In the realm of commerce, borrowing plays a renowned role in the capital structure as a means to stimulate growth and procure assets, although this may not be cheap or suitable in every situation. In seeking expert monetary advice, businesses endeavour to navigate the applicability, strategy, and justification of accruing debt.
Paul Rickard, a Corporate Finance Director for Forvis Mazars, reflects on the period from 2015 to 2022, when negative interest rates positioned debt as a favourable and cheap method to finance business expansion and mergers & acquisitions (M&A). During this time, abundantly liquid corporations took advantage of these rates to settle loans, thereby dodging the double penalty of high-interest rates on credit facilities and deposits.
A significant change has occurred recently due to rising interest rates, which have considerably elevated the expense of taking on debt, even to the point of doubling capital costs in some instances. This situation has prompted a shift in the perception of debt from being a cost-effective tool for financing to a relatively pricier one, causing firms to adopt a stricter approach to borrowing.
In the previously mentioned period of negative interest rates, the most critical limitation to borrowing capacity was leverage. However, with the rise in lenders’ outlays, usually associated with Euribor, the primary constraint on a company’s borrowing ability is now debt service, essentially, their capability to manage and repay fresh debt.
Businesses across diverse sectors utilise varying parameters to calculate suitable debt levels. For instance, in property or development finance, lenders might prioritise loan-to-cost or loan-to-value ratios, whereas for acquisition financing, the debt/equity split may hold higher importance.
Non-traditional or private lenders usually have a different level of risk tolerance relative to their conventional counterparts. These alternative lenders often assess potential borrowers and whole sectors differently, typically providing more leeway on the aspects of amortisation, distributions and streamlining credit methods, although generally at a stipulated higher interest rate.
In the comparatively small Irish market, which recently experienced the departure of numerous key lenders, these alternative lenders are rapidly assuming an essential role by supporting lending to businesses and SMEs who have been shunned by the mainstream lenders.
Brian Fennelly, a Partner at Debt and Capital Advisory of Deloitte, suggests that most established businesses, while raising capital, initially gravitate towards debt financing as it is considered the most cost-efficient external capital source and negates the requirement for a shareholder to sell a stake in the company.
Debt financing, despite being the most cost-preserving way to acquire third-party funds, involves several financial liabilities and constraints, including timely repayment of borrowed funds including interest, giving securities as collateral, and agreeing to financial terms and other stipulations aimed at safeguarding the interest of lenders. Thus, when our clientele contemplate about adopting a borrowing approach, and the suitable borrowing amount, our role as consultants is to formulate an ideal financing structure that, while being financially efficient, augments operational adaptability and curtails debt-related perils and constraints posed by lenders.
The most fitting level of borrowing for a corporation is a standard of financing that assists the company in realising their strategic intentions while averting unwarranted financial hazards. This evaluation takes into account a myriad of financial and non-financial factors, such as borrower’s maturity, amount of capital to be raised, purpose of assets, industry resilience and projection, cash-flow constancy, availability of securitisation, alignment of shareholder equity, and potentials of management teams.
Nonbank lending from diverse lenders, such as credit funds, venture debt providers, asset-based speciality lenders, family offices and various other lending platforms, has become a prevalent financing selection in Ireland, for firms in the quest for substitute sources of capital. These might be in addition to conventional bank loans, or as an alternative to raising equity.
These lenders are not bound by similar regulatory and capital sufficiency prerequisites as banks, thereby enabling nonbank lenders with the ability to offer borrowers additional flexibility.
Convertible loan notes that can be transmuted into company’s equity at a future date, usually triggered by a certain event or reaching a milestone, epitomise an amalgamation of debt and equity capital traits, and present several benefits for companies planning to secure funding while maintaining flexibility and mitigating risk.
Convertible loan notes are often used during primary financing stages for emerging and rapidly expanding companies.
