Debt is structured with specific parameters

Debt is created with defined terms, including the amount, duration, interest rate, guarantees, and commitments made to the lender. These terms influence both the company’s risk and the cost of borrowing. The right level of debt depends on a detailed financial and legal analysis, as structuring debt involves mastering finance, accounting, and law to translate these balances into guarantees, commitments, and conditions for early repayment.

Leverage affects profitability and risk

The leverage effect shows that a company can use debt to finance its operations, increasing the profitability of equity if the returns from its activities exceed the cost of debt. For example, a company with 100 million euros in assets and 8 million euros in profit can achieve higher returns with debt. However, if profits drop, debt also amplifies losses, making the level of indebtedness a strategic choice influenced by the company’s risk appetite and tax benefits from deductible interest.

Debt levels vary across companies

The acceptable level of debt differs based on a company’s financial situation and strategy. For example, the Orange group has a high debt level, while Hermes has no net debt. Banks often use debt-to-EBITDA ratios as a reference, and liquidity is crucial, as a company can be solvent but lack immediate cash. Credit lines with banks ensure access to funds when needed, avoiding financial distress.

Debt can be recourse or non-recourse

Traditional debt relies on the entire company’s financial strength, known as recourse debt. In contrast, non-recourse debt is tied to a specific asset or operation, increasing the lender’s risk and making the debt more expensive. The Accor group, for example, sold hotel walls to a consortium and retained operational control, reducing its debt. This illustrates how debt can be structured to align with a company’s financial goals.

Leveraged buyouts use high debt levels

A leveraged buyout (LBO) involves acquiring a company with a large amount of debt, typically 60–90% of the acquisition cost. The debt is repaid through the acquired company’s dividends, with interest deductible for tax purposes. However, this approach increases risk, as the company must generate enough income to cover debt payments. In France, most corporate debt comes from banks, while American companies rely more on bonds.

Negotiating debt involves duration, rate, and currency

Borrowers can negotiate the terms of their debt, including duration, interest rate, and currency. Long-term debt is better suited for long-term assets, while short-term debt carries refinancing risks. Companies like Orange manage their debt maturities to avoid sudden repayment pressures. The repayment method also matters: lump-sum payments require cash reserves, while annuities align with expected cash flows.

Lenders use protections to secure repayment

Lenders ensure repayment through the ranking of their debt, covenants imposed on borrowers, and the price they demand. Senior debt is repaid before subordinated debt, making it less risky and cheaper. Covenants require borrowers to meet certain conditions, and the price includes a margin for credit risk and fees. A well-structured debt considers finance, law, and accounting to ensure long-term financial stability.