Strategic Finance Flashcards
How to structure your growth idea when using organic growth?
- Business unit: a distinct division within a company that focuses on a specific product, service or market. Has its own management, budget and strategic plan.
- SPV: a subsidiary created by the parent company to isolate financial risk. Also called a bankruptcy remote entity.
Financial risks and factors
Fiscal factor: possibility for tax losses utilisation
Capital market factor: cheaper financing attractiveness using the commissioner’s risk profile
Foreign exchange factor: natural hedging is possible when the project is financed in the same currency as revenues and costs are earned/incurred
Country/political factor: the same jurisdiction
Economic factor: being a unit could be safer than being a stand alone company
Governance factor: less flexible to be a part of a bigger organization, decision making could take some time
Reputational factor
Key considerations for creating a business unit
structure of the unit
market demand
financial resources (can we actually create it)
staffing and talent
competitive landscape
operations and logistics
branding and marketing
regulatory considerations
integration with existing business
Financing a business unit
Internal funding within the organization
The company’s revolving credit facilities
Existing or new bank loans
Equity financing
Retained earnings and available cas excess
Benefits of SPV financing
borrowed funds in comparison with the parent company or business unit- Isolated Financial risks: SPV isolated financial risks from the parent company which can be particularly appealing to investors or lenders
- Direct ownership of assets: the SPV holds direct ownership of its assets, which can be beneficial for both legal and financial reasons
- Tax Savings: if the SPV is established in a tax haven (located in a place with less tax, e.g. another country), it might result in tax savings due to favorable tax laws in that jurisdiction.
- Ease of Creation: SPV’s can be relatively easy and quick to set up, depending on the legal jurisdiction
- Flexibility: the structure of an SPV can be customized to fit specific needs, like funding a particular project or investment.
- Financing advantages: an SPV might have the ability to secure larger borrowed funds compared to what the parent company could, potentially due to the SPV’s risk isolation and asset-focused nature
o Een SPV kan dit ten eerste omdat de SPV risico’s isoleert, geldverstrekkers kunnen meer bereid zijn geld te verstrekken aangezien hun blootstelling beperkt is aan de activa van de SPV en niet aan de bredere risico’s van het moederbedrijf. Ten tweede, de SPV kan worden gebruikt voor speicifieke projecten met duidelijke inkomstenstromen, waardoor het makkelijker wordt om investeringen voor dat project aan te trekken.
How to structure SPV financing?
- Intercompany Loans: loans from the parent company or related entities, which are typically used to start the operations of the SPV
- Proceeds from selling shares in the SPV: if the SPV issues equity, it can sell shares to investors to raise capital.
- Mezzanine financing: ‘’Imagine you have a company and need money – you don’t want a regular loan (because it includes interest) or sell a part of the company (which means giving up control), theres a mix of the 2 ‘’If I cant pay you back in cash, I’ll let you own a piece of my company instead.’’ Lender gets paid in interest / become a part-owner of the company.
- Corporate bonds issue: the SPV can issue bonds to investors, which is a form of debt financing where investors are promised periodic interest payments and the return of the bond’s face value at maturity.
- Bank loans: Traditional loans from financial institutions
Main steps setting up a SPV
- Choose the structure and the purpose of the SPV: legal form and financial structure
a. Decide what kind of legal entity the SPV will be (such as corporation or a trust) and what specifically it will be used for (like funding a project, acquiring assets etc) - Draft the legal documents (the article of incorporation, the charter, etc)
- Register the SPV
a. This step is necessary to be recoqnized as a legal entity and to conduct business legally - Obtain necessary licenses and permits
- Manage the project (growth option implementation)
Mortgage-backed securities (MBS)
Mortgage-Backed securities (MBS) explanation: Imagine there are 100 homeowners who each have a mortgage, meaning they are slowly paying off their homes with monthly payments to the bank. These monthly payments include both the repayment of the loan (the principal) and interest. Each mortgage by itself is not very easy to sell because it requires finding a buyer interested in that specific property and loan agreement. So, each mortgage is considered an “illiquid asset.”
