Some businesses with significant operating capital are reassessing their capital structures amid economic uncertainty and rising interest rates.
The prime rate, which sets the benchmark for commercial lending, was 3.25% from March 2020 to early 2022, following the Fed’s move to slash rates and stimulate the economy. Since then, rates have climbed rapidly, reaching a peak of 8.50% in mid-2023, and settling around 6.75% after recent cuts. Banks typically add a margin based on the borrower’s risk profile, so actual borrowing costs are even higher.
Businesses that may have traditionally leveraged debt to fuel growth may now be considering a more measured approach to balancing debt, liquidity, and financial flexibility. This article explores when it might make sense to reevaluate business capital structure strategy.
When to Reevaluate Your Debt vs. Liquidity
If you’re unsure whether your business capital structure strategy needs updating, here are some signs that it may be time.
Your debt-to-EBITDA ratio is near covenant thresholds: Your debt-to-EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) ratio measures how much you owe relative to business earnings. Commercial lenders may prefer lower ratios, depending on the industry and borrower profile.
If your ratio is rising toward your covenant thresholds while earnings decline and debt remains constant, it may signal the need to reassess your debt and liquidity balance.
A large loan is coming due, and refinancing means significantly higher payments: A loan at 4.25% in 2020 could refinance at 7.75% in 2025, nearly doubling your borrowing cost.
Rising interest rates on loans are affecting a growing share of your operating cash flow: If loan payments leave too little available for reinvestment, financial reserves, or seizing opportunities, your current capital structure may no longer be optimal.
Strategies to Consider When Reevaluating Your Debt-to-Liquidity Mix
Once you’ve identified a need to adjust your capital structure, your next move may depend on your cash flow, risk tolerance, and timeline. Here are two strategies to consider:
1. Restructure Your Mix of Fixed- and Variable-Rate Debt
Banks can support you in strategically balancing your fixed- and variable-rate debt across your loan portfolio. Fixed-rate loans may offer greater predictability, while variable-rate loans may provide more flexibility if rates decline.
2. Proactive Covenant Renegotiation
Consider approaching your lender if you see your business consistently trending toward a loan’s covenant threshold. Early engagement may provide more options to negotiate adjustments to your loan terms.
For example, lenders may be more willing to work on waiver amendments or other solutions if you present a clear picture of your business finances and plans to address issues impacting your covenants.
Partnering With Your Bank
Banks can help you evaluate if your current business capital structure strategy still suits your business’s cash flow and risk profile. A bank like Northstar Bank can be a strategic partner, working with you to proactively adjust your capital structure. Contact a banker today to discuss your loan portfolio and identify opportunities to strengthen your capital position.
