Bank financing as a supplement to equity – Strategic advantage or hidden risk?

When companies and investors face decisions around acquisitions, expansion, or growth, financing can play a decisive role. A key question often arises: should the entire investment be funded with equity, or can bank financing serve as a beneficial supplement? Bank loans can increase investment capacity, but they also introduce risks that need to be carefully assessed based on the specific context of the company. Choosing between equity and bank financing requires a strategic evaluation of both the opportunities and risks inherent in each financing model.

Henrik Larsen, Erhvervsdirektør hos kompasbank

Bank financing as a strategic tool

Bank financing, put simply, means that a company takes out a loan to cover part of an investment. This can enable large-scale acquisitions or projects without depleting the company’s equity reserves. It adds a level of flexibility and allows a business to seize opportunities that would otherwise be out of reach. It also opens the door to higher potential returns—provided the financed investment performs as expected.

As with any financial tool, however, there are both advantages and drawbacks. In the following sections, we’ll explore the main benefits and challenges of using bank loans to complement equity financing.

The advantages of bank financing

1. Increased investment capacity

One of the most evident advantages of bank financing is that it boosts a company’s overall investment capacity. By supplementing equity with loans, a company can pursue larger or more numerous investments than it otherwise could. This can be especially valuable in competitive situations, where acting quickly and having capital available can provide a major strategic edge. For larger companies or private equity funds with access to significant loan amounts, this advantage can create market opportunities smaller players simply cannot access.

2. Enhanced returns through leverage

By incorporating debt into their financing mix, businesses or investors can amplify the return on their invested equity. This principle, known as leverage, means that if the return on the investment exceeds the cost of the loan, equity gains can be magnified. Leveraged returns are a common strategy in private equity, where firms use debt to maximize capital efficiency and generate greater value for investors. While this strategy can lead to higher returns, it also carries increased risk.

3. Liquidity preservation and strategic flexibility

Another advantage of bank financing is that it helps preserve liquidity. By not tying up all capital in a single investment, companies maintain a buffer that can be used to cover unforeseen expenses or pursue new opportunities. At kompasbank, we often see companies benefit from this flexibility—especially in volatile markets, where the ability to react quickly to shifting conditions is critical to long-term success.

4. Tax advantages on interest payments

In many countries, including Denmark, interest payments on loans are tax-deductible, which effectively reduces the real cost of borrowing. This makes bank financing a financially attractive option compared to using only equity, which does not offer similar tax benefits. These savings can make bank loans a more favorable financing method in certain situations.

The drawbacks of bank financing

1. Increased financial risk and debt obligations

Despite its benefits, bank financing introduces a higher level of financial risk. A company takes on the obligation to make interest and principal payments regardless of how the investment performs. If the business doesn’t progress as expected or encounters unforeseen challenges, debt can quickly become a burden that limits future growth potential. This is particularly problematic in industries with volatile earnings or elevated risk profiles.

2. Dependence on bank terms and credit assessments

Banks often require collateral and evaluate a company’s financial health based on key metrics like profitability and cash flow. This can limit the company’s autonomy and make strategic decisions subject to bank approval. Furthermore, if a bank reassesses the company’s risk profile—due to changing financial conditions—it might tighten terms or deny future financing.

This dependency can complicate long-term planning. At kompasbank, we aim to mitigate this challenge by developing tailored financing solutions designed to unlock a company’s full potential.

3. Cash flow pressure and liquidity strain

Companies that take on substantial debt must continuously generate enough cash flow to meet interest and repayment obligations. This can place considerable pressure on daily operations—especially during periods of reduced earnings. If a company struggles to maintain consistent revenue, it may be forced to cut costs elsewhere, potentially affecting operational efficiency or future growth opportunities.

4. Economic uncertainty and market volatility

One of the biggest risks with bank financing is its sensitivity to broader economic conditions. During times of financial instability, banks may tighten lending criteria, making it harder to secure or refinance loans. Additionally, rising interest rates can make borrowing more expensive than initially anticipated. In such scenarios, companies may find themselves in financially vulnerable positions that threaten long-term sustainability.

Conclusion: Balance is key

The decision to finance an investment solely with equity or to include bank financing depends on a variety of factors—such as the company’s risk appetite, strategic goals, market conditions, and overall financial health. Bank financing can act as a powerful lever for accelerating growth, enabling access to larger investments and enhanced returns. But it also carries a set of risks that must be thoughtfully considered.

For many companies, a balanced approach—where part of the investment is financed with equity and part with debt—offers the most benefits. This method allows businesses to scale and improve returns while maintaining financial stability and flexibility. Ultimately, successful financing requires a thorough evaluation of both the opportunities and the risks associated with each option—and, crucially, a strong, active partnership with the bank.

Background

This article was written in collaboration with the Corporate Finance consulting firm, Flair Capital, and has also been published in the manual Seven Steps, which can be purchased and downloaded via Flair Capital's website.

Seven Steps is a manual for equity owners who are considering raising growth capital and/or contemplating a full or partial sale of their company.