I’m writing this in the aftermath of a day at the Cheltenham Festival. Cheltenham is one of the largest gatherings in National Hunt racing and, in some respects, an interesting framework for considering certain trends in the lower mid-market for those owner-managed businesses seeking to raise or restructure debt.
After a fun, but fairly soggy, day at the Festival, I found myself reflecting on the challenges for local businesses raising finance – the conditions, the runners and riders, the hurdles and, ultimately, the winners and losers.
Bear with me as I try to shoehorn a few comments (tips you might even say!) into my horsey metaphor.
The conditions
Like the going at Cheltenham this year, conditions for raising debt are certainly softer than one would like.
The wider economic challenges are well publicised. Interest rates, inflation and trading costs are all eating into businesses’ ability to leverage. Add the wider issues resulting from armed conflicts, plus the prospect of elections on both sides of the Atlantic, and you don’t have particularly firm ground for raising debt.
All stakeholders (whether lending, borrowing or advising) are having to moderate the way in which they run their race. Whilst extensions have been a popular means of buying a little time to see where moving parts land, we are increasingly seeing lenders pushing for refinancing. A borrower’s view on that obviously depends on the terms that can be achieved in renegotiation. For some, the stability or certainty that new facilities offer have been a positive. Yes, the general trend on pricing has been nudging up, but on the flip side we are also seeing greater borrower flexibility in certain cases, particularly in sustainable sectors that lenders are keen to support.
The legislative and regulatory environment also continues to bite and for businesses with exposure overseas (particularly importers and exporters in the lower mid-market) the changing sanctions regime is an issue to be increasingly mindful of.
The runners and riders
The options for lower mid-market borrowers remain fairly fragmented. The market can be harder to navigate and, increasingly, we are seeing smaller businesses move away from a purely broker led model in the search for debt. The emphasis on value, rather than price, has become more readily understood. The importance of picking the right lender (and the right product) for the conditions means that we are seeing more willingness to take advice earlier than a business might have previously considered.
In the lower mid-market, we still see the high street supporting the majority of deals involving smaller owner-managed businesses. As you move through, though, we’re increasingly seeing direct lenders increasing market share. That’s particularly so for businesses that have institutional investors.
The use of asset finance and invoice discounting has become increasingly common too. Whilst they have always been popular choices for certain businesses and sectors from a working capital perspective, we’re seeing asset-based lending and invoice financing lines forming part of a number of acquisition financings where, historically, term debt might have covered the funding requirement.
Increasingly, there’s also stronger expectation that vendors fund their exits to a greater extent than we’ve seen before. Some of that is due to the current popularity of employee ownership trusts and other structures, but vendor debt is an almost inevitable structuring consideration on every deal.
The hurdles
Whilst interest rates may have reached their peak, the cost of debt is still comparatively high for a generation of owner-managers that have enjoyed cheaper debt in the earlier rounds of financing and refinancing. Whilst those who are little older will reflect on a longer view, which perhaps is more comparable to the current market, those who are scaling and growing have certainly found the uptick in costs to be a deterrent.
We expect that as some of the wider variables settle, interest rates reduce, inflation is brought under control, conflicts are resolved and the outcome of elections are known, the resultant stability will create better running conditions. Stability is every lender and borrower’s friend because the ability to predict the cost of debt for a borrower and the return on debt to a lender are the fundamental underpinnings of the market.
Conditions have been boggy for a period and that has meant processes have taken longer and costed more to execute. We should get firmer ground as we move through 2024 and, therefore, processes should be faster and more efficient.
Inevitably, there have been businesses that have fallen. Insolvencies were up throughout 2023 compared to the prior year, although perhaps not at the levels the market feared. We are starting to see the effect of governmental intervention tail off and time will tell whether there are more causalities of economic long Covid to fall.
The winners and losers
Appetite to lend is there, but the understandable emphasis on quality over quantity is still creating pinch points in the market. Good-quality business that are well prepared, robust with their financials and reporting, well advised and, most importantly, realistic, will continue to do well. Losers may include some
that have not managed to master those basics so well.
On the other side of the table, direct lenders continue to enjoy wins at the expense of the high street, given their ability to flex. Inevitably the narrowing of the gap between traditional high street pricing and those alternative sources of debt is also working in their favour in some cases.
Personally, I think it’s still too early to definitively say how the market will look at the end of 2024, but I’d be willing to place an each-way bet that there are grounds for optimism.
Howes Percival’s Banking and Finance solicitors provide a full range of services for borrowers, lenders and investors and will work as part of your team to provide clear and practical advice to meet your business’s needs.
Contact Haydon Simmonds at haydon.simmonds@howespercival.com or visit www.howespercival.com
