What is leveraged finance?

How to use gearing to finance a business

Leveraged finance is a method of funding a business using a higher-than-normal ratio of debt to equity. It’s commonly used by companies wishing to make a specific investment or acquisition with a view to rapid growth.

Financial leveraging is considered to be a high-risk/high-reward strategy where the levels of risk and reward are determined by the ratio of debt to equity within the lending. The higher the debt when compared with equity, the higher the risk.

So, could your business use this type of funding to accelerate growth and get ahead of your rivals and what specific drawbacks of leveraged loans do you need to be aware of before applying?

How is leveraged finance used?

Financial leveraging, also known as gearing, is typically used to fund investments or carry out targeted growth or expansion projects. The purpose of securing leveraged funding is to increase the potential returns of investment.

Mergers and acquisitions (M&A) and management buyouts (MBOs) are commonly conducted using financial leveraging. It’s also important to note that, although the strategy offers significant advantages in terms of potential profit for companies, with that comes higher risk.

What are the advantages and disadvantages of leveraged financing?

Advantages

Increased borrowing capacity

The additional capital that leveraging provides offers access to larger, potentially more lucrative investments that generate higher profits – investments and projects that might otherwise be unattainable for your business if using ‘standard’ forms of financing, such as business bank loans.

Flexibility

As a short-term finance strategy, leveraging offers your company the flexibility to act quickly as opportunities arise. This, in turn, broadens your investment choices and lowers the likelihood of making poor decisions based on narrower options.

Tax-efficiency

Leveraging is a tax-efficient process, as the interest paid on a leveraged loan is tax-deductible.

Disadvantages

Higher risk

Leveraged lending presents a risk of higher losses and/or magnified debt levels if the investment plan fails due to market changes or other unforeseen circumstances. That’s why it’s important to take professional advice on financial leveraging and fully understand the possibilities of such threats materialising in your industry.

Complexity

Financial leveraging typically incorporates complex financial instruments and higher interest rates, which could be more costly than if you followed ‘traditional’ lending strategies.

Credit rating

Leveraging increases your business’s ratio of debt to equity, which could potentially impact its credit rating and your ability to secure further loans going forward. If your company defaults on a loan a marker is placed on your business credit file and remains there for six years.

How to apply for leveraged finance

Given the complexity of this type of finance, it’s crucial to obtain specialist guidance before going ahead with an application. Our team can provide the professional support you need if you’re considering leveraged financing for your company.

We’ll establish whether it’s the right course of action and help you prepare and present your application. UK Business Finance is a well-established commercial finance brokerage. We operate offices around the country, so please get in touch to find out more.