Posted on Monday, 21st December 2009 by admin
BusinessWeek Image: “Raising Capital: Equity vs. Debt ” (source below)
Successful businesses must have enough capital to weather economic downturns, but the sources of this capital differ between companies and can determine how long an organization can survive in times of slow market activity. Some businesses have financed their business largely through the equity of their owners or investors, and other businesses are mostly financed by debt, or loans from lending institutions. Taking a look at the debt to equity ratio can give the owner insights into the financial standing of the business.
What is the debt/equity ratio?
It’s a measure of how much of a business’ assets are leveraged by debt (loans that the business will have to repay) compared to equity (capital that exists inside the business from owners or investors in the business). Mathematically, it’s the amount of debt divided by the amount of equity.
If the ratio is less then 1, which is considered low, the business has more equity than debt to finance its operations. On the other hand, a high debt to equity ratio is seen risky by banks and lending institutions because it can mean that a business has been aggressively financing its growth with debt, and not from the capital invested into the business by its owners or shareholders. These businesses are seen as a riskier investment for a bank or financial institution and they are less likely to offer the loan, or offer a loan with a better interest rate.
How does your business’ debt/equity ratio compare to other businesses in your industry?
The financial analysis gained from the debt/equity ratio can help you decide how well your business is doing in a competitive market, but the actual benchmark number does depend on which industry a business operates in. The professionals at Cherry, Bekaert & Holland have offices located throughout the Southeast and can assist you with the financial advice to determine if your debt/equity is beating your competitors or falling behind. Link: Locations.
How can you get more financing?
Again, we’d like to direct you to one of our professionals at CB&H, but in a recent article from BusinessWeek, Jill Hamburg Coplan outlines some creative ways to raise money for your business and helps to explain what debt/equity can mean for your business.
“Borrowing isn’t cheap right now, but it is at least accessible. The variety of vehicles include subordinated or “junior” debt (so named because it has only a secondary claim on assets in the event of a bankruptcy). These loans come at higher interest rates, but they’re available from development agencies and others. Factors and asset-based lenders may be options for distressed companies, where the owner’s personal credit rating is below 650 and the company’s net worth is negative. Higher-risk or startup borrowers that anticipate a merger or initial public offering within eight years can explore “venture debt” and similar hybrid structures that couple a loan with a “kicker” that converts to equity.”
Read the full article here: BusinessWeek
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