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The rising-rate environment will have an enormous impact on the middle market. Buyers will be more selective and diligent in the companies they acquire, and available liquidity and deal flow will likely decline. Floating-rate debt issuers are especially vulnerable today—particularly those with heavy interest burdens, limited free cash flow, and near-term maturities.

Brian Schofield, MDHead of Capital Markets, G2 Capital Advisors

The tightening monetary policy, declining GDP growth, and lower public and private valuations will see an impact on middle market companies in the coming months. With the concern of inflation, the economy slowing down and more, this is what we can except to see from the middle market:

  • Selective and diligent buyers
  • Declining deal flow and available liquidity
  • Vulnerability among companies
  • Covenant-lite loans may assuage default concerns
  • Evolutions of investors ties with “storied” credits

Our G2 team provides a unique platform, combining deep operational industry experience with capital markets product expertise to meet client growth goals and special situations.

Learn more about our capital marketing advisory.

Capital market analysis & backdrop 

Increase in inflation rate remains a crucial concern: After months of claiming inflation was “transitory,” the U.S. Federal Reserve (the Fed) has found itself behind the curve, fighting the highest inflation rate in four decades. The Consumer Price Index (CPI) increased 8.5% for the 12 months ended March 2022, following a year-over-year rise of 7.9% as of February 2022.

The Fed is aggressively tightening monetary policy: The Fed is hiking interest rates—its most aggressive pace of policy tightening since the early 2000s. The Fed voted to raise interest rates by 25 bps in March and 50 bps in May and anticipates an additional 50 bps of hikes during its next two meetings. In addition, the Fed has begun to shrink its $9 trillion balance sheet. Meanwhile, the 10-year Treasury rate is hovering around 3.0%, its highest level since November 2018.

Declining growth as economy is slowing down: U.S. GDP growth fell to 1.4% in the first quarter. However, it was affected by certain factors that should ease throughout the year, including spiking COVID cases and slowing inventory growth. The Fed must balance tightening activity with the risk of tipping the U.S. economy into a recession.

Public markets have been hit hard: Rising interest rates, inflationary pressures, and geopolitical instability have resulted in a public market rout since the beginning of the year. While technology companies and other growth investments have seen the most significant impact, the sell-off has been broad-based and is spilling into the private markets, as further discussed below.

What does this mean for the middle market?

Expect buyers to become more selective and diligent: Valuations in the public markets tend to have a gravitational pull on private transactions. We expect buyers in the middle market to dig in further during due diligence and be highly selective in the companies they seek to acquire.

Available liquidity and deal flow will likely decline: Demand for middle-market loans may exhibit volatility in the second of 2022 as it did in the second quarter of 2020 when deal flow slowed significantly due to uncertainty surrounding the pandemic. Increased borrowing costs will render opportunistic financings less attractive and likely result in muted loan volume for the balance of 2022.

Some companies are more vulnerable than others: Due to the prevalence of floating-rate, debt-heavy capital structures, debt-bearing middle market businesses and loan issuers are more vulnerable than their larger corporate counterparts. Especially vulnerable are companies with limited free cash flow, heavy interest burdens, and near-term maturities that will need to be refinanced at higher interest rates.

Covenant-lite loans may assuage default concerns: A heavy mix of covenant-lite loans, which weaken creditor protections, may help stave off defaults.  When debt agreements include maintenance covenants, improved operating performance can mitigate the effects of higher interest rates as monetary policy continues to tighten.

Investors’ willingness to lean in on “storied” credits will evolve: After massive deal activity in late 2021, deal flow has decreased in early 2022, and investors have been more willing to consider complex credits this year. But we expect investor demand to pull back from storied credits as the forward calendar continues to build and scrutiny from lenders increases due to current headwinds.

Market volatility is high, and interest rates are projected to rise. For middle market companies looking to raise capital, now is an opportune time to leverage the expertise of a seasoned capital markets team to navigate the complex market environment and provide greater certainty of execution.”

Brian Schofield, MDHead of Capital Markets, G2 Capital Advisors

How do these trends affect you?

Our capital markets team would welcome the opportunity to share our perspectives on today’s dynamic capital markets environment and how it affects your specific situation. We have deep experience providing strategic capital markets advice to middle market companies, and we pride ourselves on making the deal experience as efficient as possible for management teams and owners. Contact us to start a conversation today and begin working towards your capital market goals.