– Colm Sheehan, Director, Corporate Finance, Crowe
Often, opting for a loan can prove to be a less costly and more orderly method of securing finance compared to equity. Nevertheless, such a financial obligation can limit a company, especially if its cash flow is not enough to cover repayment conditions. Businesses with a solid foundation and consistent inflow of cash would ideally opt for raising funds through debt. In contrast, a nascent business seeking expansion and preservation of short-term cash flows might find equity financing more suitable.
Overloading on debt can hinder a business’s expansion and development. When market prospects cannot be capitalised upon due to hefty debt repayments causing a strain on the business’s cash flow, perhaps it’s time to explore a different financing structure.
Such alternatives might include switching to an interest-only loan or perhaps raising equity to replace current debts. Non-traditional lenders, alternate from conventional banks, provide benefits like adaptable repayment tenures and increased leverage which might not be available with traditional banks.
However, these alternative lenders might sit more on the risky end of the spectrum, which could result in a higher borrowing capability. This could be offset by a more assertive pricing structure, making it essential for the borrower to weigh the pros and cons of both traditional and alternative debts.
According to David Martin, a partner and head of EY capital and debt advisory, maintaining the existing shareholder base and, consequently, control is best achieved by opting for debt. However, the business needs to have accumulated significant equity value enabling it to shoulder the debt, which will be prioritised in the capital structure. Appropriate debt planning can manage much of the risks associated with raising debts while evaluating cash-flow demands during the loan tenure helps prevent excessive leveraging.
Non-traditional lenders are now an integral part of Ireland’s financing landscape, on equal footing with other mature markets. In line with international standards, increasing interest rates have allowed these lenders to become more competitive.
Often engaging in higher-risk sectors or high-leverage transactions, for instance, their crucial involvement in the commercial and residential property finance sector in Ireland – evident entities have acted as an important stimulus for the construction of countless housing. With high leverage in mind, their concentration resides in coordinating interests with the borrower and attaining profitability within the transaction to safeguard against potential losses.
Financial instruments like convertible loan notes or mezzanine financing can fill the equity deficit, though typically at higher risk and thus, higher cost. These options may become viable at the early stages of a venture’s journey, when a founder wishes to retain control but senior debt is inaccessible. As the venture matures and the capacity to repay becomes evident over time, these can be swapped out for forms of capital less risky and less costly.
The Head of Business Development at Bibby Financial Services, Stephen McCarthy, recognises borrowing as a clever method for funding growth, managing cash flows or financing pivotal asset investments for numerous businesses, despite its cost implications in certain situations. It becomes particularly beneficial when expansion opportunities surface such as acquisitions or management buyouts, or when cash is stalled in unsettled invoices.
Nonetheless, borrowing must be meticulously evaluated. Major dangers tied to outside financing encompass over-leverage, fluctuations in the interest rate and dependence on immediate capital. Interest instalments, repayment conditions and the effect on your balance sheet must be considered against the advantages.
Recent studies suggest that 43 percent of businesses in Ireland have experienced a bad debt in the past year, marking a substantial increase from 29 percent from the year prior, making apparent the obstacles SMEs are confronting in the nation.
These escalating figures are highly noticeable, notably when nearly two-thirds of businesses that have experienced bad debt have been denied external financing. This underlines the detrimental impact of bad debt on SME’s capacity to expand. Given these statistics, it would be sensible for businesses to take several measures to prevent non-payment such as renewing credit control systems, performing comprehensive background checks on all customers before providing credit, and ensuring strict payment protocols are imposed.
Alternative finance providers, for example, Bibby Financial Services, deliver a variety of versatile and reachable monetary solutions not typically available from conventional banks. They supply bespoke services such as finance through invoices, lending based on asset value, and protection against bad debts, enabling businesses to utilise resources such as unsettled bills or stock to secure funding.
Compared to standard loans, these possibilities are usually more flexible, equipping businesses with enhanced liquidity to handle routine cash flow or support larger growth ambitions like management buy-ins and takeovers, all while avoiding long-term liabilities. On top of that, these alternative finance providers offer more personalised counsel and services, possessing a profound comprehension of particular industries or sectors.