Do you have access to the capital you need to act on opportunities to expand your business?
Suppose you want to step up production to increase your company’s market share. Or perhaps you’d like to extend your business to new markets. Maybe you’ve set your sights on a strategic acquisition. Whatever the case may be, you’ll need funding to make it happen.
Make sure you understand all your financing options before putting your plans on hold. You might be surprised by how much capital is available, from cash on hand to debt financing or even equity infusion from investors.
Each source of funding has its own unique advantages, disadvantages, and requirements. Debt financing and equity infusion alone have very different effects on your balance sheet, earnings, cash flow, and taxes.
If you want to design an appropriate capital structure for your company, start with these fundamental questions:
- What’s your growth strategy—organic or acquisition?
- What are your liquidity needs?
- Do you have cash flow issues (inflated accounts receivable, seasonal fluctuations)?
- What’s your current ownership structure and succession strategy?
- Are you willing to trade equity for capital?
Outlining your capital strategy will also shed some light on your ambitions.
If you’ve got a fully committed balance sheet, your capacity for additional acquisitions will be limited. Your willingness or reluctance to relinquish ownership of your business will determine if an equity solution can be used for additional capital beyond your capacity for debt financing.
Competitive cost of capital
Designing an optimal capital structure will ensure your business has sufficient liquidity for continued growth. Start by making sure your company is using available capital efficiently, then work on balancing your mix between debt and equity financing.
Your company’s value is driven by your ability to invest capital in ways that earn returns greater than the cost of that capital. In other words, you’ll want your return on invested capital (ROIC) to exceed your weighted average cost of capital (WACC). The more you invest and grow capital at positive rates of return, the more valuable your business becomes.
Optimizing capital structure helps achieve a competitive cost of capital and greater capital efficiency, leading to an improved ROIC. It’ll require a detailed analysis of your future cash flows based on projections of your investment needs, dividend policy, and debt or equity structuring.
Trading equity for capital
An equity investor can be an important catalyst for your company’s growth, providing experience, insight, valuable connections, and capital. Equity investors take on added risk—unlike lenders, they don’t have any collateral as security—and their returns are generally secondary to lenders’ claims. So, investors usually seek returns on equity investments that are much higher than interest rates paid on bank loans. An equity investor may also demand hands-on involvement in your day-to-day business operations.
If you’re using equity as your source of capital, factor in all the costs—from financial to managerial—and be sure to clearly define roles and expectations with your investors.
Advantages of debt financing
Debt financing almost always costs less than equity financing, especially when interest rates are low. If your business has a well-documented track record of profitability and expansion, a loan may be your best option for growth capital.
Debt financing can present opportunities for equity investment by demonstrating your lender’s confidence in your company’s ability to satisfy financial obligations. Before investing in your business, venture capital and private equity firms want to see a certain amount of debt financing and additional access to capital, which allows equity providers to leverage their own returns by accelerating your company’s growth.
Truist recently structured a $76.5 million senior credit facility; coupled with a $36.5 million swap to better manage future interest rate risks, for a young growth-oriented company that develops, acquires, and manages ambulatory surgical centers. Due to active involvement in the company’s business plans, Truist understood this financing was a prerequisite for that company to receive an additional $35 million in capital investment from two private equity firms. Debt financing accelerated the company’s growth expectations by several years.