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  • Digitization beyond just distribution: Brands that were traditionally offline continue to seek additions to bring them online as quickly as possible, and many of these partners are opportunistically acquiring brands themselves. The incredible growth in the eCommerce Aggregator space, driven both by traditional M&A activity and high-value VC investment, continues to dominate the headlines. Additionally, consumer companies continue to invest in areas like CRM and content marketing to extend the product experience and further influence consumers’ decision-making.

  • Consolidation focused on higher-order territories: Where M&A activity historically skewed toward product category or aisle consolidation has shifted into higher-order need-state territories and solutions. For example, owning the hand cream aisle has taken a back seat to owning a total care story, and owning healthy eating has been replaced by owning total lifestyle. Further consolidation is expected as many product categories and store aisles remain highly fragmented.

How to win in retail today? Be nimble and think broader

For consumer & retail companies, the ground is constantly shifting. Spiking and fickle consumer demand, supply chain snarls, inflation, and fast-evolving consumer preferences are reverberating throughout the industry. These shifts are affecting every aspect of a retailer’s business—from sales and marketing strategy to inventory and supply chain management. 

What Are Consumers Looking For?

Consumers expect more from retail companies today. They demand an easy, efficient, and enjoyable experience above all else. They increasingly expect retailers to meet them exactly where they are, and to meet their expectations instantly, all while displaying a lower capacity for frustration. 

“Retail is as real-time as it’s ever been. Pricing fluctuations, trip-driving behavior shifts, and demand for immediacy—especially given the normalization of same-day delivery and an endless aisle online—have forced everyone in retail to leave room in their long-term plans for adaptations and adjustments.”

– Brian Cohen, Managing Director & Head of Consumer & Retail, G2 Capital Advisors

Rather than temporary, pandemic-related changes that will revert back to normal, we believe these shifts have permanently altered the retail environment. 

Against this backdrop, it is critical for consumer & retail companies to embrace a more nimble and flexible strategy. Today, long-term plans are only as good as how often you revisit them. Management teams must continuously reassess their strategy and make adjustments based on the prevailing market conditions.

How do these trends affect you?

Our consumer & retail team welcomes the opportunity to share our perspectives on today’s consumer and retail environment. We can help you revisit your strategic roadmap, including whether now is the right time to sell your business, continue to grow through acquisitions, or raise external capital. Contact us to start a conversation today or learn more about our expertise in retail.

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Corporate life often mirrors personal experiences. The COVID-19 pandemic shook the foundations of our lives, prompting a series of unexpected consequences across both our personal and professional domains. At the onset of the pandemic, most people did not anticipate such a significant disruption that would last well over a year. Some have gained the “freshman 15 pounds” during quarantine due to limited mobility, lack of exercise, and extended periods in front of computer screens on zoom calls in sweatpants all day. And there are those who took the opportunity to refocus, establish discipline in their routine, and get in the prime shape of their life. This analogy can be applied to the corporate world as well. Leaning up your organization will remain critically important in this uncertain future.

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G2 Capital Advisors is pleased to present its Transportation & Logistics industry updates for Q1 2021, providing commentary and analysis on M&A and market trends within the sectors. We hope these reports find you and your families safe and healthy, and encourage you to contact us directly if you would like to discuss our perspective on the current market environment, trends, or our relevant industry experience.

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G2 Capital Advisors is pleased to present its Industrials & Manufacturing industry updates for Q1 2021, providing commentary and analysis on M&A and market trends within the sectors. We hope these reports find you and your families safe and healthy, and encourage you to contact us directly if you would like to discuss our perspective on the current market environment, trends, or our relevant industry experience.

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G2 Capital Advisors is pleased to present its Technology & Business Services industry updates for Q1 2021, providing commentary and analysis on M&A and market trends within the sectors. We hope these reports find you and your families safe and healthy, and encourage you to contact us directly if you would like to discuss our perspective on the current market environment, trends, or our relevant industry experience.

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G2’s unique team of seasoned C-level executives, restructuring advisors and investment bankers provide our clients with a clear path to long term operational stability, a sustainable capital structure, and the financial flexibility necessary to achieve their strategic goals. G2 generates substantial value for stakeholders through our operational and transactional capabilities and focus on risk mitigation.

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It’s now over a year since the start of the pandemic, and, despite a stepped-up vaccination program, and a loosening of business restrictions, a robust recovery is still a ways off. Although COVID-impacted earnings are recovering for many businesses, uncertainty remains as to what the new normal will look like, and when it will be reached.

