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.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.