Strategic Management: Capital Structure Issues for Laundries
Chief Financial Officer of Health Check Inc., and American Associated Companies, Jon Scala was published in RSA Magazine -September 2015. Click here to read the full article.
STRATEGIC MANAGEMENT:
CAPITAL STRUCTURE
ISSUES FOR LAUNDRIES
Decisions about capital structure can impact a company’s costs
and its ability to pursue acquisitions
By Jon Scala
Most operators in today’s textile
services market must focus on:
1) optimizing their capital structure,
given the low interest rate environment
since the financial crisis; 2) longterm
growth objectives, and 3) their
risk/reward profile.
The best capital structure maximizes the
business value for its equity stakeholders,
but also offers a balance between the ideal
debt-to-equity ratio, while minimizing
the firm’s cost of capital. In theory,
debt financing generally offers the lowest
cost of capital due to its tax deductibility
and higher lien position on assets.
However, it’s rarely the optimal structure,
since a company’s risk generally
rises as its debt increases. The decision
regarding what type of capital structure
a company should have is of critical importance
because of its potential impact
on profitability, solvency and the organization’s
ability to grow. Debt vs. Equity—This focuses on the
level of debt vs. equity in the overall
capital structure. Although debt provides
a lower short-term cost alternative,
it requires an increased short-term cash
outflow (interest & principal payments)
necessary to support this obligation. Although
every business would look to
minimize its cost of capital, this would
imply that the capital structure should
be 100% debt as it provides a lower cost
of capital, tax deductibility and usually
a long-term fixed rate cost. But clearly,
this is not the case as debt financing requires
strong and immediate cash flow
to support payments and oftentimes restricts
the company’s operational flexibility
with financial covenants and restrictions on cash-flow use. Equity
provides a more expensive capital cost,
but doesn’t require immediate cash payments
(except for preferred equity), and
return horizons are typically much longer
as compared to debt financing.
Business Profile—Each type of capital-structure
decision ultimately is determined
by the profile of the company,
which includes long-term growth goals,
operational flexibility needed, size and
cash-flow. Each of these factors determine
the mix between debt and equity as
they impact the amount of capital raised
and the cost of capital.
The financial-services landscape has developed
and can be much more complex,
diverse and difficult to navigate. Once a
decision is made to raise debt, equity or
a combination of both, there are a variety
of products available, depending on
which would provide the most effective
blended cost of capital. The chart on
page 89 illustrates the various financial
products available.
Ultimately, management must align its
long-term goals with capital-structure
decisions. This capital structure strategy
should be reviewed frequently, updated
and remain flexible with the operational
growth and strategic plans of the business.
Although capital structure will be a
driver for growth, it can also be a detriment
if not managed in conjunction with
cash flow and operational concerns. Given
the historic low interest-rate environment
and significant capital requirements
of the laundry sector, unique and effective
capital structures can be not only
operationally successful but can drive
competitive effectiveness by allowing
businesses to respond quickly and effectively
to changes in the marketplace. Click here for the full article.