Insight
How debt and equity contribute to healthy business growth
August 2021
Debt, equity, and investment banking are not new concepts but balancing each of them throughout the business cycle is key to healthy business growth. Monitoring periodically how to optimise and leverage debt and equity in a business is critical to its success.
I often find that business owners can have a narrow focus on debt and equity, maybe focusing only on venture capital and bank debt. Venture capitalists seek high-risk but high-reward investments while banks look for low-risk yet low-reward opportunities. This can leave gaps in much needed capital or liquidity; however, there are alternatives that can provide a more efficient balance.
Often, non-banking lenders do not experience the same regulatory constraints as traditional banks. These alternative lenders are more costly than traditional banks, but they can offer a business greater leverage and lessen the need for more expensive equity investment.
Investment needs change throughout a business lifecycle. Early on, when it’s harder to borrow, equity can be the best investment. As a business matures and its value increases, it becomes more attractive to lenders, making it easier to borrow. Initially, this debt maybe more expensive, but as a business grows and matures, it can attract cheaper, more efficient options.
Business owners may be tempted to take as much equity as possible in the early stages of growth, but keep in mind that early-stage equity will be the most expensive and dilutive. Ideally, the less dilution the better in the early stages; when dilution is limited, the percentage of investors’ holdings is greater as the business grows in value.
Business owners should appreciate the motivation behind each class of investor. Equity investors seek the maximum return on their investment, while debt investors are seeking repayment of the loan plus agreed interest. Owners must appreciate how their investors evaluate risk and return on their investment and understand that each party has a set of specific interests that may not be aligned.
Finally, business owners need to make decisions early on what will provide the most benefit as the business matures and grows. They also need to know how to switch between debt and equity across a business’s lifecycle, so that they can optimise returns when it’s time to sell.
Case study
A US-based company was on a rapid growth trajectory, having landed a contract that would increase its annual volume ten-fold to $250 million. At the time, our client lacked the scalable infrastructure and capital to support this transformative growth.
This company engaged our investment banking professionals to create a scalable infrastructure, credibly quantify its financing needs, target and qualify potential investors, develop a sales document for investors, go to market, field offers and ultimately close on a successful raise. Our team was adept at simplifying the highly complex opportunity and determining that the need would be for approximately $180 million.
It is typically challenging to convince the investor community that a ten-fold growth can be both defendable and attainable. Based on our experience, analytical guidance and knowledge of targeted investors, however, we received multiple bids for the entire $180 million. Realising that this was a competitive process, the winning bidder not only provided a compelling package for the $180M but they also offered a $20M equity investment in the company in order to be awarded the deal.
Since the successful close, the company grew to well over $1 billion and ultimately sold to a larger entity – creating a robust return for those original investors.
About the author
Ken Segal
Boston, USA
Ken is a partner at Russell Bedford’s Boston member firm, LGA, with over 25 years of experience assisting businesses and their owners to maximise enterprise value, while minimising risk. Ken has extensive experience assisting businesses with evaluating debt and equity structures, sourcing financing, due diligence, and exit planning. He ensures businesses are prepared to respond to internal and external factors that either accelerate or interfere with growth, while leveraging the tools and insights developed to pivot and ensure continued success.
ksegal@lgallp.com