After a slow M&A market in the spring and summer of 2020, activity has picked up through early 2021. Many have delayed M&A in the hopes of maximizing the value of the businesses they’ve built. Nevertheless, there are ways for sellers to achieve their goals, even in the midst of uncertainty.

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“This recession will finally end the private-sector ‘debt super-cycle,’ says firm that invented the term” – MarketWatch, April 4th, 2020

Over the past decade, forecasters have been anxiously tracking rising corporate leverage levels and the proliferation of covenant-light loans, while lamenting the woefully declining credit quality of borrowers. Lenders could only “amend and pretend” for so long, they argued, and it would be just a matter of time before we witnessed an apocalyptic deleveraging event that would finally mark the end the current debt cycle. The sovereign debt crisis, tariff war, inverted yield curve, all came and went, but a global pandemic should have been the final straw. As infections and lockdowns spread in early 2020, commentators competed to see who could predict the biggest surge of bankruptcies and corporate defaults.

By Q3 defaults had fallen to below pre-COVID levels, and yields had declined dramatically across the board. In a shocking turn of events, debt issuance had surged to record levels, providing liquidity to healthy and distressed borrowers alike. The ultimate irony was, as S&P Global noted, investors “were so supportive that some of the corporate sectors that saw the largest increases in bond issuance relative to the prior five years were those most negatively affected by economic lockdowns.” Undeterred, commentators have now rolled forward their doomsday forecasts, bracing for an even bigger deleveraging and fallout in 2021. But what if we have collectively “broken” the corporate debt cycle? Consider the following three factors:
First, and foremost, is the Fed backstop, which involved unprecedented direct lending to both investment grade and distressed borrowers. Overnight, the Fed’s balance sheet nearly doubled to $7.4 trillion, all but ensuring that the Fed will be a permanent participant in private credit markets. Markets are inarguably in “risk on” mode, and it’s difficult to imagine any kind of crisis of confidence in the foreseeable future.

Second is the near-mythical “search for yield” and its side-effects, specifically the prolific rise of non-bank lending. Institutional investors, grappling with falling returns on fixed income and other assets, have pushed deeper into the private credit market. AUM at private debt funds has skyrocketed from under $200B in 2007 to nearly $900B, with $300B of dry powder waiting to be deployed. The new breed of lenders is more creative and better-equipped than traditional banks at segmenting and capturing risk premium at all levels of the capital structure. These investors, willing to take greater risks, were happy to put money to work during the pandemic, while banks battened down the hatches and sat on the sidelines. For these lenders, COVID has become a mere EBITDA adjustment, and most were willing to ride out the storm and “amend and extend” into 2021 leaving the search for yield poised to continue unabated into the future.

Last, but not least, is the evolution of lenders’ strategic options for dealing with distressed loans. Historically, a bank loan workout was a lengthy affair, with a forbearance or amendment followed by a two or three-year operational turnaround of the borrower. Today’s lenders prefer to move quickly to exercise their remedies. They are frequently turning to secondary debt sales, special-situation refinancings, carveouts or expedited sales of the company. Increased specialization means that there are buyers for every type of security, asset, and distressed business or division. For deeply troubled credits, options such as Article 9 foreclosures or Section 363 sales can be used as a tool to efficiently foreclose and sell viable assets at premium prices, and then wind down the remaining liabilities through either an in- or out-of-court process. As a top-tier middle market restructuring advisor, we employ these strategies (and more) every day on behalf of our clients, and have witnessed firsthand how lenders can now dynamically shift risks throughout this ecosystem. More and more, lenders rely on our firm to provide not only financial and operational support, but also integrated banking capabilities and increasingly advanced legal sophistication.

In sum, we could be witnessing the end of the broad-based credit cycle, and the start of a new era characterized by more complex, localized pockets of risk accompanied by fewer, but larger, distressed events. The current debt-cycle may live on for some time yet.

Konstantin A. Danilov is a Vice President at G2 Capital Advisors, which provides M&A, capital markets and restructuring advisory services to the middle market.

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When crises like the pandemic wreak havoc on businesses, having the right resources in key leadership roles determines whether a Company will successfully navigate a distressed turnaround situation or not.  Rapid

and decisive crisis stabilization determines success.  G2 Capital Advisors’ (“G2”) primary objective in a turnaround is to establish a capital and operating structure in line with the strategic priorities and cash generation of the enterprise.   In partnership with key stakeholders, G2 extends the cash runway of the Company to create time for revitalization.  This liquidity management exercise requires information to be developed and presented to a host of critical players, including but not limited to, shareholders, lenders/creditors, management, employees, customers, vendors, and any court appointed Trustees, if so needed.

