Finance is one of the most important components of a business and is required in all aspects and stages for a business to grow. The quantum of finance required varies, depending on the stage the business is in. Various transactions undertaken in the business world also require funds. Transactions, such as acquisitions, mergers or even reverse mergers, require a significant amount of capital as opposed to the amount required for normal expansion of a business. In such circumstances, a business may often rely on leveraged finance investment banking to fulfil its requirement for funds. Both sources of finance rely on different instruments of the capital markets and may serve different purposes as per the requirement of the company. Leveraged finance, which saw a decline in its interest after 2008, has regained its vigour, with the total size of the market increasing to USD1.2tn.
What is Leveraged Finance?
Leveraged finance is an extension of finance to a company, enabling it to borrow additional loans even if it is currently under considerable debt. As the company has significant debt, it is often rated below investment grade and carry a higher risk of default. Subscribers who subscribe to such debt instruments are often aware of the risk but still invest in the company, as it has the potential to turn around. Such debts are offered in the form of high-yield bonds or mezzanine financing (given preference after below-investment-grade bonds in case of bankruptcy).
Many consultants provide their clients the service of obtaining leveraged finance to help them overcome financial difficulties. Such leveraged loans or finance are granted by banks or financial institutions who further sell such loans to institutional investors or retail investors based on the tranches. This would reduce the cost of the leveraged finance while allowing investors to profit or earn interest if the company successfully manages to turn around its operations. Leveraged finance is, thus, associated with debt financing for an organisation with high levels of debt, which is generally of sub-investment standard.
Corporate/Investment Banking:
Corporate finance or investment banking is also associated with raising funds for various business activities, but these funds are not limited to debt financing or leverage, as is the case with leveraged finance. In addition, investment banking is involved in a wider variety of operations rather than merely raising finance for a company; it is involved in various transactions within its operations, such as mergers or acquisitions and buyouts, including leveraged buyouts, initial public offering for a private company and restructuring of a company. It can even be argued that leveraged finance could be considered a part of the investment banking function with a specific role. Investment banking focuses on a wider array of activities, while leveraged finance focuses on a specific role, which is to raise additional debt to fund business operations or even fund an acquisition in certain scenarios. Leveraged finance in this sense is a limited term, whereas investment banking is a wider term that may very well include leveraged finance as well.
What is their utility?
Leveraged finance is frequently employed in a situation where raising equity is not an option. Such a situation often arises in the case of a management buyout of a company, wherein the company’s management raises debt and takes over its administration. In such situations, management may not have the financial capacity to inject liquidity; however, through additional debt and operational efficiency, it aims to turn around the business and repay the debt on the books of the company. Leveraged finance investment banking is a popular way to raise funds to acquire a company, with leveraged buyouts often executed based on the earning capacity of the company.
Leveraged finance is a high-risk strategy, as there is a chance of default by the company (due to the already existing leverage on the books of the company). Such finance can be restructured to allow breathing space for the company’s management. While leveraged finance and companies engaged in this space focus solely on high-yield bonds and below-investment-grade bonds, investment banking includes other forms of finance. Many consultants often have different departments for both the activities. Acuity Knowledge Partners provides both services to its clients, allowing them to take advantage of the existing situation before them
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