In today’s world, funding solutions are available for practically every business requirement. Lenders are available to support in various situations, from financing growth and acquisitions to managing cash flow and turnarounds.
However, funding needs often aren’t straightforward. In some cases, companies have deeply complex needs they have to address. Innovative and outside-of-the-box solutions are needed.
Structured finance was designed to meet complex financial needs. We explore what structured finance is and how it helps companies.
What is structured finance?
Structured finance refers to a financial vehicle created to address complex funding needs or those seeking options outside conventional modes.
Structured finance will typically involve one or more transactions to be completed, which increases the risk of the deal. Corporations commonly use it. It looks at utilising all asset classes as security.
Traditional lenders, such as banks, do offer it for larger SMEs and corporates. But you may also need to find a specialist to work with your company.
Examples of structured finance
Many forms of finance fall under the ‘structured finance’ umbrella. Asset-based lending (ABL) and development finance also falls under this umbrella. We have listed them some of the other areas:
- Collateralised debt obligations (CDOs) – a funding package that combines loans, mortgages and other assets to convert them into tradeable debt instruments that are offered to investors
- Collateralised bond obligations (CBOs) – combining junk bonds to create an investment-grade security, thereby creating diversification and reducing risks for investments
- Collateralised mortgage obligations (CMOs) – where mortgages are combined and sold as one investment, ranked by maturity and risk
- Credit default swaps – a contract that shifts the risk of a fixed income product to another party in exchange for a premium
- Syndicated loan – a loan extended by a group of financial institutions to one borrower
- Hybrid securities – a broad group of securities (e.g. stocks and bonds) that have debt and equity traits
Benefits
There are many advantages to using structured finance.
Firstly, structured solutions typically offer significant capital injections that go far beyond what a traditional lender may be able to provide.
One of the most significant benefits of structured finance is that it is designed to meet challenging funding needs. As a result, more companies have access to the funding they need.
It is commonly used to develop financial markets, fund corporations in evolving industries or facilitate business growth. ABL funding, it is commonly used in MBO, MBI and mergers. This means increased opportunities for growth, which further benefits the broader economy and society.
Structured financing is used to manage risk by transferring it from sellers to buyers of the structured products. It allows them to reshape liquidity while minimising the hazards associated and passing it elsewhere,
Collateralised bond or debt obligations will offer individuals better opportunities to source higher financial returns by purchasing instruments as a package. Pooling funds and securities together make a greater return on investment available. This means investors also gain rewards as well as the businesses involved – so it’s a win-win for everyone.
Other considerations
Structured finance is complex, so it’s no surprise there are plenty of considerations to make before you commit.
One of the most significant is the risk associated with structured solutions. This is mainly involved with debt, mortgage and bond obligations. For example, if a debt loan defaults, the financer will be unable to pay investors their returns, leaving them at a detriment.
The risk exposure will vary between different parties involved in the solution, so you must take the time to understand the hazards posed to your business before you commit.
Unlike some funding types, structured products tend to be non-transferable, so they can’t be shifted to other forms of debt in the way a standard loan could. You must meet the criteria initially set out when you committed to the funding.
Structured finance is also more complicated to understand due to the multiple facets involved, which may be off-putting to some. Seek the expertise of a reliable corporate finance advisor or commercial finance broker who can take you through the process and implications.
Conclusion
Structured finance is valuable for those seeking solutions for non-standard situations.
However, there are many factors associated with it that you need to consider. Alongside the advantages, there is potential risk and plenty of other implications to understand before you commit.
It’s therefore advised to take your time understanding structured finance and work with a corporate finance advisor or commercial finance broker to access their expert guidance.
If you are seeking funding for your business, Pegasus will take you through the various options on the market and find one that suits your objectives. Our extensive range of contacts has a solution for every scenario – no matter how complex.