Decisions about capital structure can impact a company’s costs and ability to pursue acquisitions. Given historic low interest-rates and significant capital requirements of the laundry sector, unique and effective capital structures can support operational success and drive competitive effectiveness by allowing businesses to respond quickly and effectively to changes in the marketplace.
Given the current environment in the industry, laundry operators should carefully consider working capital structure. Operators interested in growth in today’s textile services market must focus on:
- Optimizing capital structure given current low interest rates
- Long-term growth objectives
- Their risk/reward profile
The best capital structure maximizes the business value for its owners offering a balance between the ideal debt-to-equity ratio, while minimizing the firm’s cost of capital. In theory, debt financing generally offers the lowest cost of capital due to its tax deductibility and higher lien position on assets. However, it’s rarely the optimal structure, since a company’s risk generally rises as its debt increases. The decision regarding what type of capital structure a company should have is of critical importance because of its potential impact on profitability, solvency, and the organization’s ability to grow.
Key factors to be considered when making capital-structure decisions include:
Debt vs Equity—This focuses on the level of debt vs. equity in the overall capital structure. Although debt provides a lower short-term cost alternative, it requires an increased short-term cash outflow (interest & principal payments) to support this obligation. Every business should minimize its cost of capital and debt financing appears to provide a lower cost of capital, tax deductibility and usually a long-term fixed rate cost. But clearly, this is the not the case as debt financing requires strong and immediate cash flow to support payments and oftentimes restricts the company’s operational flexibility with financial covenants and restrictions on cash-flow use.
Equity provides a more expensive capital cost, but doesn’t require immediate cash payments (except for preferred equity), and return horizons are typically much longer as compared to debt financing.
Business Profile— Ultimately, capital-structure decisions are determined by the company’s profile, which includes long-term growth goals, operational flexibility needed, size, and cash-flow. Each of these factors determine the mix between debt and equity as they impact the amount of capital raised and the cost of capital.
Today’s financial-services landscape is much more complex, diverse and difficult to navigate. Once a decision is made to raise debt, equity, or a combination of both, a variety of products are available to provide the most effective blended cost of capital.
Ultimately, management must align its long-term goals with capital-structure decisions. Your capital structure strategy should be reviewed frequently, updated, and remain flexible with the operational growth and strategic plans of your business. Although capital structure will be a driver for growth, it can also be a detriment if not managed in conjunction with cash flow and operational concerns.
Laundry operators should carefully consider all of the above, given the current environment in the industry. Succession planning is an ongoing issue for textile services companies, and given the large number of operators that are for sale, or that will come up for sale in the near future, organizations need a flexible capital structure that will enable them to execute on such opportunities.
In addition to succession-planning issues, consolidation in the industry is accelerating, specifically in the healthcare market. Hospital consolidation is increasing and more local and regional laundries face the prospect of acquisition by larger regional or national laundry operators that have a deeper reach in service-area capabilities due to hospital mergers and acquisitions, along with the vendor consolidation that typically follows.
Companies must consider capital structure decisions carefully because they play a vital role in the cost structure of an organization. Moreover, they also allow for, or prohibit growth opportunities through sale or acquisition.
Jon F. Scala, CPA and CEO of American Associated Companies, (662) 231-8305 email@example.com Join Jon for a focus group on Friday, Oct. 2nd at the Universal Unilink Business Development Conference, Isle of Palms, SC.