Leveraged finance is the term used to describe the funding of an enterprise or business that has above-average debt for their industry. Connor Mulvey is a financial professional based in Chicago. He explains that having above-average debt suggests that the funding is riskier and costlier than traditional borrowing. Because of this, businesses will often rely on levered financing to achieve a detailed — but short term — goal. For example, they may be looking to make a business acquisition, buy back company shares, fund a dividend or engage in a buyout or they could be trying to invest in some form of cash-generation asset.
Depending on the financial institution, the Chicago resident highlights that there may be some differences in their interpretation of ‘leverage finance’. However, they will almost always include two primary products:
- Leveraged Loans and,
- High-Yield Bonds
A key driver in most leveraged finance, especially when speaking with regard to leveraged buyouts, is “in-between debt”, more formally known as a mezzanine. Connor Mulvey says that this type of debt is frequently used by mid-cap businesses around the US and throughout the EU as an alternative to bank debt or higher yield bonds. In terms of ranking, it falls between high bank debt and business equity. These types of investors assume greater risk potential than those who purchase bonds, but they see higher returns, averaging upwards of 20%.
Connor Mulvey notes that traditionally, it is smaller businesses (those not large enough for bonds) who use mezzanine debt, but recently it has become commonplace for larger leveraged acquisitions.
There are multiple financial tiers involved in leveraged finance. They include things like high-value secured bank loans, and subordinated bonds and loans. Leveraged financers need to efficiently determine how much financing should be raised based on the type of financing used. In the event that a financer overestimates a company’s capabilities, they may lend more than can be repaid or they could be left holding bonds they can’t sell.
As a knowledgeable financial professional, Chicago-based Connor Mulvey answers the following questions:
What is Leveraged Acquisition Finance?
Leveraged acquisition finance refers to the lending of loans or the issuing of higher yield bonds to fund the acquisition of a business or parts of a business by its senior executive team (management buyout), or from an external senior executive team (management buy-in) or some other 3rd party.
What is Leveraged Recapitalization?
Whenever a company assumes substantial debt with the intent to pay some sort of high dividend or buy back shared, they will take advantage of something called leverage recapitalization. In the case of the buy-back of shares, the remaining shareholders benefit from a more financially-leveraged business. Firms will typically use this practice as a way to protect themselves from a hostile takeover.
What is Leveraged Asset-Based Finance?
Leveraged asset-based financing refers to the raising of debt-related capital for businesses with physical assets or some form of contractual cash flow to be used for highly levered asset funding or special projects. Chicago’s Connor Mulvey offers examples of this: leasing, project funding or enterprise security.
Like all other elements of finance, leveraged finance involves the ability to clearly identify, analyze and solve risks. Those risks include:
- Risks related to credit and other financial scenarios — economic conditions, interest rates, exchange rates, taxes, etc.
- Risks related to the provisioning of financing — legalities, paperwork, settlements, etc.
- Risks related to liquidity — the ability of a leveraged company to refinance itself if the market changes.