The golden rules for balancing capital structure

Cashflow keeps a lot of SMEs up at night, which is what makes optimising their capital structure so key.

Capital structure is the mix of debt, equity and asset finance that is used to fund a business, and this balance can make a huge difference to the sustainability and success of a business. Such finance decisions need to best suit a business’s nature, structure and strategy. So what are the golden rules for SMEs when it comes to capital structures?

1. Consider all the options

Many SMEs’ first thought when they need cash is to go to their primary bank, who might then offer them a loan or – if the SME needs new equipment – a finance lease. Sometimes this ends up being the best option – but, in order to be certain, it should never be the only one considered.

2. Reserve your debt (and equity) for expansion

Various market pressures continue to restrict bank lending; and SMEs are likely to need a loan from their bank at some point – but this makes it that much more important to keep that line of credit open.

One way to do so is to call on specialist asset finance providers where possible and appropriate and preserve your capacity to borrow from your bank for other purposes in future.

Using your equity to buy equipment might not be best either: equity is better used for the highest possible returns, including returns to yourself or other shareholders, while spending it on depreciating assets offers a poor return on your hard-earned capital.

3. Look ahead…further

It’s crucial to consider the total cost of debt – and its full impact on your business strategy. This means considering how long you will need assets for – and what assets you may or may not need years down the line. Are the assets tied to a particular customer or product that might also have shelf-life?

It also means measuring the effective life of the assets you need – not just whether they might break down or wear out, but also whether they might become technologically obsolete.

4. Choose a partner that knows more than you – not less

An SME is an expert in its area of business – but it may not be an expert on either equipment or financing. You may need to draw on expertise in these areas to answer some of the above questions and come up with the optimal solution and capital structure for you.

You should look for and expect a partner that will take the time to understand your business and will continue to support you after the lease is signed. And you should expect added value from your partner beyond payment terms – how quickly can they respond? How much can they tailor their offering to your needs? What do they know about the equipment, its lifecycle and resale value? Do they also offer support with maintenance, instillation?

All these factors should be considered when deciding your capital structure, to leave your business as healthy and future-proofed as possible.

Anthony Roberts, Managing Director, Eclipx Commercial

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