Two years ago, I wrote a Harvard Business Review article about how middle market companies were under-served and over-charged for capital transactions. Nowadays, with all the turbulence in financial markets, a new kind of squeeze is on for mid-sized companies.
For the past year or more, all kinds of economic warning signs have been flashing for business leaders — rising interest rates, falling stock prices, the growing risk of recession. In times like these, cash is king. You might need it to protect yourself in a storm; or, you might want cash because you have a chance to play offense.
But how will you line up those funds? According to the 2022 Annual U.S. PE Middle Market Report, Pitchbook, investments in middle market companies from private equity firms has drifted downward over the past 10 years while lending to middle market companies has fallen nearly 60% over the past year.
What’s more, you cannot rely on commercial banks for your lending needs the way you probably used to do. Since 2014, the role of banks in leveraged lending has declined from about 80% to under 10% of all leveraged loans. And the trend of non-bank predominance in middle market lending is growing ever stronger.
However, even the private debt market of specialty lenders, business development companies (BDCs), family offices, and non-bank lenders now faces a big test amid 2023’s uncertain economic outlook. After nearly a decade of rapid growth, private debt could be in for a rude awakening as higher interest rates and more restrictive covenants threaten companies’ abilities to service their borrowing costs. These factors in turn force investors to think twice about their private debt exposure. Meanwhile, aggressive monetary tightening and the very real prospect of a global recession could also dampen the deal pipeline for alternative lenders, much as it has already done for private equity capital providers.
Yet, on the bright side, investors are raising large amounts of new debt and equity capital. In early April, The Wall Street Journal reported that Assured Guaranty Ltd and Sound Point Capital Management agreed to join forces in a $47 billion corporate debt fund to take advantage of the high demand from investors who want to put their money into private debt hoping for higher yields than the stock market is providing. Big-name PE firms also remain bullish on their private credit strategies. In December, private equity firm KKR was urging its limited partners to increase their allocation to private debt, and Blackstone’s credit arm has more than doubled its AUM (assets under management) over the past five years.
And on the equity side of the house, middle market PE fundraising remained steady at $133 billion in 2020, 2021, and 2022 — up from an average of $95 billion in 2017 and 2018 according to Pitchbook’s 2022 Annual U.S. 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 past capital providers to get the best deal. The right deal, with terms that benefit you, may be with an equity investor or lender you don’t even know yet.
Recently, a senior executive of 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 is doing a debt securitization. They were paying their investors 3.5% interest on the securitization notes last year. They are currently doing a deal at 8.5%. Thus, when they advance money to business owners, the cost to those business owners will be going up.”
The bottom line is that you are going to be paying more to raise capital for the foreseeable future. The likelihood is that you will be under-served and over-charged for capital in the coming months or years. And, this will affect many companies just like you. According to the National Center for the Middle Market, on average approximately one-third of middle market companies will seek a loan in a given year.
Three Ways Mid-Market Companies Can Go Hunting for Funds
If you need to secure funding for your business, where should you begin your search? Try these three avenues:
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 through for you. With pandemic impact, inflation, and general economic turmoil on the horizon, that old gang of capital suppliers has changed. Your local commercial bank, private equity firms, and many non-bank lenders may no longer be anxious to work with you, but you can try shopping around.
Hired help.
If you’re too busy running your business to comparison shop on your own, you can hire someone to shop for you. Hordes of commercial loan brokers and M&A advisors have sprung since the dawn of the pandemic to help middle market companies wade through the alternatives. You’ll have no trouble finding thousands of commercial loan brokers ready to charge you 2% to 5% to help you find loans. And equity financing intermediaries changing anywhere from 4% to 10% for capital raising abound.
Networks & online marketplaces.
Find the best deal through a tech-enabled marketplace. While nearly all lenders — including banks — offer some sort of online solution to your financing needs, several new tech-enabled marketplaces have sprung up to help. Shopping tools like Opus Connect and Axial are equity fundraising networks. Cerebro Capital lets you 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 the use of their tool beyond whatever rate you pay to the ultimate 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 many 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 avenues can get you the funds you need to grow, there’s more at stake than the money itself. Terms, ease of process, and maintaining control of your confidential information and the timing of the process are important to any successful deal. Circumstances vary and the trade-offs are real, but whatever route you follow, try to:
Under the current circumstances, getting a good deal on new capital is not going to be like it was during the past “cheap money” environment. But in many ways, navigating the new capital acquisition landscape is easier — the resources are often at your fingertips. You just need to remember to be realistic about what you can get out of a deal, use the best available data security to transmit it safely, and negotiate the terms you ultimately are willing to pay. Find a process that works for you — preferably one that is relatively simple and cost effective for you and your company.
This content was originally published here.