When to pursue debt refinancing and why
You may find that refinancing or renegotiating your business debts can put you in a stronger financial position.
Look at what you owe, and on what terms
Businesses usually borrow to help them grow. Banks are typically the first port of call for most small and mid-sized businesses, according to research by BGF, but in addition to bank loans, your business may have credit cards, invoice and asset finance or other forms of borrowing. The first step towards successful debt refinancing is understanding what you owe, 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 and 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 a refinance.
Consider consolidating your debts to simplify your situation
Once you have an overview of your debts, you can decide whether it is in your interests to refinance. One reason for doing so is to simplify the management and stability of your finances. Debt consolidation – bringing together a number of debts with just one provider – makes it easier for you to see what your business owes and when. It is also a way of reducing the number of negotiations, the impact of individual lenders’ terms, and the external influence on your business strategy of your finance requirements.
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 often, for more traditional lenders, using credit scoring. If you think your risk has improved – perhaps you’ve been successfully trading for a while with good cashflow – 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 interests – unless you can convince a lender that, with a more stable financing platform, your overall risk is lower.
See if the market environment is favourable for borrowers
The market environment also influences the interest rates available to you. In recent years, central banks in the UK and elsewhere have kept interest rates at historically low levels to try to stimulate economic activity. In this environment, many firms have been able to access low cost debt. As a borrower, low interest rates ought to be in your favour.
Consider seeking longer term debt
Confidence around the future supply of capital is a cornerstone of most business growth strategies. You can remove some of the uncertainty about availability of capital by agreeing longer term finance, avoiding the possibility of a need to refinance or to renegotiate debt at the wrong moment. This is known as your debt maturity profile. Timing the maturity profile of your business’s debt finance lines is a core skill. You don’t want to focus on refinancing existing debt at the wrong time, either for your business or the market. Accessing long-term finance with a lower level of ongoing repayment can also leave more cash within the business to reinvest for growth. While there is a high level of competition around business lending, most facilities are still offered on a five-year or shorter timeframe.
Is debt refinancing an opportunity to borrow more?
While seeking debt refinancing, you may find you are able to increase your overall borrowing. It goes without saying that you should think carefully before taking on additional debt; however, if you have a good plan to invest that extra money, for instance in business expansion, then it may be shrewd to borrow more. When considering what is a comfortable level of debt within your business, think about what level of contingency you will require and how predictable you expect your profits and cashflow to be in the future. If you have good visibility of your future performance you may feel able to take on a higher level of debt – remembering that a higher level of external debt may also mean a higher level of financial risk within your business.
Consider equity funding while debt refinancing
So far, we have discussed swapping debt for other debt. Another option is to sell an equity stake in your business to raise additional funding for growth, and to refinance some of the debt on your balance sheet. The advantage of this strategy is that you could rid yourself of ongoing interest and capital payments, freeing up cashflow to reinvest in the business. BGF has provided equity funding to about 400 small and mid-sized businesses in the UK and Ireland. Our investors have a great deal of experience in debt refinancing and more.
Or consider other options
There are hybrid options too. As well as equity funding, BGF can offer long-dated loan notes to growing businesses. Sometimes businesses choose a combination of equity funding and loan notes. Other options include convertible loan notes, which are instruments that function as a loan up until a certain point in time and are then converted into shares. An experienced investor such as BGF can talk to you about which funding structures might be most suited to the needs of your business.
Are there drawbacks to debt refinancing?
Check the penalties
Before refinancing, check if you will have to pay any penalties to your existing lenders. Some lenders will impose an early repayment charge if you try to pay off your debt before the end of a fixed term. The benefits of debt refinancing may outweigh the cost of the penalties, but it’s important to do the sums before you commit.
Remember transaction costs and fees
There may also be transaction costs associated with refinancing that must be taken into account. Likewise, ensure you have considered any fees associated with your new borrowing.
Be careful what you commit to
You may think you have secured a great deal by locking in a low interest rate for ten years, but what if interest rates fall further in the next 12 months? Although it is reassuring to know your outgoings in advance, having the ability to restructure your balance sheet in response to a changing environment can be helpful too.
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.
How we can help
As the largest growth investor in the UK and Ireland, BGF has invested in about 400 small and medium-sized businesses, deploying a total of around £2.5 billion of investment. Our teams are spread across the UK and Ireland in a network of regional offices.
We have broad sector expertise, investing in everything from high-growth online businesses to advanced manufacturing companies and start-ups developing life-saving medicines. If you’re interested in what we have to offer, please contact us today.
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