What should your business consider when debt refinancing?

Debt refinancing can be a highly useful tool for growing businesses, helping to simplify their debts, reduce the costs associated with their borrowing, and freeing up capital for growth. You may find that refinancing or renegotiating your business debts can put you in a stronger financial position — but it may not be the best option for everyone.

What is debt refinancing exactly and what should you consider before refinancing your own company’s debt? Read on to find out.

What is debt refinancing?

Debt refinancing is the process of replacing your existing debt with new debt, typically to reduce interest payments and improve cash flow, or to consolidate multiple loans (debt consolidation). It may involve switching away from your current debt provider(s).

This type of debt management tends to be used by individuals or businesses in a stable financial situation that can qualify for better terms. For instance, a homeowner might refinance their mortgage, to benefit from lower interest rates.

Is debt refinancing the same as debt restructuring?

Debt refinancing and debt restructuring are both strategies for debt management, but they serve different purposes. While debt refinancing is focused on taking out new loans, usually with better terms, debt restructuring involves modifying the terms of existing loans, to make it more manageable.

Debt restructuring typically involves borrowers renegotiating with creditors, to change the terms of existing loans, such as reducing interest rates, extending repayment periods, or even reducing the amount owed.

This form of debt management might be used by borrowers that are struggling to meet interest payments, and are at risk of insolvency, such as a company in financial distress. But it can also be a proactive way to manage your business finances, to benefit from market changes or to free up cash for your growth strategy.

What are the benefits of debt refinancing?

Debt refinancing and debt restructuring can be advantageous for businesses looking to:

• Negotiate lower interest rates on their loans
• Shorten or extend repayment periods
• Reduce total monthly outgoings
• Gain more control over their cash flow
• Better match debt obligations to their growth and investment plans

What are some drawbacks of debt refinancing?

Despite the potential gains to be found from these debt management strategies, they may not be right for all businesses.

As debt refinancing often involves making judgements about future movements in interest rates (or other external factors), depending on the nature of their debt, it may require businesses to have significant knowledge and experience of debt markets.

There can also be monetary costs associated with debt refinancing — transaction fees, for instance, or early repayment charges, if a business pays off its loan before the end of a fixed term.

Is debt refinancing right for your business?

Debt refinancing is a tool for managing debts, not a strategy for paying them off; and deciding how much debt is appropriate and sustainable for your business is a decision that should be made carefully, and with guidance from your advisers.

There are a number of questions to ask yourself before pursuing debt refinancing, all of which can affect the suitability and cost of this strategy for your business. Some key considerations include:

1. What is your current debt status?

SMEs usually borrow to help them grow. While bank loans are typically the first port of call for most small businesses, you may also have credit cards, invoice and asset finance, or other forms of borrowing. The first step towards successful debt refinancing is understanding what your business owes, to whom, and on what terms.

Where cash has been tight for some time, your business may have also built up higher-than-normal credit positions with suppliers, creditors, or HMRC. You should consider what is a sustainable position for those non-bank forms of credit for the future, when considering what to raise through debt refinancing.

2. Can you consolidate your business debts?

Once you have an overview of your borrowing, you can decide whether it’s in your interests to commit to debt refinancing. One reason for doing so is to simplify the management and stability of your finances. Debt consolidation makes it easier for you to see what your business owes and when.

Businesses that have debts from multiple creditors may also choose to consolidate their loans if they find it easier to negotiate better terms with a single party (or at least a smaller number of lenders). It’s also a way of reducing the number of different monthly payments you make, the impact of individual lenders’ terms, and the external influence of your finance requirements on your growth strategy.

3. Has your credit risk changed since you last borrowed?

Lenders decide the terms of your borrowing based on their perception of your credit risk and, for more traditional lenders, often using credit scoring. If you think your risk has improved (perhaps you’ve been successfully trading for a while now, with good cash flow), then you may be able to borrow at a lower interest rate, with more favourable terms than before.

