This article looks at trends which we expect to impact the mid-market as 2020 continues.
In the latter part of 2019, the general election and Brexit dominated the front pages. Global political turbulence continues, but with a clear majority in parliament and Brexit day having passed, there should be some certainty in that sphere at least.
The early months of 2020 have brought with them new uncertainty in what will be the economic response to COVID-19. With the situation changing so rapidly, it’s unclear at this stage the extent to which we will feel the effects in the mid-market, and for how long.
This article will look at other recent developments, along with changes in documentation and shifts in attitude we have seen as a result.
Increased liquidity and impact on documentation
Growth in non-bank lending continues to drive liquidity in the market, which is unlikely to slow while interest rates remain low. The resulting competition for strong borrowers is filtering through in the detail of the documents we are drafting in both bank and non-bank lends.
Dynamic, optimistic businesses want documents that reflect their plans: accordion facilities are now commonplace, and whilst they don’t offer certainty of funds, they do show lenders’ willingness to review deals, grow businesses and react to opportunities in the market alongside their customers.
With that we have also seen grower baskets regularly feature in mid-market deals, again reflecting an ability to pre-empt and efficiently respond to change throughout the term. Strong borrowers are pushing for more flexibility in other areas too, with the regular reappearance of an ability to equity cure at least three, and sometimes four, times over the life of a loan, as well as flexibility around how cure monies are applied.
At the same time, borrowers need to accept lender policy requirements around, for example, Anti- Money Laundering (AML) and sanctions, and, more recently, documentary flexibility for Brexit and the demise of LIBOR. Future-proofing documents in this way not only reflects attitudes, but should also result in overall cost savings on both sides if/when changes to facilities are required.
The rise in prominence of green loans and sustainable lending will continue. Many of our clients are driving to be more responsible about the way they operate and are supportive of green/sustainable initiatives, and a path has been laid for this appetite to be reflected in mid-market documentation.
The LMA have issued Green Loan Principles: a framework of market standards and guidelines for the use and management of proceeds, evaluation and selection of projects, and related reporting transparency. Alongside that, increased regulation, specifically around reporting requirements, should make sustainability linked KPIs easier to monitor and incentivise through pricing.
A global adjustment rather than a trend, the market should become even more alive to this issue over coming months and years as lip service and greenwashing simply won’t do. With the incumbent Governor of the Bank of England highlighting that enough isn’t yet being done to tackle climate change, there is increasingly a mutual expectation for borrowers and lenders to drive change, providing real opportunities for growth in this area.
Tech boom mark 2
The existence of specialist technology teams within many of the high street banks is testament to market confidence in the continued growth and importance of these businesses, and the requirement to understand how they operate as well as their financing needs.
Many of the underlying legal principles are still moving. There has been and continues to be, much discussion around the suitability of non-tangibles - such as crypto-assets - as security, for example. But it makes sense that a market whose bread and butter is cashflow lending is both willing and able to overcome the hurdles around the valuation of non-tangibles and IP.
We expect the overlap in technology and financing expertise to continue to expand which should allow mid-market tech firms to realise their growth strategies with the support of clued up investors and lenders, rather than needing to rely on bigger funds.
Structuring, the rise of ABL and the return of crown preference
Another reflection of current liquidity is the prevalence and availability of invoice discounting/asset based lending (ID/ABL) lines. Previously considered a quick way to bridge a gap in cashflow, ID/ABL lines are more frequently being offered as part of a package alongside term debt or even as the sole provider of acquisition finance.
As the prevalence of ID/ABL deals increases, a number of private equity firms are moving their portfolio companies onto ABL facilities. Several ABL financiers now offer cashflow facilities alongside the more traditional facilities that they have been known for. This flexibility is resulting in ABL being an increasingly credible financing option.
One further impact will be the change to HMRC’s ranking on insolvency. HMRC will assume preferential creditor status, ranking them ahead of floating charge holders. This change is expected to take effect in December. In the medium term this is likely to result in lenders reviewing their security, reporting and pricing requirements. Stock lending and revolving loans are likely to become more difficult -given the reliance on the floating charge. As a consequence, borrowers may explore alternative forms of finance with less reliance on the floating charge, such as ID facilities and plant & machinery loans.
We enter 2020 with more political clarity than the UK has been seen in many years. After a cautious 2019, with a slow-down in economic growth in the run-up to December’s election and overall UK deal volume down, early signs for Q1 of 2020 were optimistic.
The UK mid-market is liquid: there are lots of lenders out there and traditional acquisition term debt is not the only option, with financing evolving. Borrowers can afford to be cautious about finding the right fit, acknowledging that lenders with the right experience and expertise can really help with growth strategies, particularly those who are willing to be innovative with their products and packaging.
That said, there will be real challenges: a UK-EU deal will need to be reached for stability to continue; and the question of the longer-term impact COVID-19 will have on financial markets clearly remains.