Now, a financial institution like a bank comes along and gathers all these 100 mortgages together into one big pool. Instead of dealing with 100 separate mortgages, the bank is now dealing with one big collection of mortgages. The bank then creates “shares” of this pool that can be sold to investors. These shares are the Mortgage-Backed Securities. When an investor buys one of these shares, they are essentially buying a small part of each of the 100 mortgages. They won’t own the homes, but they will receive a portion of the monthly payments from all 100 homeowners.
For the investors, it’s like they are lending money to all these homeowners and in return, they get a piece of the interest payments. It’s similar to buying a bond where you lend money and receive interest, except in this case, the interest comes from the homeowners’ mortgage payments.
The benefit for the bank is that it gets a large sum of money right away from selling the MBS rather than waiting for 30 years to collect all the mortgage payments. The benefit for the investors is they get a steady stream of income from the monthly payments.
However, if some homeowners fail to make their payments or default on their mortgages, the value of the MBS can go down, and the investors might not get all the money they were expecting. This risk is what led to significant problems during the 2008 financial crisis when the value of many homes dropped and many homeowners defaulted on their mortgages.
Illiquid assets
Assets that can not be easily sold or exchanged for cash without a substanital loss in value in contrast to liquid assets like stocks or bonds (sold against market price) e.g. real estate, heavy machinery or ownership stakes in private companies,
Drawbacks of SPV usage
- Complex and require specialized legal and financial expertise
- Can be expensive, particularly for smaller growth options
- Reputation risk, if it doesnt succeed
Mezzanine Financing
Mezzanine financing is a way for companies to raise
funds for specific projects or to aid with an acquisition
through a hybrid of debt and equity financing.
* Mezzanine lending is also used in mezzanine funds
which are pooled investments, similar to mutual funds,
that offer mezzanine financial to highly qualified
businesses.
* This type of financing can provide more generous
returns to investors compared to typical corporate debt,
often paying between 12% and 20% a year.
* Mezzanine loans are most commonly utilized in the
expansion of established companies rather than as start-
up or early-phase financing.
* Both mezzanine financing and preferred equity are
subject to being called in and replaced by lower interest
financing if the market interest rate drops significantly.
Debt financing structures
Loans: Borrowing a fixed amount from a financial institution or lender with an agreement to pay back the principal along with interest.
Bonds: Issuing debt securities to investors in exchange for capital, where the company agrees to pay the bondholders interest at fixed intervals and to return the principal on the bond’s maturity date.
Lines of Credit: Establishing a credit limit with a lender which the company can draw upon as needed, paying interest only on the amount drawn.
Convertible Bonds: Bonds that the lender can choose to convert into equity in the company under certain conditions.
Lease Financing: Borrowing funds to purchase or lease assets, with the lender retaining ownership of the assets until the loan is repaid.
Debt financing definition
Debt Financing: This involves a company borrowing money that it must repay with interest, without giving up ownership. Instruments include loans, bonds, and credit lines.
Equity financing definition
Equity Financing: This is when a company raises capital by selling shares of stock, thus giving up a portion of ownership and control in the business to shareholders.
Hybrid financing
Hybrid Financing: These structures combine elements of debt and equity financing, such as convertible bonds which can be turned into equity, or preferred stocks which have features of both equity and debt.
Pros of debt financing
Interest on debt is tax-deductible
Debt financing allows companies to maintain control over business
Debt financing provides a predictable repayment schedule
Cons of debt financing structures
Debt financing requires regular payments despite of company’s performance.
Failure to repay debt can lead to bankruptcy or financial distress
Debt financing can result in high interest costs and restrictive covenants
Equity financing structures
Common stock
Preferred stock
Convertible equity
Stock options
