How is Leverage Finance Investment Banking Used to Increase Equity Returns?
Many companies use the term ‘leverage finance’ to increase their equity returns in their everyday business activities. Although leverage finance brings several benefits for the companies, many business owners new to the finance world may find it confusing. Since it effectively increases equity returns, understanding it in detail is worth it.
Here we are discussing the basics of leverage finance investment banking and how it increases equity returns.
What is Leverage Finance Investment Banking?
Leverage finance investment banking is the strategy of borrowing funds to increase ROI, acquire assets, or raise company funds. If the return on the invested value is more than the interest paid, the company makes a significant profit. Businesses borrow money to create debt from the lenders and promise to repay it along with the interest charges. A highly leveraged business is one whose debt is higher than equity. Accordingly, the investors can make the correct decisions before investing in any company, firm, or property.
A company may use investment banking in leverage finance for multiple reasons: to increase their assets’ value, acquire new equipment, or increase shareholder value. The aim is to increase equity returns and the return on investment. Asset value and loan interest are the two primary factors coming into play in leverage finance. If the asset value increases and goes higher than the loan interest, the asset company receives higher returns and experiences profit.
Based on the above logic, the asset value must increase more than the interest amount to bring profit to the company. Many companies use a combination of debt and equity to raise funds or finance their working capital. Therefore, to run a business, leverage finance is something that the business owner must understand, as it plays a crucial role in managing business operations.
Advantages of Leverage Finance
Leverage finance investment banking is a multi-faceted tool that is complex in nature but enhances equity returns when a company or investor uses it wisely. These are the advantages that help a business expand its horizons:
- Companies borrowing loans via leverage finance make relatively small investments.
- Companies investing in leverage finance buy more funds and assets for their organization.
- When the asset value increases, it benefits the company by giving them higher returns on their investments and staying within a profit margin.
Here is an example of how leverage finance investment banking results in outsized equity returns. Let’s say an investor has $1,000 and borrows $15,000 from a lender at a 6% interest rate. If they invest total of $16,000 and receive growth of 15% within a year, they return $15,900 to the lender, and the investment value at the year-end will be $18,400. So, the borrower is left with $2,500 with a net profit of $1,500 after subtracting the initial investment of $1,000. That’s an equity return of 150%!
Understanding the Effects of Leverage Finance
Although the effective debt cost is lower than the equity, leverage increases a company’s cash flow and earnings. However, there are risk factors like changes in liquidity, industry stability, and shifts in the interest rates and overall economy. Companies offering leverage finance services use data-based solutions to understand leverage use, assess risk and returns, and forecast cash flows. Accordingly, the corporate and investment bank or specialist advisory firm may select an appropriate rate to find a company’s present value.
What Leverage Finance Services Do?
The job of leverage finance service providers is divided between structuring debt, analyzing risk and credit, and communicating with the clients. They examine their debt investors and clients’ credit profiles and analyze potential returns to the sponsors. They determine capital structure according to the client’s projected finance. Besides these, they are also experts at originating deals, conducting capital market research, managing asset/portfolio, and handling trade and sales of debt instruments. Working with a leverage finance services provider offers an opportunity to collaborate with PE firms. It is particularly attractive to businesses and individuals interested in private equity.
Other leverage finance services offered include benchmarking, indicative rating analysis, debt headroom analysis, pitchbook support, market updates, LBO model, covenant analysis, industry research and overviews, financial modeling, RPF support, and many others. Get in touch with a Knowledge Partner for extensive support across project finance, leverage loans, acquisition financing, debt restructuring, refinancing, and other finance-related dynamics and solutions.