On the other hand, if your credit rating has deteriorated, you may be offered less attractive terms than in the past. In that case, debt refinancing is unlikely to be in your interest — unless you can convince a lender that, with a more stable financing platform, your overall risk is lower.

4. What is the current debt market like?

Depending on the state of the debt market, interest rates may or may not be favourable for borrowers right now. For instance, in a market environment where central banks are keeping interest rates low, to try to stimulate economic activity, businesses might be able to access lower-cost debt.

5. Is debt refinancing an opportunity to borrow more?

Through effective debt refinancing, you may find you’re able to increase your overall borrowing. It goes without saying that you should think carefully before taking on additional debt, but if you have a good plan to invest that extra money (in business expansion, for example), it may be shrewd to borrow more.

When considering what a comfortable level of debt is within your business, think about what level of contingency you’ll require and how predictable you expect your future profits and cash flow to be. If you have good visibility of your future performance, you may feel able to take on a higher level of debt — remembering that this might also mean a higher level of financial risk within your business.

6. Do you require longer-term finance?

Confidence around the future supply of capital is a cornerstone of most business growth strategies. And you can remove some of the uncertainty around this by agreeing longer-term finance, reducing your likelihood of needing to refinance or renegotiate your loans at the wrong moment.

While suitable for both short-term and long-term financing, debt refinancing can provide an opportunity to lengthen the terms of your business loans, if desired. This is known as your debt maturity profile. Timing the maturity profile of your company’s debt finance lines takes considerable skill; you don’t want to focus on refinancing existing debt at the wrong time, either for your business or the market.

Accessing longer-term finance, with a lower level of ongoing repayment, can also reduce your monthly outgoings, leaving more cash within the business to reinvest in growth.

While there is a high level of competition around business lending, most facilities are still offered on a five-year or shorter timeframe.

7. Have you considered alternative funding options?

We’ve discussed swapping existing debt for new debt, to help unlock capital for business growth. But another option is to sell an equity stake in your business, to raise additional funding and to refinance or repay some of the debt on your company’s balance sheet.

The advantage of this strategy is that you could rid yourself of ongoing interest and capital payments, freeing up cash flow to reinvest in the business. This is something our team has supported several businesses with to date — as we’ve provided equity funding to hundreds of SMEs across the UK and Ireland, and our investors have a great deal of experience in debt refinancing.

And there are hybrid options too. Alongside equity funding, investment firms like BGF can offer long-dated loan notes to growing businesses, for instance, with companies sometimes opting for a combination of equity and debt financing.

Other options include convertible loan notes, which are debt instruments that function as a loan up until a certain point in time and are then converted into shares. Experienced investors can talk to you about which capital structures may be best suited to your business and its growth plans.

8. Are there risks to you debt refinancing?

There are always potential risks to look out for when considering debt refinancing for your business. To help decide if the benefits of refinancing outweigh the costs, make sure to:

• Check if you’d have to pay any penalties to your existing lenders for refinancing
• Account for transaction costs and any potential fees associated with new borrowing
• Be careful what you commit to, when locking in a long-term deal (what if interest rates fall further, for instance)

The takeaway?

Managing debt is an active, ongoing process, as you should be aware of developments in the market that could affect your company’s financial position, like changes in interest rates. The key is to ensure your debt level is sustainable and appropriate for your business, while also confirming that your borrowing’s arranged on the best terms available in the market.

Depending on your motivations for seeking debt refinancing, it may be worth talking to our team. BGF is not a lender like a bank — we offer patient capital to help ambitious businesses accelerate their expansion plans. If you feel your debt is a constraint on your growth, we may be able to offer you a combination of minority equity investment and long-dated loan notes to help free up capital for your business. You can introduce yourself to our team here.

 

The information contained in this article is for general information and use. It does not constitute any form of advice and is not intended to be relied upon in making any investment decision. Independent advice should always be sought as to whether a particular transaction is suitable having regard to your personal and financial circumstances.