Business mentor, speaker and angel investor Mark Lyttleton has extensive experience of working with both private and public companies seeking to raise collateral to support and grow their business. This article will outline various aspects of financial structuring and how a founder’s choice of financing can impact their company’s long-term sustainability and success.
A company’s financial structure dictates how it finances its assets and operations. Structuring encompasses the mix of equities and debts the company relies on to manage its day-to-day operations and finance its assets, comprising long-term debt, short-term debt, owners’ equity and short-term liabilities.
Financial structure is distinct from capital structure, as the latter term covers only long-term debt and equity.
Irrespective of whether it is private or public, every company is free to choose its own financial structure. Both private and public companies have access to similar sources of funds, except for equity, with the WACC – or ‘weighted average cost of capital’ – of a company hinging on its financial composition. Financial structure has a direct impact on the valuation of a business. It is therefore crucial for companies to strive for the optimal financial structure to maximise their value.
A company that is more reliant on debt may offer a higher ROI or ‘return on investment’. However, financial structure with more debt could jeopardise a company’s ability to meet its obligations.
A business that is either a monopoly or oligopoly would be better placed to support more debt because it is easier to accurately forecast sales and cashflows. On the other hand, a company operating in a highly competitive industry would struggle to support such a financial mix, as increased competition is likely to culminate in less reliable earnings and cashflows. This could result in the company reneging on its debt obligations, making a structure with less debt and more equity more appropriate for companies operating in highly competitive industries.
The Chief Financial Officer (CFO) plays a critical role in determining a business’s optimal financial structure. CFO’s generally rely on trend and ratio analysis to help them deduce the right financial structure for a particular business.
Private and public companies essentially have the same framework for developing financial structure, although there are important differences between the two. Either type of company can issue equity. Although private equity is created and offered in much the same way as public equity, private equity is only available to select investors rather than being sold via a stock exchange or public market. Equity fundraising for private companies takes a very different format to a formal initial public offering (IPO), with private companies often proceeding through multiple financing rounds, which in turn impacts their market valuation.
When deciding between equity and debt, financial managers will ultimately seek to finance the company at the lowest rate possible for the level of business risk they are running, thereby reducing the capital obligations of the business and potentially allowing greater capital investment. In evaluating the capital structure, financial managers seek to optimise the WACC.
Key metrics for analysing financial structure are essentially the same for both private and public companies, although public companies are required to make public filings, providing transparency for investors analysing the company’s financial structure. Private companies, on the other hand, typically only disclose financial statements when reporting to investors, making their financial structure and financial health harder to gauge from the outside.