Beyond the Headline Rate: Evaluating Funding Structures

Beyond the headline rate: how experienced finance directors actually evaluate a funding structure

By Arran Turner

I've sat across the table from enough finance directors now, discussing enough funding structures, to know the good ones ask the same question, in different words, within the first ten minutes: not "what's the rate," but "what happens when this doesn't go to plan."

That's the right question. Evaluating funding structures properly means treating the interest rate as one input among several, not the headline that decides the deal. A poorly built funding structure can look cheap on the term sheet and still be the most expensive thing your business signs this year, once you factor in what happens at drawdown, what the covenants actually require of you, and how the repayment profile holds up against a project that runs eight weeks late or a client who sits on a retention payment longer than the contract allows.

Finance directors in construction, engineering and manufacturing have less patience for headline-rate pitches than almost any other sector, and for good reason. These businesses live with long project cycles, seasonal working capital swings, and capital tied up in plant and machinery that has to keep earning whether or not the invoices have cleared. A funding structure that ignores those realities isn't a bad deal so much as the wrong shape of deal entirely.

Why does the headline rate mislead so many buyers?

The rate is the easiest number to compare, which is exactly why it gets weaponised. Two facilities quoted at 8.9% can behave completely differently once you look at how interest accrues, whether it's calculated on the original balance or the reducing one, and what fees sit outside the headline figure entirely: arrangement fees, documentation fees, exit fees, fees for amending drawdown schedules mid-contract.

A flat rate and an APR on the same facility can look deceptively close on paper and diverge sharply in practice, because a flat rate is calculated on the full original amount for the whole term, while APR reflects the reducing balance you actually owe as you repay. On a five-year asset finance agreement, that difference compounds into thousands of pounds that never show up in the number a broker leads with.

None of this means the rate doesn't matter. It means it's the start of the funding structure analysis, not the end of it.

What should a finance director actually be reading in the term sheet?

Five things worth reading properly, in roughly the order a poorly considered funding structure tends to reveal them:

Covenants. What financial ratios does the facility require you to maintain, and how often are they tested? A facility that requires quarterly interest cover of 3x sounds reasonable until your busiest quarter happens to fall right after you've just taken delivery of £400,000 of new plant on hire purchase and your balance sheet temporarily looks worse, not better, for having invested in growth.

Drawdown terms. Can you draw the facility in stages against project milestones, or is it a single lump sum on day one? For a construction business running three sites at different stages of a build programme, a facility that only releases funds against completed and certified work is a very different instrument from one that releases against invoiced value, and the gap between those two can be the difference between paying subcontractors on time and not.

Security requirements. What is the lender actually taking a charge over, and what does that mean if a second facility becomes necessary later? A debenture over all assets sounds standard until you need a second lender for a specific piece of equipment finance eighteen months later and discover the first lender's charge makes that awkward or impossible without a deed of priority.

Repayment structure. Fixed monthly payments, or a facility that flexes with revenue? Manufacturing businesses with genuine seasonality, a Christmas-goods producer running flat out from July to October and quiet the rest of the year, are often sold facilities structured for a business with even monthly turnover, because that's the default product, not because anyone checked whether it fits.

Behaviour under stress. This is the one almost nobody asks about, and it's the one that matters most. What happens if you miss a covenant test by a small margin? Does the facility default automatically, or is there a cure period and a conversation? Some lenders build in genuine flexibility for a business that's fundamentally sound but has had one difficult quarter. Others treat any breach as a trigger event. You will not find out which kind of lender you've signed with until the moment you need to know, so it's worth asking directly before you sign, not after.

How does retention money change the funding calculation for construction businesses?

Retention is the clearest example in construction of a working capital problem that a standard funding structure often doesn't fix, and a poorly matched funding structure sometimes makes worse. A typical main contract withholds 5% of certified value until practical completion, then releases half of that, with the remainder held through the defects liability period, often twelve months. On a £2 million contract, that's £100,000 sitting with your client for the best part of a year, doing nothing for your cash flow while you're still paying subcontractors, suppliers and wages against the full value of the work.

An asset finance facility for your plant doesn't touch that problem at all, because it's solving a different one. What retention actually calls for is a facility that recognises certified-but-unpaid value as a genuine asset, which is where invoice finance, or in some cases a specific retention finance facility, earns its place alongside equipment funding rather than instead of it. The finance directors who get this right aren't choosing one facility type over another. They're building a stack: asset finance for the plant, a working capital facility sized around the retention cycle, and headroom held in reserve for the project that runs late through no fault of yours.

Asset-based lending or invoice finance: how should a manufacturer choose?

This is one of the more common funding structure decisions manufacturing FDs face, and it's rarely as binary as it's presented.

Invoice finance, whether factoring or discounting, unlocks cash tied up in your debtor book, typically up to 90% of invoice value within a day or two of raising the invoice, rather than waiting the 30, 60 or 90 days your customer contract specifies. It suits a manufacturer with a concentrated but creditworthy customer base and genuine, provable sales ledger value.

Asset-based lending goes further, combining that invoice facility with a charge over plant, machinery, and sometimes stock and property, to build a larger, blended facility. It suits a manufacturer whose growth is constrained less by unpaid invoices and more by the sheer capital intensity of the business, where the machinery on the factory floor represents real, financeable value that a pure invoice facility ignores entirely.

The mistake I see most often is a manufacturer assuming these are competing products and picking whichever a single lender happens to offer, rather than working out which mix of assets in the business is actually underused as security, then building the funding structure around that answer.

What does a well-structured facility actually look like under stress?

Take a mid-sized engineering business I'd describe as fairly typical of the sector, and typical of the funding structures I see arranged for it: steady order book, a seasonal dip over the summer shutdown period most manufacturers observe, and a habit of financing CNC equipment through hire purchase as the order book grows. A facility built purely around the headline rate on that equipment finance, with no attention to the wider funding stack, tends to hold up fine right up until a large customer pays late in the same month a new machine's first payment falls due. That's not a hypothetical. It's the single most common way I've seen a fundamentally healthy business hit a genuine cash crunch.

The fix isn't a cheaper rate on the machine. It's a funding structure with enough flexibility elsewhere, a working capital facility with headroom, or a repayment holiday clause built in from the start, to absorb one bad month without triggering a covenant breach or forcing a scramble for short-term borrowing at a worse rate than anything in the original structure.

That's the real test of any funding structure, and arguably the only test that matters: not what it costs when everything goes to plan, but what it costs, in cash, in flexibility, and in the time your finance team spends managing it, the first time something doesn't.

What should finance directors ask before they sign?

A short list of funding structure questions, but worth having in front of you at the term sheet stage rather than discovering the answers after drawdown:

Is the rate flat or reducing balance, and what is the true APR?

What financial covenants apply, how often are they tested, and what happens on a minor breach?

Can the facility be drawn in stages against project milestones, or only as a lump sum?

What security is being taken, and does it restrict future borrowing against the same assets?

Does the repayment schedule reflect the actual seasonality of the business, or a generic monthly default?

Is there a cure period for covenant or payment issues, or does the facility default immediately?

How does this facility interact with existing finance, particularly where retention, invoice finance or a debenture is already in place?

None of these questions are hostile to the lender or broker sitting across the table. A good one will have answers ready, because they've had this conversation before with finance directors who've been caught out once and don't intend to be caught out twice. That, more than any rate on a term sheet, is usually the clearest signal of whether a funding structure has actually been built for your business or simply sold to it off the shelf.