Interest-bearing Debt

Interest-bearing debt is a measure of the long-term debt a company has. Since financial planning with business owners focuses primarily on the Equity Value of the business, interest-bearing debt plays a key role in estimating business valuation and the proceed potential of a business owner.

Interest-bearing debt directly increases the Equity Value of a business, since it must be satisfied with excesses in liquid assets (estimated as net working capital) at the time of sale.

Interest-bearing debt explained

Interest-bearing debt refers to loans, bonds, notes payable, or other obligations a business has that require the payment of interest over time.

Common examples include:

Bank term loans

Revolving credit lines

Equipment financing

Bonds or debentures

Shareholder loans with interest clauses

This debt is typically long-term in nature (due beyond 12 months), though short-term interest-bearing liabilities can exist.

Impacts of interest-bearing debt on valuation

When working with business owners as a financial advisor, it's important to focus on the Equity Value within the business.

In the event of a sale, debt liabilities would first need to be satisfied with any excesses in liquid assets. The remaining value after satisfying these obligations represents Equity Value, the value the shareholders are owed.

Equity Value = Enterprise Value + Net Working Capital - Interest-bearing Debt

When estimating Equity Value, liquid assets are used to satisfy short-term and long-term obligations.

Liquid assets are represented as Current Assets in the net working capital calculation

Short-term obligations are represented as Current Liabilities in the net working capital calculation

Long-term obligations not due in the next 12 months are represented as interest-bearing debt

Interest-Bearing Debt in financial planning

For a financial advisor, gaining a comprehensive view of a client's debt means understanding business obligations as well.

This is essential for:

Exit Planning: Helping business owners understand how debt affects their eventual proceeds potential

Cash Flow Planning: Working with owners to ensure the businesses obligations can be met before taking out additional cash from the business

Debt itself is not inherently bad and can be used to support growth strategically. However, owners should be aware of the trade-off between financing growth and reducing the value of their equity at exit.

In Summary