Description

There are no hard and fast rules for optimizing a company’s capital structure, companies that are strategic use an efficient combination of senior debt, mezzanine debt, and equity capital to minimize their true cost of capital. It's also important for a business owner to analyse the difference in value between an ownership interest in a stagnant or underperforming business and ownership in a growing company. Listed below are some of the equity and debt available to raise funds:

• Senior Bank Debt
• Subordinated Debt
• Shareholder Equity
• Quasi Equity
• Mezzanine Debt

Senior Bank Debt
Senior bank debt is the borrowed money that a company must repay first if it goes out of business. The lender holds claim to the borrower’s assets above all other debt obligations. The loan is considered senior to all other claims against the borrower, meaning the collateral can be sold to repay the senior debt holders first, followed by junior debt holders, preferred stock holders and common stockholders. This makes the senior bank debt a lower risk to the borrower and therefore a lower interest rate.

Subordinated Debt
Subordinated debt is a debt that can only be claimed by an unsecure creditor, in the event of a liquidation, after claims of secured creditors have been met. Subordinated debt can be used for growth capital, acquisitions, recapitalizations, and management and leveraged buyouts. Subordinated debt holders need to ensure there is enough free cash flow to service the debt, since the debt is either unsecured or partially secured. Therefore, despite the high-interest rate on subordinated debt, if the business is flowing good, consistent free cash flow, it may be best to obtain subordinated debt rather than a pure equity injection.

Quasi Equity
Quasi-equity debt security (also known as revenue participation investment) is useful for enterprises that are legally structured non-profits and therefore cannot obtain equity capital. This type of security is a form of debt, but its returns are indexed to the organisation’s financial performance. If future expected financial performance is not achieved, a lower or possibly zero financial return is paid to the investor. Conversely, if performance is better than expected, then a higher financial return may be payable. Quasi-equity provides a more equal sharing of risk and reward between investor and investee.