Types of Debt and Capital Structuring for Businesses

Accessing Finance: The Foundation

An important driver of production is accessibility to liquidity and inventory. Even if your business is sufficiently profitable, accessing leverage to fuel growth is essential for capturing market share. As part of your planning, you should have an established understanding of ROIC (Return on Invested Capital) for your operations, including insights into your working capital forecasts.

Effective leverage starts with de-risking through business intelligence. This means creating a financial model that reflects your business processes at a micro level and gaining insights into your key drivers. As a rule, you should only leverage when the interest rate (including application fees) is lower than your return based on what you deploy that invested capital on.

Correctly structuring your balance sheet and controlling your cash flow reduces operational risks while increasing returns. As a rule, always keep the debt and only reconsolidate if a better interest rate is offered.

Trade Finance

Trade finance for businesses has two forms, and most operators are not utilizing these to their full potential.

For Your Clients

A financing partner can assist in pre-qualifying your inventory as collateral while fast-tracking payments from your customers. They can provision letters of credit and more. Having a close partnership with a financing provider helps deliver a superior customer experience. Ease of purchase is essential in capturing demand.

This differs from Working Cash Flow Facilities (WCF) as it is discounted on purchase orders you receive.

For Yourself

A financing partner helps set up payment assurance and other arrangements necessary for your supplier to provide goods. This streamlines supply chain and removes associated risks. Even without active use, having trade financing pre-approval on standard inventory, including international orders, significantly de-risks your cash flow and liquidity.

Reverse Factoring for Your Suppliers

Supply chain finance includes offering a reverse factoring facility to your suppliers. If you use standard payment terms, having your financial partners work with both your customers and suppliers is essential. Offering suppliers immediate access to liquidity based on your purchase orders supports their businesses and allows them to serve you better.

Line of Credit

A credit facility where you can draw at any time. Setting it up typically involves a fee. Having access to a line of credit enables quick access to debt without restriction, though you allocate some collateral and usually pay a fixed facility fee (often charged monthly).

Every business should have this facility to cover unexpected expenses. However, how much you should get is equally important. You should draw upon the credit facility in full to reduce the weighted average cost due to fixed facility fees. This means scheduling future expenses and drawdowns along with planned asset expansion.

Using line of credit to finance assets with turnaround times of less than 6 months works well in structuring.

Equipment, Inventory and Asset Collateral

While traditionally lines of credit are collateralized against guarantees such as property or the business itself, you can also use equipment and inventory to unlock 30% to 40% of their post-depreciation value for leverage. This allows better positioning of your debt structure.

Acquisition Finance

Effectively documenting SOPs and business processes enables synergetic planning. An effective growth strategy is acquisition, where you acquire customers, processes, or assets from another business. Financing this requires financial modelling and definitive synergies to define the strategic takeover.

As a rule, leveraging is better than self-financing, provided you efficiently allocate resources. Acquisition finance can be unlocked before acquisition based on a term sheet contingent on your current operations.

Sometimes you acquire vertically or acquire a business with net zero or negative ROIC. For this, you need to strategize your acquisition based on supporting cash flow to cover the interest from existing operations.

Working Cash Flow Facility / Discounted Cash Flow

Here you put your debtor book as collateral, where purchase orders are discounted to often 80% of their value for your drawdown allowance. This is similar to reverse factoring, but instead of your customers providing this facility, you provide yourself with this option at a fixed line of credit limited to a certain percentage.

Every business should have this facility as it unlocks fast-moving liquidity. As good practice, cover your operational expenses from this while using revenues and profits to finance process improvement, asset acquisition, and expansion.

Asset Finance

Asset finance covers equipment and other assets, including technology. Usually, the asset you acquire serves as collateral, similar to a car loan, but collateral is restricted to 40% to 60% depending on type.

Reasons to use asset finance include replacing depreciated equipment, buying new equipment to increase production, adding equipment to reduce production costs, or vertically integrating the supply chain. Strategically plan depreciation schedules, growth, and vertical integration pipelines. Gain pre-qualification on the schedule as a group to coordinate with other debt planning.

Traditional Debt

Traditional debt is often used to supplement acquisitions and consolidate higher debt rates. It is borrowed against the whole business. Unless your growth plan is aggressive and requires immediate capital of large volume, a better alternative is working with flexible on-demand finance where you only start paying interest when the asset or working cash flow is deployed.

It is never optimal to have idle cash sitting in the business. Capital should always be working.

Project Finance

Project finance is based on specific long-term infrastructure or industrial projects with potentially limited lifespans. For example, if you are providing R&D and production for a defense contract, this would be considered an independent project with its own financial modelling and fixed duration.

Project finance structures isolate the risk and return of specific undertakings from the parent business, enabling larger ventures than the balance sheet alone would support.