Do I Need to Review My Business’s Capital Structuring?

Capital and debt structuring can be difficult concepts to comprehend as a business owner; it is a highly specialised area relying on many years of experience, training, and expertise gained over that time.

Although you may have previously invested time (and money) in structuring your capital previously, it is important to note that it needs regular reviewing to adjust for changing market conditions, (including general financial; conditions, interest rate outlook, banking industry view on debt and specific industries) and your own personal, family and business circumstances which are bound to be constantly changing.

Not only do circumstances change, but so too do our business strategic objectives. Both will influence what is the optimum structure for you and your business as will your actual or perceived analysis of the risks you potentially face in the future as do your health and estate planning objectives and circumstances. Any change to any of these factors can require review and “tweaking” of your debt or capital structures.

As there are so many factors that influence and affect the structuring of your capital, it can be tricky to decide if you have the correct balance and mix of debt and equity to have the optimum and most cost-effective capital structure, meet your current and future objectives, provide flexibility, maximum taxation advantages, minimise risk and secure the future of your business.

I do not know of anyone in business who in the last few years has not been some change in any or all of these areas. If this is the case, you most probably need to review your current structure to determine if it is the most cost-effective, yet safe option for your business.

Obviously, the recent significant increases in interest rates have resulted in many business owners asking questions such: as do I have the right type of debt? Should I adjust the mix to have more debt or more equity?

Below are five questions you need to ask about your business to decide whether it is worth restructuring your capital. However, as a cautionary note, I do stress just like no one size fits all, there generally is no optimum structure achievable to satisfy all of the above criteria, as in many circumstances costs of implementing the absolute best structures would involve many structures and legal agreements. These, as such, would be prohibitive to implement and maintain. Additionally, more often than not, one aspect will compete against another (ie. The best tax structure might not be acceptable to equity investors or financiers or conflict with estate planning objectives).

Have there been significant changes in your business’s financial position?

If your business has experienced a large amount of growth (or vice versus) or you expect it to in the future, you should be reviewing your current capital structuring. Debt in particular is extremely complex as there are so many different types, with varying terms and conditions that can vary so much and place restrictions or constraints on what you can and can’t do in your business.

Whilst not seen as restrictive at a given point in a company’s evolution, the advent of time and changed circumstances at a later date may see the conditions or covenants imposed constrict the growth of the company, cause conflict with shareholders, or block the ability to effectively succession plan or bring in new investors. The options that arise from a review are enormous; from as basic as deciding to start paying off debts more quickly to reduce interest expenses, to initiating a major equity raise, or floating the company.

Have there been changes to the market?

Changes to the market in general, such as raising or lowering interest rates, indicate that it is probably a good time to review your structuring. This is because interest rates affect the cost of debt capital. Thus, if interest rates change, you must re-evaluate how this will affect your ability to service your business’s debt repayments now and in the future, and in conjunction with changing or potential changes to market conditions.

Also, be wary of external equity investment conditions and the shareholder agreements that come with it. This influx of new capital may seem perfect now, but what are the terms and conditions that apply for the future? For example, venture capital funds are generally only short to medium-term investors with a 5-to-7-year horizon before wanting an exit, which your business needs to be able to fund.

That is not to mention the basis of their investment is a return on investment – they are generally seeking an appropriate dividend return, capped off with a healthy capital gain on exit.

Is my business subject to debt covenants?

Debt covenants are restrictions that lenders build into loan agreements to limit the actions of the borrower and protect their advances. These protect the lender by restricting certain actions by the borrower, and are often overlooked at the time in the desire to secure the funding without appropriate analysis of the future consequences. Periodically reviewing your capital structure will ensure that you can stay within these covenants and avoid default initiating a renegotiation, or refinancing before it becomes a critical problem.

Are you wanting to incorporate succession planning or bring in investors?

Succession planning involves planning for substantial amounts of wealth to be transferred as your business adopts new ownership, together with appropriate changes in management personnel and practices.

Therefore, if this is a future consideration, this must be taken into account when planning or restructuring your capital. In particular, multi-generational businesses may have a high reliance on guarantors’ security support for debt from the more senior and exiting shareholders: can your existing debt level be maintained in the absence of their financial and security backing if they leave?

The same also applies in estate and family law matters with the demise/departure of a director, shareholder, or guarantor. Whether you have or are planning to bring in investors (or more investors) should also factor into your planning, as this affects your business’s shareholder equity and debt financing and potentially the effect of dilution without generating significant growth and profits could dilute investors’ return on equity.

Conditions that apply to your current debt agreements or shareholders’ agreement may not be acceptable to an incoming investor or possibly even restrict dilution all these need careful consideration and review of documentation.

Do seasonality differences affect your business’s income?

If your business experiences extreme seasonality differences that affect your income (for example, if you have ‘quiet times’ of the year or weather conditions such as drought that significantly affect your income), this is something you will need to take into consideration when reviewing your capital structuring requirements. Hence the need for robust long-term financial forecasting and ‘what if’ analysis for various scenarios which is an essential part of any capital structuring review/process. This ensures your ability to pay back debts with an appropriate margin for the unknown, comply with equity investment terms, and not constrain the growth of your business under all circumstances into the future.

As no two businesses are the same, so too there is no one-size-fits-all when it comes to capital structuring – your chosen structure must suit your business, your shareholders, financiers and your industry.