Building Long-term Value: Plan on It
"Everything has a price, as the saying goes, but a lot of p...
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Companies are considering how their capital structures can protect against a broad range of catastrophic risks. But that's like a health plan that pays out only for the most costly, life-threatening diseases. Did BP envision a drilling accident that would shut off its access to short- and medium-term capital markets and result in worldwide condemnation? If it did, it certainly didn't prepare accordingly.
Those types of risks can be hard to identify and quantify and difficult to hedge. And certain events—financial-market meltdowns, product liability, and acts of God—are tough to insure against in traditional policies. In addition, there is typically a great deal of time and ambiguity surrounding the litigation that generally follows these events. Here's what to consider in building a financial hedge against the large risks that can crush a company:
Meeting leverage needs
If the scenario applies, you can maintain debt ratios consistent with a target financial rating. By running less-leveraged, you gain flexibility and create what might be called a "crumple zone" for large negative events. It may help in the case of, say, missing an interest payment, but it can be economically costly. What's the right earnings-per-share hit needed to support a long-term, save-the-company strategy? What's the proper reduction in return on equity? The answer will differ for every company.
Another tactic might be to use less debt and go after longer maturities, less bank debt, or roomier covenants. Considering leverage versus other finance risks is another way to get comfortable with higher amounts of debt. Taking on debt offers substantial tax benefits, but you pay higher interest rates and reduce flexibility in terms of making investments.
If you do run with more leverage, you can protect yourself in other ways, such as by lowering operational risk. Regardless of the path you choose, you need to periodically update your assumptions and adjust to financial-market movements.
Sources: Capital Crumple Zones, CFO
Salem Five's financial experts can help you review your current debt structure and ensure that you and your business are prepared for any eventuality. From offering a range of loan and line products, to helping you plan for long-term growth and change, we can help you prepare for the future while mitigating risk for your business.
Contact a Salem Five financial expert