Many turnarounds fail due to a lack of alignment between the Board of Directors and executive management on a strategy and timing to fix the Company.  Bringing in a trusted third-party restructuring advisor, such as G2, to oversee the turnaround as an independent fiduciary can achieve such strategic alignment.    Not all restructuring advisors are created equal and each situation prescribes particular skill sets and capabilities to effectively navigate the corporate turnaround.  Of utmost importance, every restructuring and turnaround 1) must have a foundational plan, and 2) that plan must be published and communicated broadly.  The entity or entities managing the turnaround must draw ideas out of the Company’s employees and stakeholders and galvanize them into action with an action strategy with specifics on what, when, and how.  In the post-COVID environment, planning and communication have become even more critical as certain industries find themselves at a pivotal juncture.  For many companies, massive strategic and operational shifts, and even fundamental changes to existing business models, will be necessary for a turnaround to be successful in this “new normal.”   

Our successful turnarounds are accomplished by focusing on 4 C’s – Communication, Concentration, Cost Control, Cash Flow.  Traditionally Financial and Operational focused restructuring firms stay on opposite sides of the fence.  For  middle market companies, hiring separate firms is cost prohibitive and inefficient.  G2 is uniquely positioned to provide a one-stop shop with a fully integrated team comprised of operational, financial, and investment bankers to address stakeholder needs and maximize ultimate recoveries.

To address critical aspects of a turnaround, G2 proposes a two-pronged approach to focus on both Financial and Operational Restructuring elements.  G2, as an integrated firm, can manage both aspects of financial and operational restructuring within one team.  Usually, a transactional Chief Restructuring Officer (CRO) where there is a strong management team, or an operational Chief Transformation Officer (CTO) where the advisor steps in to run the Company day to day.   G2 is differentiated in our ability to provide both functions to our clients with foundational industry experience:

FINANCIAL RESTRUCTURING

Owning fiduciary responsibilities and represents an independent voice using the Company’s financial data to address concerns of all stakeholders.

  • Reports to Board of Directors.
  • Serves as liaison to lenders, creditors, etc.
  • Manages all external communications.
  • Leads negotiations with vendors or customers.
  • Establishes go-forward operating cash flow budget.
  • Generates required reporting.
  • Manages any legal filings.
  • Develops formal Restructuring Plan, driving to a successful Restructuring Transaction.

OPERATIONAL RESTRUCTURING

Working with existing management to determine appropriate operating parameters.

  • Identifies useful assets and operations.
  • Discontinues non-performing assets, divisions, products, etc.
  • Prioritizes strategic initiatives.
  • Identifies a few areas for concentration.
  • Implements cost control measures.
  • Minimizes Company cost structure.
  • Manages internal communications with employees. Supports external communications.
  • Sets go-forward performance targets.
  • Augments interim management needs.
  • Architect and executor of Revitalization Plan.

G2 believes any changes in organization culture will be driven by a vision, encourage feedback and require prompt action.  The CRO in conjunction with a Company’s CEO and management teams must champion that change by cultivating it within the organization.  By actively engaging all employees and helping them understand the new direction of the Company, G2 can achieves multiple objectives:

  • Managing stakeholders
  • Implementing rolling go-forward 13-week cash flow
  • Developing strategic priorities (and if necessary, pivoting to succeed in the post-pandemic “new normal”)
  • Stabilizing operations 
  • Identifying performance / process improvements
  • Driving organizational change
  • Identifying Company structural change
  • Instituting risk mitigation parameters
  • Identifying new financing needs
  • Supporting clear communications

Frequent and continuous communication with all stakeholders and interested parties remains critical. G2builds confidence and trust within these groups through transparency and honesty.  G2’s decisive and clear actions thereafter drive the successful turnaround process.

G2’s highly capable team, including seasoned interim CFOs, Controllers, or FP&A resources, not only can help our clients navigate challenging liquidity or performance environments, but also can drive improvement in core finance/accounting functions. Feel free to reach out to the G2 team to learn more about the approaches we are using across our 45 plus clients in our industries of focus.

Jeffrey Unger
Chairman & CEO
Boston, MA
[email protected]

Ben Wright
Chief Operating Officer
San Francisco, CA
[email protected]

Chris Capers
Managing Director
Boston, MA
[email protected]

Konstantin Danilov
Vice President
Boston, MA
[email protected]