derivative bonds to fixed-rate ones to lock in lower rates.
2. Reducing reliance on debt
In 2020, many businesses that were overly leveraged didn’t survive. Companies are now looking to rebalance their debt-to-equity ratio as a result. This strategy seeks to reduce potential “risk creep” from debt, as well as to increase the likelihood of sustainability through volatile periods.
“We have learned that having a balanced capital structure is really important in the ever-increasingly uncertain world that we live in,” says Jim Pirouz, head of Capital Markets at Truist Securities. “It’s essential to have the right mix of debt and equity in one’s capital structure to survive the threat of another potentially severe outbreak of a COVID-19 variant or some other unforeseen event that causes the economy to set back.”
3. Hedging (aggressively) against inflation
There are a few strategies being used today to protect capital from the steep inflation increase.
First, businesses are aggressively locking in equity gains to current rates to offset the capital gains tax.
Others are delving into derivatives during the financial rebalancing process to protect the cost of capital. Since rising interest rates and inflation are likely to cause further volatility, how companies prepare for inflation today will have long-term effects on capital preservation.
Finally, organizations are also choosing to purchase excess inventory to hedge against short-term increased costs and further supply chain disruption.
4. Improving risk coverage
“Companies today are paying more attention to how their insurance programs are constructed,” says Steve Aldrich, managing director at McGriff*. “Now they closely read the exclusions in their policies. Some are reducing their deductibles, so they’ll pay less if they need to file a claim, thus preserving capital for an uninsured loss. Others are increasing their liability limits.”
They’re also thinking of risk more comprehensively. For example, what are the risks of a labor shortage? Are there greater safety concerns on the factory floor, for example, if there are fewer workers and/or if the workers have less training due to high job turnover? What cybersecurity concerns may have been magnified by the increase in e-commerce?
One approach that’s gaining popularity is creating a self-insurance reserve or forming a captive insurance company to cover “uninsurable” risks. “Senior management knows that the next unknown is out there,” says Aldrich. “They don’t know what it is, but they’ve become aware that there are a lot of risks for which traditional insurance won’t respond.” A comprehensive risk assessment to identify, quantify, and address risk should be a priority.
Capital preservation promotes a sustainable strategy
Capital restructuring provides value beyond the initial capital preservation and financial risk management, especially during periods of uncertainty. Through risk mitigation, companies can leverage access to capital to fund growth and expansion, even as other organizations are struggling to stay afloat.
At the end of the day, a resilient financial foundation provides the best insurance for meeting business objectives and mitigating as many risks as possible.
* McGriff Insurance Services, Inc.