Corporate Finance Tools

How does Leveraged Finance Work?

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Leveraged finance is the decision to acquire debt that is more than average or normal rates in hopes of greater return on investment and profits. It’s done to purchase investment assets, under the assumption that those assets will go up in value.

It’s a useful way of maintaining ownership of the company, repurchasing shares, working towards a buyout or invest in a self-sustaining cash-generating asset. However, it is often risky because of the effects it has on a company’s operations and finances.

The risk emerges when a company becomes too unstable and there is volatility in its cash flow—which could mean the day to day expenses will become harder to manage—the earnings are also affected by this volatility. With unstable earnings and cash flow, it can be difficult to bring in investors or lenders who will be willing to put their money in a company that can suffer loss so easily.

When leveraging, there also needs to be accountability of factors such as the shift in liquidity of the company, the economy and inflation that can also affect interest rates, and the stability of the industry the company works in. All these things need to be factored in during an analysis of a company’s performance, and assessing cash flows, future actions and current standing.

Depending on a company’s plans, whether they’re internal or external buyouts by managers and shareholders respectively, or complete acquisitions, leverage acquisition financing can be a useful way of regaining majority shares. This can be done via bank loans, for instance.

Another form is leveraged recapitalizations which is also with the intention of repurchasing shares or paying off extraordinary dividends to keep shareholders interested, instead of wanting to pull out. It’s one way of preventing hostile takeovers in a company.

Leveraged asset-based finance is what we’ve talked about above, using debt to purchase assets that will pay off in the long run.

Leveraged finance is a tricky path to steer down but can be very useful for a company. Learn more through our website!

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