This article is the fifth in a series designed to explain the iCIRT assessment process and illuminate 'What Good Looks Like' for businesses aspiring to achieve a strong rating. An iCIRT rating is the result of an objective and independent assessment across six critical pillars: Character, Capability, Conduct, Capacity, Capital, and Counterparties.
Here we focus on the ‘Capital’ pillar of the iCIRT assessment.
iCIRT rated Brolen Homes achieved a strong ‘Capital’ assessment score, reflecting their sound financial foundation and resilience.
Defining 'Capital': Is the business financially resilient?
When iCIRT assesses a company’s ‘Capital’, it examines its financial resilience and long-term viability. It scrutinises its ability to fund operations and absorb the impact of periods when trading results might be poorer than expected. Or put another way, it assesses how much ‘skin in the game’ owners have.
The Capital pillar differs from the 'Capacity' pillar of the assessment, which examines whether a business has the operational and financial resources to deliver on commitments in the short-term. Capital scrutinises the long-term mix of funding sources for the business, ensuring it has a solid financial foundation to endure challenging market conditions.
Key aspects under scrutiny include:
Financial backing:
The value of and mix of equity is examined. Is the business a nominal $2 company or does it have substantial committed capital? Are earnings from profitable trading being retained in the business or distributed to shareholders. A company that doesn’t grow its equity at the same rate as its top line revenue will have a smaller contingency to weather trading losses or adverse events.
iCIRT rated Binah Group achieved a strong ‘Capital’ assessment score, reflecting their sound financial foundation and resilience.
Funding sources:
iCIRT examines how assets and work in progress are funded. Is it a loan from shareholders, long-term debt from reputable financial institutions or high-interest, short-term mezzanine funding, which can be more speculative and harder to service.
⭐The capital pillar assessment is very similar to what a financier would consider when evaluating a loan application, as they are also interested in your ability to endure a higher interest rate environment or a period of economic downturn.
Debt serviceability:
Where debt facilities are in place or imminently needed, a company’s ability to service that debt is scrutinised. Metrics like interest coverage and financial leverage are key. Can the business's operating earnings reasonably cover these costs? And would a lender have an appetite to extend or even maintain the facilities that are being offered to the business?
Headroom and covenants:
Does the business have adequate headroom in its debt facilities? Are they fully drawn, or is there room to manoeuvre? Also assessed is how well a company is meeting the financial and reporting covenants (ie the rules of a debt facility) or if there have been any technical defaults.
iCIRT rated Orwell Constructions:
How to strengthen your 'Capital' profile for an iCIRT rating
Businesses aiming for a strong score in the 'Capital' iCIRT assessment can take several proactive steps. Here's “What Good Looks Like”:
Re-evaluate your funding structure
Put yourself in the shoes of an unsecured creditor and review your capital structure from the perspective of a supplier or contractor impacted by your business failure. Really focus on the equity position of the business - how are you funding the business and why? For example, if you’ve capitalised with loans from shareholders that you have no intention of ever withdrawing, give consideration to whether a different structure, such as share capital or preference shares, would be more suitable. Also ensure any deeds and guarantees you have in place are not there to remediate a weaker capital structure.
⭐What If your capital structure is complex?
iCIRT recognises that many businesses employ complex capital structures and does not penalise complexity itself. However selective disclosure, lack of transparency or undocumented complexity is a key concern.
Transparency and full disclosure
A willingness to be open is paramount. This means readily providing requested information, including making sure all inter-company loans and financial agreements are properly documented with clear terms, conditions, and repayment schedules.
Prioritise creditors
If you have inter-company loans supporting a particular company, ensure these rank in a way that considers the priority of creditors. A loan that's deferred in favor of other commitments shows a commitment to your business's financial health.
Optimise your funding facilities
A strong capital score is often linked to having adequate headroom and flexible terms. Consider whether it's appropriate to increase a credit limit or extend the term of your financing agreements. You might also be able to renegotiate or remove restrictive covenants from your facilities, which may reduce the risk of a technical default.
⭐ Being proactive with your finances when things are going well is far better than waiting until you desperately need help.
Consider retaining earnings
Consider whether distributions/dividend payments need to be made or whether earnings can remain in the business to reinforce its capital profile.
By focusing on strengthening your capital structure, businesses can improve their iCIRT rating prospects and build stakeholder trust by demonstrating a responsible and resilient financial foundation.
Stay tuned for the next article in this series, where the focus will be on the 'Counterparties' pillar of the iCIRT assessment.
Useful resources:
Understand how we assess ‘Character’
Understand how we assess ‘Capability’
Understand how we assess ‘Conduct’
Understand how we assess ‘Capacity’