The Banking Crisis and Growth Capital Liquidity

Posted on: May 16th, 2023

growth-capital

Middle market business performance has been strong in the first quarter of 2023. Continued overperformance requires growth capital, which is bound to become tighter as the new banking crisis evolves into a new phase. The market is confronted with a loss of confidence in banks with strong financial ratios, and the no-confidence contagion appears to be spreading.

Yet, this crisis poses upside opportunity for intrepid businesses armed with growth capital. When the tide of warm liquidity recedes and empty vessels such as crypto and SPACS are sinking, middle market companies with growth capital have the ballast to set sail. Banking liquidity is becoming constrained as evidenced by a slowdown in growth capital lending activity. Basic banking activities such as wire transfers and ACH’s are also becoming more challenging for some banks, which is odd. In times of uncertainty, it pays to budget in an ultraconservative way to mitigate deleterious effects from a shortening of the financial supply chain. Financial supply chain issues were a huge factor in the 2009 Banking Crisis.

As larger companies got pinched by their banks, they decelerated their payments to their vendors, which in turn caused them to slow their payments to their vendors. This had a cascading, negative multiplier effect on the entire economy as companies had to wait longer for their receivables collections yet had to speed up their payments to their vendors. This naturally caused a good amount of working capital to tighten such that excess cash on the balance sheet was diverted from growth capital uses to shoring up working capital. The stage is set for a repeat of this painful period which underscores the need for all middle market companies to get out in front of this.

Even if you believe you are well capitalized with growth capital, it would be wise to stress test your working capital beyond the normal historical levels. Growth Capital lenders are cognizant of the need of middle market companies to fund working capital, in times of growth and stress. Their mandate allows for flexible utilization of their growth capital loans, as long as the funding activates long term cash flow growth in conformance with the strategic growth plan.

As new acquisition financing credit funds pivot to non-private equity sponsored deals, many lack experience with the asset class. Non-sponsored deals such as direct loans to companies or loans to independent sponsors making acquisitions are quite different from private equity backed deals and require a different thought process and engagement style from the lender.

During their underwriting processes, acquisition financing providers analyze probable performance projections for their proposed borrowers. The underwriter often toggles between a few scenarios to sensitize the growth variables leading to slower revenue and margin growth over time. The lender’s underwriting view is usually an extension of its credit intelligence and historical experience.

Mezzanine debt loans occupy the risky echelon beneath the bank but ahead of the equity in a capital structure. They are naturally subordinated to the bank loan via an intercreditor agreement wherein the senior lender retains the power to block their interest or force them to standstill.