Equity fund raising, for some time now, has been growing at a much slower rate than the previous years. The trend which started last year, might continue for the rest of 2023. While the overall macro picture globally hasn’t worsened, liquidity conditions haven’t shown signs of returning to what it was in 2021.
Amid rising commodity prices, among others, the policymakers’ prime objective seems to be combating inflationary pressures. Central banks across the developed economies, including in India, have continued to hike interest rates in their fight against inflation. In the first week of February 2023, the US Federal Reserve raised the benchmark interest rate by 25 basis points. Almost immediately, the Bank of England increased interest rates by 50 basis points to a multi-year high of 4 per cent. Around the same time, the European Central Bank raised interest rates by 50 basis points.
In its policy review, the US Federal Reserve said it would still require its benchmark overnight interest rate to be increased further and remain elevated at least through 2023. This will have further impact on availability of money at cheaper rates.
When the money was still cheap, we witnessed record number of equity funding deals in start-ups, huge valuations and multiple rounds of investments being made by investors. This growth was fuelled by a low interest rate regime. Investor appetite also grew at a fast clip. Valuations of several companies seemed outstretched, and companies that got massive funding were far away from the profitability curve, driving more and more funding into less and less mature companies.
However, the scene is reversed now. With tightening of liquidity taps, investors and lenders have shifted their focus on profitability, diversification, and a more measured capital consumption rather than fast-paced deployment and large bets. While arguably the new focus has more theoretical backing, it comes as a surprise to businesses, investors and founders, who were earlier pushed for “growth-at-all-costs” approach.
In the last six months, debt and equity deal ticket amounts have gotten smaller. Interest has shifted towards companies, with focus on unit economics, indicating a more cautious approach.
Private credit has come to light as the go-to financing options for many business owners in small- and mid-performing credit space. While banks remain sluggish due to traditionally following a conservative approach, big investors are keen to deploy capital via private credit route which offers attractive IRRs.
As per investment data firm Preqin, private debt market will reach $2.3 trillion by 2027. According to BlackRock report released in October 2022, global private credit fundraising would reach $208 billion. Mid-market deals, in particular, are gaining traction.
However, higher interest rate, coupled with slow economic growth, is presenting a fragile picture. Higher interest outgo not only would impact a company’s ability to service increasing debt, it would also lower the growth prospect in the near term. The pressure on businesses that expanded or have plans to expand at an aggressive pace will increase and, consequently, the return expectation on both equity and debt will go up. Investors in private debt need to be well-diversified and recalibrate their ROI over a longer term.
While efforts at taming inflation will continue, the general perception is that interest rates are near peak, and after some time the central banks would need to reduce interest rates to deal with recessionary pressures. But, in the short term, interest rate environment will continue to remain high.
Amit Shankar is Vice-President, Credit, Vivriti Capital