Good news for private companies: Robust economy translates into EBITDA growth

EBITDA Growth. At the time of the interview, expectations were high for fourth quarter 2020 GDP growth. While the actual growth rate fell short of those expectations, the late-February upgrade to 4.1% nonetheless indicated a robust economy.

The outlook for 2021 is even brighter. This week the Organization for Economic Co-Operation and Development (OECD) more than doubled its growth forecast for the U.S. economy, to 6.5% (see the March 9 Bloomberg article, “U.S. Stimulus Set to Turbocharge World Economy as Europe Lags”).

Note: Similarly, the Atlanta Federal Reserve had predicted 6.1% GDP growth for the third quarter of 2021, but late summer's supply-side strains, caused largely by lackluster job growth, caused the Atlanta Fed to downgrade its prediction for the quarter to 1.3%. See "Where Did All the Workers Go?" in the October 8, 2021, Wall Street Journal.

Impact for Business Owners. Of importance to business owners contemplating the sale of the company, robust GDP growth tends to translate into robust growth in EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), which is an important factor in a business’s market value.

Private Capital Market. The private capital market is healthy. The fourth quarter of 2020 was a challenging time – not because of liquidity constraints, but because there was so much work related to COVID-deferred deals that should have closed earlier in the year.

The new year began with favorable liquidity conditions and more time to dedicate to the market. Many investment bankers – including SPP Capital Partners, with which IBG Fox & Fin has a relationship – have lowered their pricing and expanded their leverage tolerances, reflecting what they perceive as a forgiving market for issuers.

Direct Lenders vs. Commercial Banks. There is a continuation of a trend that started several years ago, with direct lending and private debt funds replacing commercial banks as the primary source of liquidity in the market. Private debt funds grew from $300 billion in 2010 to $845 billion in 2020 and are expected to reach $1.4 trillion by 2025.

That growth has created a bit of “disintermediation” for commercial banks — i.e., reducing or eliminating the use of banks as intermediaries between capital producers and consumers – and to some degree the subordinated debt market. As a result, deal structuring is more efficient; it is common to see one lender providing the senior and the sub all in one instrument, getting leverage up to five times with a single lender.

Still, bank pricing and the commercial bank market represent the lowest cost of capital, and banks are having to be a little bit more competitive because of the amount of capital that is coming to the direct-lending community on a private basis.

In the bank market, asset-based lending ranges and cash flow pricing are in the lower LIBOR (London Interbank Offered Rate) ranges. In contrast, non-bank direct-lending market pricing starts at about LIBOR 5 and goes up to about LIBOR 9. Borrowers pay a premium to go into a direct lender to achieve looser covenant packages.

Banks require amortization structures, ranging from 4.5% to 15% per annum, while a non-bank direct-lender leverage amortization is generally between 1% and 5%, a much easier debt service component.

There is also ease of execution component with a non-bank lender, which will not require inter-creditor agreements and does not have to deal with the Fed, the FDIC or the OCC.