Over the past year or so, all kinds of economic warning signs have been flashing for business leaders – rising interest rates, falling stock prices, growing economic risks. In times like these, cash is king. You may need it to protect yourself in a storm; Or, you may want money because you have the opportunity to play offense. But how do you line up those funds? Investments in middle market companies from private equity firms have been on a downward spiral over the past 10 years while lending to middle market companies fell nearly 60% last year. Additionally, you can no longer rely on commercial banks for your lending needs the way you probably did in the past. Under the current circumstances, getting a good deal on new capital is not what it used to be in the “cheap money” environment. This article offers advice for middle-market companies trying to raise capital in uncertain times.
Two years ago, I wrote for Harvard Business Review article about how middle market companies are underserved and overcharged for capital transactions. Nowadays, with all the turmoil in the financial markets, a new type of squeeze exists for mid-sized companies.
Over the past year or so, all kinds of economic warning signs have been flashing for business leaders – rising interest rates, falling stock prices, growing economic risks. In times like these, cash is king. You may need it to protect yourself in a storm; Or, you may want money because you have the opportunity to play offense.
But how do you line up those funds? According to the 2022 Annual US PE Middle Market Report, Pitchbookinvestments in middle market companies from private equity firms have been on a downward spiral over the past 10 years while lending to middle market companies has fallen nearly 60% in the past year.
Additionally, you can no longer rely on commercial banks for your lending needs the way you probably did in the past. Since 2014, the role of banks in leveraged lending decreased from about 80% to less than 10% of all leveraged loans. And the trend of non-bank predominance in middle market lending is growing.
However, even the private debt market of specialist lenders, business development companies (BDCs), family offices, and non-bank lenders is currently facing a major challenge among non- sure outlook for the economy in 2023. After nearly a decade of rapid growth, private debt could be in for a rude awakening as higher interest rates and stricter covenants threatens companies’ abilities to service their borrowing costs. These factors are forcing investors to think twice about their exposure to private debt. Meanwhile, aggressive monetary tightening and the real prospect of a global recession could also slow the deal pipeline for alternative lenders, as it has already done for private equity capital providers.
However, on the bright side, investors are raising more new debt and equity capital. In early April, The Wall Street Journal reported that Assured Guaranty Ltd and Sound Point Capital Management have agreed to merge into a $47 billion corporate debt fund to take advantage of high demand from investors who want to put their money into private debt hoping for higher yield than the stock market provides. Large PE firms also remain strong in their private credit strategies. In December, private equity firm KKR encourages its limited partners to increase their allocation to private debt, and the credit arm of Blackstone has more than double its AUM (assets under management) for the last five years.
And on the home equity side, middle market PE fundraising remains steady at $133 billion in 2020, 2021, and 2022 – up from an average of $95 billion in 2017 and 2018 according to PitchbookThe 2022 Annual US PE Middle Market Report.
What Does This Mean for Middle Market Companies?
Middle market companies – typically those with between $25 million and $1 billion in annual revenue – can no longer rely on previous capital providers to get the best deal. The right deal, with beneficial terms you, be partnered with an equity investor or lender you never knew about.
Recently, a senior executive at a national accounting firm (40,000 clients with $50 million and under in revenue) told me, “One of my clients, a merchant cash advance company did a debt securitization. They paid their investors 3.5% interest on securitization notes last year. They are currently doing a deal at 8.5%. So, if they advance money to business owners, the cost to business owners will increase.”
The reason is that you will pay more to raise capital for the foreseeable future. The likelihood is that you will be under-served and overpaid for capital in the coming months or years. And, it affects many companies like yours. According to National Center for the Middle Marketon average approximately one third of middle market companies seek credit in a year.
Three Ways Mid-Market Companies Can Look for Funds
If you need to get funding for your business, where do you start your search? Try these three methods:
Your circle.
You can start by looking for the best deal you can get from your known circle. But the “usual suspects” may not come to you. With the impact of the pandemic, inflation, and general economic chaos on the horizon, that old gang of capital suppliers has changed. Your local commercial bank, private equity firms, and many non-bank lenders may not bother working with you, but you can try shopping around.
Hired help.
If you are too busy to run your comparison shopping business yourself, you can hire someone to shop for you. Crowds of commercial lenders and M&A advisors have sprung up since the dawn of the pandemic to help middle-market companies navigate alternatives. You won’t have a hard time finding thousands commercial loan brokers willing to charge you 2% to 5% to help you find loans. And equity financing brokers charge anywhere from 4% to 10% for raising capital that much.
Networks and online markets.
Find the best deals through a tech-enabled marketplace. While almost all lenders – including banks – offer some sort of online solution to your financing needs, many new technology-enabled marketplaces have emerged to help. Shopping tools like Opus Connect and Axial equity fundraising networks. Brain Capital You are allowed to submit your loan application to a pool of nearly 2,000 lenders split roughly 50-50 between commercial banks and non-bank lenders. Cerebro charges a fee for using their tool above whatever rate you pay to the last lender. The same is true for RealAtom and iBorrow, both designed for commercial property financing. If your financing needs are larger ($50 million or more), you have several advisors and funders to choose from such as MidCap Financial and Alliance-Bernstein.
Know What You Want and Shop Smart
While any of these three methods will get you the funds you need to grow, there is more at stake than the money itself. The terms, ease of the process, and maintaining control of your confidential information and the time of the process are important to any successful deal. Circumstances vary and the trade-offs are real, but whichever route you take, try:
- Improve your chances of getting funding. Pay attention to operational efficiencies by making sure you have tight control and that you are lean. AlixPartners points to a higher probability of closing deals for companies with good operations.
- Go for the best terms. Shopping among alternative capital suppliers. Shopping helps you compare prices, agreed valuations, collateral, conditions, and covenants.
- Maintain confidentiality and process control. Protect your confidential company information, avoid pressure from third parties at the time or trying to lead you to a deal you don’t want.
- Understand your total costs. If you use third parties (brokers, advisors, online tools, lawyers, tax advisors, etc.) to help, make sure you understand how much you’re paying for the help you’re getting and who’s paying for it. any payment.
Under the current circumstances, getting a good deal on new capital is not what it used to be in the “cheap money” environment. But in many ways, navigating the new landscape of capital acquisition is easier – the resources are often at your fingertips. You just have to remember to be realistic about what you’re getting out of a deal, use the best available data security to send it safely, and negotiate terms you’re willing to pay. Find a process that works for you — preferably one that’s relatively simple and cost-effective for you and your company.
