Middle Market Companies Face New Daunting Economic Realities
Published on by Barnes Dennig in COVID-19, Transaction Advisory
Business owners are facing a new economic reality: never before have cash reserves been so vital to sustaining business continuity. Private equity firms are urging their portfolio companies to draw down on their open lines of credit to gird themselves for the most turbulent financial downturn in the last 90 years.
That’s excellent advice for any company right now, private equity owned, or not.
Amid all of the chaos in the market, certain business-positive conditions have emerged:
- For borrowers, interest rates have returned to the 2008 – 2015 lows, with prime now down to 3.25%. To put that into perspective, prior to that seven-year period, the prime rate had been higher than 3.25% dating back to 1955. Low borrowing rates reduce the sting of going to the bank and can enable many borrowers to sustain themselves in spite of all the other negative forces cast upon them.
- From an acquisition perspective, the sellers’ market of 2013 – 2019 has quickly become a buyers’ market. One silver lining to the very painful collapse of the capital markets is that business valuation multiples will likewise drop substantially, enabling buyers to take advantage of low acquisition prices and very favorable borrowing rates. Private equity firms know this. They will be actively buying companies.
Conversely, the changing economy also spawns substantial challenges:
- Lenders and investors will be much more cautious in deciding where to invest. The “rising-tide-lifting-all-boats” economic expansion period has been detonated. Some industries, such as information technology and infrastructure services, will be in favor and highly rewarded with availability of capital. Other industries that depend heavily on human interaction like tourism, entertainment, hospitality, and retail will be shunned, as the capital markets attempt to interpret how the cultural shifts in American lifestyle in the age of the global fear will impact business earnings.
- A premium will be placed on the ability to demonstrate financial sustainability through forecasting and historical trend analysis in the face of economic downturns. Business that do their homework in illustrating their viability in spite of macroeconomic woes will have the greatest chance of prosperity in a changing global economy.
- Sellers will face substantial headwinds in seeking exit valuations to which we have become accustomed. Middle market private companies take their valuation cues from their public company peers, and unless and until public company valuations recover, sellers will face the unsettling choice of exiting at a discount or holding on in a ‘wait-and-see’ suspense. Neither option is particularly appealing.
Comparisons to, or drawing wisdom from, other economic declines may not provide the best guidance for businesses. We have never faced such a global social affliction. This is not a case of the financial markets turning on specific world events, like the threat of war, or an energy crisis, etc. During this nascent period of social distancing, self-quarantines and shelter in place orders, the demand for goods and services will continue, but until we adapt socially to a new world order of understanding which changes are temporary and which are permanent, our present situation will leave many businesses in an economic stare-down. Accordingly, access to cash and cash reserves will be the most crucial of all resources to ensure sustainability.
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When faced with the rapidly shifting business environment that we face due to the COVID-19 pandemic, it’s essential to partner with an advisor who can help you navigate the turbulent waters. If you have questions about the present economic situations facing middle market businesses, funding sources, what it means for your business, or need assistance with mergers, acquisitions, tax, audit or accounting issues, Barnes Dennig can help! For additional information call us at 513-241-8313 or click here to contact us. We look forward to speaking with you soon.
