When taking up debt, you need to understand the implications and consider the following five rules
I work everyone Day with company founders who deal with the challenges of promoting growth and at the same time keep their finances in balance. One topic that we often talk about is how we can use debt to drive the growth of the company – without it becoming a problem.
In my experience, debt can be a valuable part of a company's capital structure. The key is to use debt for the right purposes and understand the implications. For example, short-term loans (with a term of one to two years) are useful to finance receivables and inventories and to control cash flow. These working capital facilities have attractive interest rates (often around 5%) and are well understood by the lender community.
In contrast, mezzanine loans (typically three to five years) are more appropriate to provide the flexibility and runway needed to demonstrate certain initiatives before securing an equity investment or liquidity event , As a rule, these loans have a limited term, are not secured by any specific working capital assets and are subordinate to the working capital loans. Because of their higher risk profile, they are more expensive than short-term loans. Lenders typically strive for a return of 15% to 20%, which is split between a current interest rate of 10% and an expected appreciation of the shares upon receipt of the warrant cover.
Regardless of the type of debt that a company incurs, certain principles must be observed to prevent the debt from jeopardizing business success. If you decide to go into debt, you need to understand the implications and follow these five rules: