Financing

Perspectives

Financing in 2017

Private company issues and opportunities

Overview

Driven by an economy that continues to pick up speed, private companies are gearing up to borrow more in the year ahead. Our latest annual survey of private and mid-market companies found that more of them plan to tap cash-flow financing, secured loans and private sources of capital as their optimism in the economy’s direction grows.1 Some may be looking to get ahead of rising interest rates. Three Federal Reserve rate hikes since December 2015 have started to push up borrowing costs, though rates remain low by historical standards and a growing economy is expanding private companies’ borrowing capacity.

Issues

Interest rates have risen enough in recent months that private companies are getting more “rate-conscious,” says John Deering, a managing director at Deloitte Corporate Finance LLC. That’s because in recent years the London Interbank Offered Rate (LIBOR) – a benchmark rate for establishing interest rates on many loans – was well below the 1 percent floor established for many financing arrangements. Now that LIBOR has risen above that mark, variable-rate deals are rising, and so are private companies’ interest expense. “It’s a major consideration in our world,” says Deering.

The value of private equity deals was 25 percent lower in 2016 than the year before and reached the lowest level since 2013, according to Preqin.2 While higher pricing certainly played a part, Deering says uncertainty around the recent US election is also making private sponsors cautious about committing capital until the impact of the new administration’s policies on demand and profitability are clear. “Private equity firms are not seeing as many deals compared to this time a year ago,” Deering says. “It appears the entrepreneurs are taking a short term, wait-and-see attitude and part of that is related to the election results.” On the other hand, “the private equity firms expect the buy side pace to accelerate in the very near future”.

Meanwhile, the market for initial public offerings was chilly in 2016, after a host of new offerings received a poor reception from investors.3 While our mid-market survey picked up a large increase in the number of respondents expecting their companies to pursue an IPO in the next 12 months, Deering says the current market may be better suited to big technology companies with “explosive” growth opportunities. “The biggest red flag in the current environment is feasibility,” he says. “It’s very challenging to attract research coverage for traditional mid-market companies and, at the end of the day, if you’re not trading at above-average volumes, you’re almost treated as a private company anyway.”

Opportunities

Despite these warning signs, Deering says most lenders are staying active and aggressive in working with younger, entrepreneurial companies. Business development companies—or BDCs—have been much more active in the middle market recently as their stock prices have rebounded and they are under investor pressure to deploy capital. Deering says there are now more than 40 BDCs vying for investment opportunities, up from only a handful five years ago. “They are very motivated to get dollars out the door,” he says.

Private equity firms are staying busy as they have increased their appetite for dividend recapitalizations amid investor pressure and more aggressive debt markets. Such arrangements are meant to generate early returns for investors before portfolio companies are sold, and Deering says PE firms are turning to recaps much earlier in the investment cycle. A dividend recap can help reduce investor pressure and buy company management more time to execute their strategy, but it’s only meant for companies that are healthy enough to absorb the extra debt.

“It’s like putting 30 percent down when buying your home and then turning around and taking equity out of it only a year later,” he says. “It beats trying to sell your home too soon.”

Private companies can also take action to stave off the impact of rising interest rates. Deering says “more sophisticated” borrowers in the middle market are entering into interest-rate protection products in which they swap variable-rate terms for fixed rates on a portion of the debt. “If you are highly levered, this is something to be seriously considering,” he says. “You don’t want a great year of operating performance to be derailed by rising interest expense.”

Questions to consider

  • Have you considered partnering with a BDC to tap additional expansion capital?
  • If your company is backed by private equity, is it financially healthy enough for a dividend recapitalization?
  • Have you considered interest rate swap or cap products to reduce your exposure to rising interest rates?
  • If you’re considering going public this year, have you laid enough groundwork that you’re confident of a warm reception by investors?

Visit the Private company issues and opportunities homepage to view a list of topics.

References

1 “America’s economic engine – Breaking the cycle,” Deloitte, February 2017, https://www/deloitte.com/us/dges/breakingthecycle.

2 “Preqin Private Equity & Venture Capital Spotlight January 2017 – 2016,” Value Walk, January 29, 2017, http://www.valuewalk.com/2017/01/preqin-private-equity-venture-capital-spotlight-january-2017/.

3 Stephen Grocer, “Stock Market Rallied in 2016, IPO Market Didn’t,” Wall Street Journal, December 27, 2016, http://blogs.wsj.com/moneybeat/2016/12/27/stock-market-rallied-in-2016-ipo-market-didnt/.

About Deloitte Corporate Finance LLC

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This publication contains general information only and Deloitte Corporate Finance LLC is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte Corporate Finance LLC shall not be responsible for any loss sustained by any person who relies on this publication.

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