June 9, 2023 | 5-minute read (908 words)
In the ever-evolving world of business, entrepreneurs and startups face numerous challenges in their pursuit of sustainable growth. One critical aspect that can significantly influence their journey from pre-seed startup to profitability is corporate finance. And, more specifically, the strategic management of their capital structure.
The decisions key business leaders make regarding the composition of their financing — including their debt and equity mix — can significantly impact their ability to maximize shareholder value. That’s what makes corporate finance one of the most complex and impactful strategies for growth.
In this article, we’ll take a look at how your startup’s capital structure can change your growth trajectory, how leverage can boost your profits and your risks, and three proven strategies you can use to increase your long-term shareholder value. If your startup is considering fundraising or reevaluating its capital structure, these insights may help.
What is the best capital structure?
Capital structure refers to the debt and equity financing you use to cover your startup’s operations, investments and growth initiatives. The optimal balance between these sources of funding depends on your industry, operations and growth goals.
The capital structure you choose early on in your growth journey can have a significant effect on your shareholder value. If you choose to take on more debt to fund your operations and investments, you can enjoy greater liquidity and potentially generate a higher return on investment for every dollar of debt you take on. And because debt tends to come at a lower cost than equity, your profitability can increase faster. That, in turn, leads to enhanced shareholder value.
Equity, on the other hand, doesn’t come with fixed interest payments or principal repayment requirements. That’s why equity financing gives your startup greater flexibility from the beginning — especially in your agile early growth stages. And because equity investors want to see your startup succeed, they tend to offer their targeted expertise, mentorship and valuable connections as part of the funding deal. The ROI on a valuable equity partnership is difficult to calculate, but the long-term benefits of equity can outweigh the short-term growth from debt — and create greater shareholder value over time.
If you’re unsure which capital structure your startup should use, consider working with a corporate finance professional well-versed in both. Outsourcing this key strategic maneuver to an experienced CFO can position your company for greater growth, less risk and stronger shareholder value from the start.
The impact of leverage on your shareholder value
As described above, debt financing can offer your startup faster growth, greater capital and amplified shareholder value — but that leverage can also come at a significant cost.
As your startup takes on more and more debt to finance growth and operations, your overall risk increases. If your startup struggles to generate enough profit to cover your interest payments, that little bit of leverage can quickly bankrupt your young company. Or, if you encounter financial difficulties or can’t complete your intended outcome with the cash you have on hand, your startup may be unable to pay back the debt — tanking your shareholder value in the process.
Too much leverage can jeopardize the financial stability of your company. But the right amount of leverage positions your company for amplified returns.
For example, say you’re a technology startup seeking funds to increase product development. You choose to utilize debt financing and successfully secure a loan. You then use that loan to complete product development and begin manufacturing your new product. And the product is an instant hit! As the sales roll in, your ROI quickly surpasses the interest on your loan, and you’ve used leverage to scale effectively.
If the company in the example above chose to rely on equity — or bootstrap their growth — they could have missed out on the fast-paced growth of a well-timed product. But if the market wasn’t ready for their product, that debt could have bankrupted the business.
Each startup can choose to use leverage — and take on risk — differently. But the general concept is the same. A bit of leverage in the right market can be the key to sustainable growth.
How can your startup apply these insights to increase shareholder value?
In addition to managing your cash flow carefully and minimizing risk where possible, your startup can use these three strategies to maximize shareholder value:
1. Use debt strategically. Amplify your returns and increase your inexpensive working capital by using the right amount of debt to fund your high-potential initiatives. Carefully calculate the optimal level of debt that gives your startup the opportunity to grow, without overleveraging your venture.
2. Balance your debt and equity. The right mix of debt and equity depends on your risk tolerance, goals and the market around you. Striking the right balance between cheap debt and equity that comes with built-in expertise can help your startup optimize its capital structure and increase shareholder value.
3. Outsource your CFO services. Collaborate with an experienced CFO to create a tailored corporate finance strategy that optimizes your capital structure and drives greater shareholder value. Outsourcing allows startups and businesses at every stage, to keep their costs low without sacrificing the services they need for growth.
Corporate finance is a complex, but necessary, part of building a stable company. By integrating these three strategies into your corporate finance plan, you can offer your shareholders exceptional value — and position your startup for long-term success.