Want to maximize the value of your business? One of the best ways to start is by taking a look at your capital efficiency.
Ensuring you have the right capital mix (or the right ratio of debt to equity) will help you maintain an appropriate level of debt that enables you to meet your financial goals.
What is capital restructuring?
Capital restructuring balances your debt-to-equity mix by adding, retiring, or reissuing debt to reach an ideal range. What’s an ideal range? That depends on several factors, such as the size of your company, your industry, your capital expenditure and labor costs (or capital intensity), and your cash flow.
This is one reason why talking to your Truist relationship manager regularly—throughout the lifecycle of your business—can be helpful. As your circumstances change, your relationship manager can be proactive about helping you analyze your debt-to-equity ratio and reset your financial foundation quickly.
Why your debt-to-equity ratio matters
If your debt-to-equity ratio is at the low end of your ideal range (too much equity), you’re relying too much on equity holders (shareholders), who expect a higher rate of return than lenders. Your company could also miss out on debt tax advantages.
If you’re at the high end of your ideal range (too much debt), you’ve lowered your capital costs, but you’ll have little room to adapt if the economy fluctuates or your business goes through a downturn. You may want to consider lowering your debt and the accompanying risk of repayment.
The benefits of capital restructuring
- Restructuring capital can help you manage risks, including interest rate risk.
- Caps, collars, and swaps of floating rates for fixed securities can reduce your exposure to rate changes.
- If you’re thinking about selling your business or transitioning, a debt-to-equity ratio that’s close to your ideal range will make your company more attractive to investors or buyers.
When to consider capital restructuring
The best time to restructure your capital is when interest rates are low. Doing so can lower debt costs and repayment risk while freeing up capital to fund growth.
Capital restructuring can benefit your business in many scenarios, such as when you’re:
- Looking to expand. If you have unused debt capacity, you can use financing to find the cash you need to expand your operations and put capital to work generating returns.
- Planning to transition in the next 5 years. With dividend recapitalization, you can get additional liquidity from your business. You can use dividend payments as debt to pay retiring owners or exiting investors. An employee stock option plan (ESOP) uses a similar mechanism to secure debt to fund owner liquidity.
- Looking to stabilize your financial structure. To retire excess debt, consider low interest loans to reduce cash flow demands and help your bottom line.
- Applying for a Small Business Administration (SBA) loan. Restructure your company’s ownership with an SBA 7(a) loan to finance goodwill. SBA loans offer favorable down payments and rates.
- Looking to buy back equity. If you’re a stable company, you can use debt financing to repurchase equity sold during a growth phase.
Knowing that capital restructuring is a good fit for your business isn’t the same as knowing how to go about it, and there are more than a few approaches. Restructuring debt, equity, assets, and dividends—and engaging in mergers and acquisitions—are just a few ways to go about the process.
Two types of capital restructuring
The individual circumstances of your business will determine which method works best for you. But here are two that are frequently used (and why):
- Rationalizing leverage. Refinance existing loans or obtain new ones using real estate, equipment, and receivables—or, in select cases, future cash flows—as security. Free up funds for growth by refinancing to lower-cost capital sources.
- Equity buyback. Swap equity for debt by purchasing your company’s previously issued stock with debt financing. You’ll boost your return on equity while shifting to low-cost and tax-deductible debt.
Rationalizing leverage may seem more appealing at first. But the amount—or quality—of real estate or equipment you can bring forward to refinance may make the terms of the second approach more advantageous.
The most important thing to remember is that capital restructuring can be a useful tool for building and strengthening your business—now and in the future. When you’re ready, we’ll be here to help put it to work.