The financial structure of a company is the mix of financing types that are used to invest in resources and fund operations.
Types of Financing
Bring in new funds for investment and operating capital by borrowing. Borrowing can take on many forms such as bank lending and bond issues. The types of borrowing also vary by terms such as short term and long term debt.
Pros: Existing shareholders are not diluted. Interest may be tax deductible (US taxes).
Cons: Debt payments may cut into cash flow necessary to keep the business running. Risk of default may result in equity holders losing their investment.
Bring in new investment in exchange for equity.
Pros: New funds for investment and to fund operations. No debt payments.
Cons: Dilution of existing shareholders. No tax deduction.
Refinancing can be used to change the financial structure of a business. Refinancing can fall into two categories:
- Injecting new capital into the company for expansion or to finance ongoing operations.
- Changing the financial structure of the company.
New capital may be needed for growth, or to cover operating losses for a company having difficulties. The new capital may come from debt or equity.
Changing the financing structure involves a change in financing policy. For example, a company may decide to increase its debt to equity ratio by taking on new debt and using it to buy back stock.
Conversely, a company may sell equity and use the proceeds to pay off debt.
Companies that go through bankruptcy, and survive, will by necessity undergo refinancing.
A change in dividend policy can be used indirectly to change the financing structure. For example, instead of paying dividends, the funds can be used to pay down debt or buy back stock which will change the debt to equity ratio.