The Debt Diet
With the new year upon us, many set personal goals, typically around health and wellbeing. Keeping with the theme… financial health and wellbeing should remain a focus for businesses alike.
The Debt Diet, like any good diet, aims to remove the bad debts and replace them with good debts. This is achieved through regular review of the debt/funding adequacy deployed in a business at each stage of its life cycle. As is often the case, businesses are either carry too much bad debt (fats), incorrect of debt/funding structure (poor diet) or both.
Understanding the timing of cash injections for any business is critical, but which type of debt is appropriate is make or break. As the saying goes, “Debts are like gym memberships, easy to sign up, you go once maybe twice, keep paying and try to forget about them, but you realise it’s not for you, they cost a fortune, so you eventually cancel, then you go and find another gym”( Hoeft, 2018).
Jokes aside… all businesses go through a life cycle of some sort. For simplicity, let’s assume the stages are Start Up, Growth, Maturity, and Exit. At each stage, the business will likely require debt, possibly even at the exit stage. Structuring the debt at each stage to ensure you maintain control and business health is important. Options:
STARTUP
The Startup phase is when the business is most vulnerable, it still not be clear if the business idea is viable. Investors may be circling to take their slice of the action at a bargain price.
Considerations:
Cash burn – spend rate, how much cash is needed per month?
‘Runway’ - how long will the cash last?
Equity – control & ownership retention? what is the valuation?
Exit Strategy – what is it? when? how?
Diet:
Loan – private/personal loans. Small, maybe unsecured.
Grant – explore government grants available for business.
Equity – sale of shares or interests to an investor at an agreed valuation.
Sweat Equity – sale of shares or interests to key personnel/suppliers, in return for labour or services.
GROWTH
The business is commercially viable. An understanding of the target market/s and market acceptance has been achieved. Growth is experienced across various areas in the business – profitability, income, staffing.
Considerations:
Growth – existing or new markets?
Cash burn – cash required to execute the growth strategy?
Equity – control & ownership retention? what is the valuation?
Exit Strategy – revisit exit strategy.
Diet:
Bank Debt – unsecured/secured, short term/long term debt.
Non-Bank Debt – secured/unsecured loan from shareholders or third party, likely higher interest than a bank.
Cashflow finance – secured over Assets (e.g. Debtors or Stock).
Equity – Share issue at an agreed value.
MATURITY
Product or service offering is well known in the market. Modest growth should continue, preparing for exit.
Considerations:
Cash requirements – burn rate, what do you need?
Exit strategy – revisit strategy
Sale suitor/s – trade sale, merger, listing; or
Succession – family members, key management personnel
Diet:
Debt reduction – where appropriate.
Debt efficiency – convert bad debt to good debt.
EXIT
The 60ft yacht is just about delivered…. Without the end in mind and the right diet, it is unlikely the business will have reached this point or If it has, it is unlikely value is maximised.
Considerations:
Retirement – vendors involvement/participation post sale
Taxation implications and concessions on sale.
Superannuation – role of SMSF in sale (if any).
Estate Planning – death planning (arguably should have been considered earlier).
Vendor Finance – vendor finance component in the sale price (if any).
Diet:
Merger;
Trade sale;
Succession – sale to family or key management; or
Listing or Initial Public Offering (IPO).
Ensuring the Debt Diet is healthy and appropriate at each stage in the cycle, is key to maintaining control, reaching the finish line and maximising value. Have a chat with your advisor.