Leveraged finance is an important aspect of investment banking that helps investors generate funds or income through borrowing. Its value lies in savvy well-informed investing decisions, as investors believe that the income from assets that are purchased through borrowed money will exceed the initial cost of borrowing. In an investment bank, you can usually find a department of employees who are specialists in deals regarding leveraged finance. This team is capable of assisting investors in several ways with the primary goal being to help companies issue more debt to fund company investments or future growth. Leveraged finance teams must work closely with other departments to help fulfill a company’s needs.
Leveraged finance is an especially attractive route for companies that already have a high debt burden. Companies with high debt will expose themselves to further risk if they choose to issue additional bonds and securities. Therefore, companies with high debt are more likely to issue debt through leveraged finance. Since finalizing deals based on financial leverage requires a more specialized role, investment banks offer their services to help companies structure the most efficient financial leverage plan.
Types of Leveraged Finance Deals
Refinancing Debt: This is the process through which companies can replace old debt structures by taking on new debt. The new debt terms are usually structured to offer the borrower lower interest rates and payment amounts on the existing debt. Companies then use the funds received from the new debt to repay the old debt (since it has a higher interest rate). Thus, companies can refinance debts to create more favorable repayment structures that offer lower interest rates and payment amounts, giving companies more flexibility and purchasing power.
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New Acquisitions: If a corporation wishes to make a new acquisition i.e., purchase a new company, it can use debt to do so. Investment banking services work with corporations to help make such a transaction possible. When a corporation purchases a new acquisition mostly using funds from debt issuance, it is known as a leveraged buyout (LBO) transaction.
Dividend Recapitalization: This is when the investors of a company receive a special dividend that helps them recoup part of their investment. Companies generate the funds for this dividend by taking on more debt. Dividend recapitalization helps reduce the risk for investors as they get to liquidize a part of their investment. It is a technique commonly used to help investors increase their returns without having to sell their stake in a company.
Mortgage: A common type of financial leverage loan for individuals is a mortgage. If an individual wishes to purchase a house but does not have the funds, they can use a mortgage to finance the transaction. A mortgage classifies as financial leverage because it uses the process of debt to create wealth.
Benefits of Financial Leverage
Financial leverage can help companies and individuals:
- Increase return on investments.
- Increase purchasing power.
- Improve flexibility.
- Create favorable terms when issuing debt. (e.g. refinancing debt)
CONCLUSION
Financial Leverage can help companies with a high debt burden conduct transactions they would not have the capital to do so otherwise. Investment banking services play a key role in offering the support companies need to make the right decisions. While the uses and benefits of financial leverage are evident, there is also an element of risk that companies must be aware of. Leveraged finance is a double-edged sword since poor decision-making can also lead to further losses and put a company at financial risk. Companies can rely on the expertise provided by investment bankers and other financial institutions to increase their chances of conducting successful deals and transactions.
