Mod 2 - Financing Capacity & Deal Structuring Flashcards
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In determining capital structure it is important to have a proper understanding of
- business
- where business is in life cycle
- various forms of capital available
- factors to influence the ability of company to optimize capital structure”
define equity capital
“This refers to money invested and owned by the shareholders (owners).
Typically, equity capital consists of two types:
a. Contributed capital: Money that was originally invested in the business in exchange for
shares of stock or ownership.
b. Retained earnings: Represents profits from past years that have been kept by the
company and used to strengthen the balance sheet or fund growth; acquisitions or
expansion.
Many consider equity capital to be the most expensive type of capital a company can utilize
because its “cost” is the return the firm must earn to attract investment.”
define debt capital
“This refers to borrowed money that is deployed in the business. There are numerous forms of debt capital, ranging from long term
bonds to short-term working capital loans”
“what is the optimal capital structure?
“The optimal capital structure for a given entity is the mix of debt and equity that maximizes shareholder value. This can be thought of as the capital structure that results in the lowest weighted average cost of capital.
The target capital structure for a business is a balancing point of maximizing shareholder value without creating excessive risk.”
under- levered business impacts on value
“under-levered business results in a higher cost of capital, as the business is
financed exclusively with equity”
over- levered business impacts on value
“over-levered scenario, the business utilizes the cheaper debt. This, however,
increases the risk profile to the equity holder(s), who in turn demand a higher rate of
return on their investment.”
optimal capital structure impact on value
“optimal capital structure, the business has found the appropriate level of debt
and equity that results in the lowest possible weighted average cost of capital.”
Start up and early stage financing
“The company is still mostly engaged in research activities and is in the
assessment/ development phase of a concept or product. Commonly-used sources of financing for companies at this stage are
personal savings of the firm owners and financing from friends and family members, along with
angel investors who specialize in early stage investments.
Financing’s may also be directed toward product development, market research,
building a management team, and developing a business plan.
Not likely to raise capital through debt and will have higher reliance on equity.”
Growth and expansion stage financing
“Needs financing to increase production capacity, pursue market or product development
or to simply provide additional working capital to fund the expansion of the business.
Equity base is leveraged to the limit. Financing is increasingly sourced through reinvestment. Established operating history allows for access to sources of external financing from banks and trade credit. Bank products offered LOC, term loans, lease financing, asset based loans”
Mature company financing
“The company is solidly established and is large enough to absorb setbacks without
risking failure. Financing may be required to sustain its growth plan by acquisition, establishing
new production facilities or launching new product lines.
Possible for public financing, private equity, or hedge funds.”
Financially distressed financing
“Phase where it has to
significantly restructure its operations in order to survive or return to generating sufficient
positive cash flow, financing will be needed to absorb the related costs. Such as reorganization
costs, lay-off costs, abandonment of product lines or production facilities, disposal of assets at
low values and the acquisition of new, more efficient ones.”
How have Canadian Banks traditionally lent? How has this changed?
“Canadian banks have been asset backed lenders. Advancing funds on strength of borrowers assets.
Fewer companies have traditional assets and more intangibles. Banks have increasingly assessed cash flow potential in addition to assets as protection.
Credit assessments based on businesses ability to reimburse dent as a function of current and future cash flows is referred to Enterprise value lending.”
What are balance sheet considerations of lending?
Banks still look to the liquidation value of the borrowers assets to determine the amount of money they are prepared to advance or lend. The theory is that the underlying assets can be relied on to recover a portion of the money lent.
What items do lenders consider when reviewing the nature of the company’s industry?
“Generally lenders prefer industries that are reliable, contracted cash flows, and high level of tangibles. The nature of the industry can affect the financing needs of the company. These are assessed on:
- competition
- barriers to entry
- political factors
- revenue sources
- technological factors
- pricing”
How do lenders assess the business risk?
Similar to valuation engagement such as key person, customer, market share, competition, technology. Mgmt should work with advisors to help them understand the risks and attempt to mitigate.
