If you are in the business of starting new companies, one of the most important issues to your company’s success is how to manage your company’s capital structure. Capital means everything and if you don’t manage your company’s capital structure properly, then you will find that your business is doomed to fail. Managing your company’s capital structure means two things. It means ensuring that your company has the right amount of debt and equity capital to carry on with your day to day activities, and it also means ensuring that you never run short of any of these basic ingredients.
You need to understand how to manage your company finance effectively to avoid running short of cash, and in this respect, you need to look at two different approaches to capital structure. You can opt for either specialty capital or debt financing. You will find that specialty capital is one approach to improving your company finance management which can help you manage your cash flow problems. In short, specialty capital means raising additional funds from either private investors or banks to give your company a better financing option.
Private financing can be difficult for a small business and is often seen as a less desirable form of finance, but you must learn how to raise the funds that are necessary to keep your business going. If you are a small company with only a few employees and a small market share, then you may find that it is very difficult to get sufficient capital from a third party. However, if you have sales which are substantially above your competitors, then you will find that you are able to attract more investors and that your debt to EBIT (earnings before interest and tax) ratio can become favourable. Of course, you will need to show that your earnings are substantially higher than your competitors’ to secure these types of loans, and in most cases, you will also need to have some kind of assets to secure the loan from.
Another approach to capital structure is to use debt capital to finance operations. This may sound strange at first, because using debt capital does not seem to be a practical solution for a business, but if you look closely at the business model of a company, it will soon become apparent that this is not necessarily the case. Most businesses will find that borrowing money and converting this into equity is actually much more cost effective and can result in a more efficient working capital structure.
As we said earlier, it is most often the case that businesses will need to raise debt capital, and will need to use debt capital and equity capital structures to achieve this. However, what if your revenues do not continue to rise at the same rate as your costs? In that case, you might find that you do not have enough cash on hand to fulfil all of your short-term obligations, and so you will also need to look at debt capital. The alternative, of course, is to seek interim financing, and many businesses will do well to utilise interim financing when they are looking for some quick cash to stay afloat.
Another reason that businesses will often choose to take debt rather than equity in their business is that debt gives them an advantage over their competitors, since they do not have to provide any equity. They can raise the money they need by selling their existing assets, and as long as they meet the repayments on their debt then their position is secure. However, if they increase their debt then they risk losing any future profits they make as a result of their increased market share. That said, most businesses are able to increase their earnings per head in a matter of months, even weeks, so this may not be an immediate worry for a company.
Of course, if you are looking at raising debt capital then you will need to consider whether you are being offered a discount rate or an interest rate with penalty charges. If your offer does not include these then you should raise the capital amount a little further and consider seeking either an interest only or a conversion mortgage, which allows you to change your repayment terms as you go. Of course, any company that engages in specialty capital must have a risk management plan in place to mitigate any risk that it may encounter in relation to its debt portfolio. For this reason you should always seek independent financial advice before proceeding.
Many small businesses are not large enough to raise their own equity, and in these circumstances they will often choose to engage in what are known as merchant cash advances. These advances are provided by a number of different financial institutions, but they generally work in the same way as other forms of debt capital. You will be expected to put up some of your company’s assets as a form of collateral, though this is not usually a large amount as most businesses will have a very low ratio of assets to liabilities. Once you have paid back the advance all your debt will be settled, and your retained assets will be replaced by whatever new enterprise was financed. This means that you will be leaving your business open to the market, and you will be able to raise sufficient capital from a number of sources without having to provide equity for the venture.