At the 2023 Chicago Smart Business Dealmakers Conference, Chartwell Financial Advisory Managing Director Will Bloom discussed how those in the M&A space had faced over the past few years a dynamic market. The disruption of the pandemic was followed by a significant government investment in the economy in a low-rate and robust capital environment, which resulted in significant M&A activity in 2021. Then inflation became a factor as did the fear of the potential recession, and in 2022, volume fell off a cliff. Financing also was falling at the same time, causing banks to wrestle with the impact of that and greater regulation to their balance sheets. That slowed down their supply of capital in the marketplace.
“Ultimately, 2022 was a difficult and challenging year for the marketplace,” Bloom said at the Conference. “If you were raising capital for growth or you're looking to recapitalize your business, there were a lot of crickets.”
2023 was somewhat of a rebound year, especially in the second half. There was a pickup in in recapitalizations and buyouts because lenders were coming back to the market to put capital to work. The market also benefited from capital flows moving somewhat out of equities and into private credit relative to the public bond market. That came into play in the lower middle market to fund deals. Appetite for risk was also growing, but certain sectors remained more cautious than others.
In a much higher interest rate environment, the underwriting market focused on fixed charge coverage and a borrower’s ability to service debt when the cost of capital was much higher relative to just the leverage or the attachment point of leverage into an enterprise. Those were also key drivers in the underwriting and the credit appetite.
Something he says they were cognizant of was the cashflow ability of a business and its sustainability. They wanted to see what assets were present and how healthy they were.
“You start with the asset base and the asset-based market is, on the lending side, very robust,” Bloom said. “Banks that are healthy, their first interest in lending those monies out are to companies that have strong asset base, particularly liquid assets, that don't have great volatility in their value. Then we look at the cashflow dynamics and the sustainability of those cashflow dynamics. And then we think about what other opportunities are there down the capital structure to consider on a maybe less traditional equity perspective — so, junior capital. Because there's a lot of capital flowing into the private credit markets, that means at the top of the balance sheet down towards the bottom of the balance sheet, looking for a better relative value — risk versus return — because of the higher interest rates. And if you can find capital, whether senior or down maybe 75 percent into the enterprise value, you can leverage and utilize that to your advantage from an equity perspective. So, some of our clients, whether they're selling or whether they're looking to capitalize themselves to recap shareholders or look for growth, were thinking about some alternative forms of capital as well.”
Ultimately, as he looked forward, he said he’s optimistic. Some of the boom-and-bust asset classes had corrected, though some such as AI were and are yet to be determined. But for the traditional industries, he expected corporates and businesses would adjust and manage.
“We're still at 5x the interest rate cost,” he said. “We're still at an average cost of capital if you look at it over a longer term, 60 year period. So, these aren't crazy rates. We're not back in the Carter era. We have good demand drivers globally. And banks are becoming more healthy. And the private credit is being significantly invested in, meaning lots of capital flows going in there. And the banks are going to have to compete. Therefore, as their regulation loosens on them, they're going to be able to compete. Therefore, there's going to be more credit. More credit supports more investing. And so, I think it's more of a softer landing, if anything, in the next year or two. Not a major bust.”
