As the Dust Settles on Brexit: What’s its Impact on the Middle Market

Posted on: November 9th, 2016

It’s been three months since the British public surprised the global financial community by voting in favor of ‘Brexit’ in a 52% to 48% vote. As soon as the results came in, financial experts were seen fiercely debating the pros and cons of the Brexit vote.

While a lot has been written about the effect of ‘Brexit’ on global markets and on businesses in the UK, the vote’s impact on the US Middle Market can be seen reflected in three specific areas.

Concern about the Interest Rates remain unfounded

For the average US-based middle market private equity fund, any threat to interest rate levels is a concern. However, post Brexit, the London InterBank Offered Rate to Fed Funds (LIBOR-FF) spread, which is a key measure of credit risk within the banking sector that tracks the movement of LIBOR against the US federal funds rate, held fairly stable around a range of 25 to 35 basis points.

This is in sharp contrast to the financial crisis of 2007, when the spread reached levels north of 350 basis points.

The loss of the ‘EU Passport’ for US Companies

The UK, more particularly London, is the most commonly used destination by US middle-market companies as a springboard into the EU.

Greatly preferred due to the lack of a language barrier, a huge talent pool, and easy access to the rest of Europe, this convenience may pose a problem post Brexit.

Unlike earlier when a London headquarters was all that a US-based company looking to expand into Europe needed, now they will have to seek separate establishments in the UK and in Europe.

A good time to buy

Subsequent to the vote, the exchange rate fell to roughly $1.36, from an average of about $1.60, putting the GBP near a multi-decade low relative to the US$.

In more basic terms, a target company in the UK that would sell for GBP 10 million will cost about 14% lower in US Dollar terms compared to two or three years ago.

This is great news for mergers and acquisitions and for US buyers of British firms. Platform acquirers in the US have more purchasing power.

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.