Funding Fundamentals: Why, From Whom, and On What Terms

Between July 2022 and September 2023 the ECB raised its deposit rate at ten consecutive meetings, from minus 0.5% to 4%. Nothing about most European businesses changed in those fourteen months. Their customers were the same, their margins were roughly the same, their management teams were the same. What changed was the price of the money they had already borrowed, and for anyone on unhedged floating-rate debt the interest line roughly doubled or worse. Some companies had chosen that exposure knowingly. A surprising number had never thought of it as a choice at all.

Funding decisions are made one facility at a time, usually under time pressure and often by people whose main job is running the business. The result is often an unplanned capital structure, built reactively, and not designed to support the company's long-term goals. This often leads to more expensive funding, restrictive conditions, giving up more control of the business than is necessary, or even increasing the likelihood that you lose control altogether.

The articles in this cluster supply the fundamentals that should sit underneath each of those decisions.

• Why the company needs money. What are you funding?
• Who is providing the funding?
• What is the form, structure and terms of the deal?

If you understand and answer each of these questions, you can avoid a lot of the major pitfalls associated with funding.

Why: the need should determine the instrument, not the price

This is an argument honoured more in theory than in practice. Companies borrow for a wide range of reasons, and each of those reasons has different requirements, different terms, and different costs. From the monthly working-capital gap to a once-a-decade acquisition, from funding a factory to funding a dividend, from refinancing old debt to simply holding cash against a bad year. Each has a natural tenor bucket, approximate flexibility requirements and a handful of default providers.

• A ten-year asset funded with a three-year loan locks in refinancing risk.
• A permanent working-capital need covered by an overdraft is not only expensive, but also leaves you highly reliant on a poorly documented facility that a bank could cancel at any time.

From whom: every channel closes independently

Funding used to be a choice between which bank, but the menu of options is far broader now. Banks, private credit funds, venture and private equity, insurers and pension funds, bond and commercial paper markets, development banks and government agencies, and a long tail of alternative lenders.

Each has its own balance sheet, risk and return targets and its own reasons for being interested in you, and each has its own idiosyncratic vulnerabilities which could lead to pressure on refinancing or funding that has nothing to do with your performance.

Bank capital in 2008 and 2023, venture funding in 2022, sterling bond markets after the September 2022 mini-budget, supply-chain finance when Greensill failed in 2021. If you were unlucky enough to be exposed to the affected funding source in one of these periods you will understand why diversification should apply to funding as much as deposits once you grow beyond an early-stage company.

On what terms?

It starts with Debt or Equity. Then there is a myriad of options in between.

The source of capital is just the first in a long series of decisions with each funding round. Secured or unsecured, senior or subordinated, recourse or non-recourse, short or long term, fixed or floating, amortising or bullet repayments, corporate-level or asset-level. Once these terms come easy you are ready to dive into the complexities of documentation, covenants and credit enhancement.

The same job at three sizes