“The starting point is obviously inflation,” says Antoine Boggini, co-founder of BHB & Partners, when asked about the private debt outlook. “And its direct consequence, which is the increase of interest rates.” This is affecting corporate borrowers but also governments and individuals, he says, mentioning the real estate market and house prices in Luxembourg.
For corporates, he explains, the short-term impact is a fall in the prices of fixed rate bonds. A little further down the road, however, he foresees more reallocations into private debt, which is already starting to happen: “it’s a completely different environment compared not to five years ago, but to last year.” Investors were getting some 3-4% in recent years for non-risk-free assets, whereas now, he says, two-year government bonds in the US are yielding 5%.
“On the supply side, for the borrowers, that’s tough,” he adds. “Because what company can afford, today, such a higher cost of debt?” Typical lenders used to be banks, even if the proportion has been decreasing since the 2008 financial crisis, but “what we are noticing is that the trend has recently accelerated, with private credit groups ready to provide private loans for larger deals”--which are enabled by significant amounts of dry powder. “I think we’ll have to see how they [private equity firms] grab that opportunity.”
Changing strategies and operations
As a result of this environment, says the BHB & Partners co-founder, established companies are altering their capital structures. “Due to increasing interest rates, they are shifting to less debt and more equity.” Until recently debt was almost free, he explains, whereas nowadays refinancing is more difficult. Companies therefore need new ways to fund their businesses, such as an equity injection from current or new shareholders; or, for cash-rich businesses, cashflows from operations can be used to repay debt.
“These higher interest rates, for me, are like a kind of a new blood [being] diffused by the central banks into the economy.” It will take time, he adds: the impact will be felt over years.
For startups, however, the outlook is different. “The question [here] is more about liquidity.” With less liquidity, early-stage entrepreneurs will find it harder to find financing and new investors, says Boggini. “What we can see is that they are adjusting their business plans to actually keep cash.” New financing rounds are being pushed back, for example. “It means less external growth and fewer internal projects.”
Ultimately, says Boggini, the central banks’ decision to increase interest rates will slow down the economy’s growth, in order to control inflation. Startups may find fundraising harder, but it could be good news for other players like banks: “They can do their intermediation role between short-term lenders and long-term borrowers… [and] a steeper yield curve could have a positive impact on their profitability in the coming years.”
Evolution of valuations
As a valuation expert, Boggini has observed a trend towards sophistication in the field. While core principles and methodologies haven’t really changed, implementation has: he points to a rise in terminology like “calibration”, “back-testing”, “scenario analysis” and “option pricing models” in valuation practices. On the training side, he adds, more and more non-experts such as lawyers or tax specialists want to become more conversant on valuations.
This article first appeared in the Spring 2023 issue of Delano magazine.