Accessing Capital in a Post-COVID Economy

JPMorgan Chase & Co. teamed up with the San Diego Business Journal to resurrect the publication’s annual Fastest Growing Private Companies list. The 2023 edition returned after a two-year hiatus during the pandemic.

To mark the occasion, the two organizations co-hosted an awards reception at JPMorgan Chase’s One Paseo office in Carmel Valley on Nov. 1 for the top businesses featured in this year’s list.

The reception celebrated the return of the Fastest Growing Companies list, which was not produced for two years due to the COVID pandemic’s effect on business growth during that period. JPMorgan Chase sponsored the list’s return and the awards event, which featured a panel discussion on access to capital and how JPMorgan Chase serves growing companies in San Diego.

“San Diego has always been a vibrant and innovative city and the business community repeatedly thrives off of this dynamic. Its great getting back together with the San Diego Business Journal where we can recognize the leaps and bounds businesses have made, especially the last two years,” J.P. Morgan  Private Bank Managing Director and Market Director for San Diego Bambos Charalambous told the attendees at the start of the presentation. “Together, we wanted to reinvent this event, increase its importance, and recognize some of the amazing work your companies are doing every day.”

The panel discussion was moderated by JPMorgan Business Development Executive Marcus Vogel and featured JPMorgan Middle Market Financial Sponsors Group West Coast Lead Ian Walsh and Aaron Ryan, JPMorgan Chase’s San Diego Market Director of Middle Market Banking.

‘Matchmaking Business’

Given the audience of privately owned companies, Walsh explained that JPMorgan’s Financial Sponsors Group serves to connect JPMorgan’s private equity, growth equity customers and its commercial bank and private bank customers who are “at different stages of their evolution.”

“Some of these businesses are at a size that investment banks won’t come down to offer formal mandates or investment bank capabilities,” Walsh said. “In the past, we could not serve them until they reached a certain size. The creation of this business development function is where we seek to interface with commercial banking clients, private banking clients that are all looking to raise capital and have conversations.”

Those conversations, he added, address topics like when is the time to bring on a minority partner; whether a founder should sell the business in a full exit or bring in a two-step exit; and when is the best time to raise capital for a growth.

“So, it gives commercial banking and private bank clients a little access to some of the strategy and most of all the network effect that JPMorgan has,” Walsh said. “We’re a bit in the matchmaking business to make sure that if we have a customer of the bank looking to access capital, we can help them along the journey — from setting up informal meetings with capital partners so we know can have an informed discussion with them, all the way through to a formal investment banking mandate.”

Ryan, who leads JPMorgan Chase’s Middle Market Bank in San Diego, said JPMorgan’s matchmaking process is important to the bank’s success, adding that its large size allows it to help companies of any size.

“My role is to help people navigate and access the many resources of the firm,” he said, adding that JPMorgan’s “competitive edge in San Diego starts with a commitment to the community and market.”

“San Diego is unrivaled in where people want to go and create businesses,” Ryan said. “I see a lot of companies that will often reference ‘We are a San Diego company.’ You don’t see that in every market. I think that’s what makes San Diego so unique.”

Ryan also highlighted San Diego’s potential in weathering a “possible looming recession.”

“There is good reason to battle test your company, your financial projections, and get ready for the worst-case scenario, but we tend to be optimists and are confident that this class of businesses, in this market will do really well in the long term,” he said.

When to Raise Capital in High Interest Environment

Following the discussion on JPMorgan’s business services, Vogel kicked off the discussion on raising capital.

He asked: “At what point is it appropriate for people to raise capital?”

Given today’s interest rate climate, Walsh pointed out that high interest rates are not necessarily barriers to raising capital.

“In 2007 interest rates were high, LIBOR was 5%, and that was a record M&A year,” he said. “It’s not so much the level of interest rates, it’s the steadiness – and people want stability. Every market wants stability where you can actually get clarity to what something is worth, how you value it.”

Walsh explained that the “ugly” M&A years of 2021 and 2022 were because interest rates were moving at a rapid rate and businesses and investors could not predict how much debt would cost and therefore could not accurately value companies “so everything got put on pause.”

He added that a lot of business founders also got “caught in the trap” of the past decade’s low interest environment where they wouldn’t have to consider giving up equity in their companies to raise capital because “buying debt was easy.”

“That math changes pretty quickly,” he said, and explained that founders no longer have the “no-brainer” capital exercise of borrowing, and instead have to weigh raising debt at double-digit interest rates against paying “a couple percentage more on a cost of capital basis” by bringing in an equity partner.

“That’s the first time that’s happened in almost a decade. It’s always been, ‘I’m not going to dilute myself,’” Walsh said, adding that the upside in diluting equity for founders is the chance to find partners who have a strategy, a playbook, have run a similar concept, and are aligned with where they want their business to go “instead of a faceless lender that’s going to say, ‘You owe me this much interest at the end of this term.’”

Recovering from COVID’s ‘Outlier’ Years

In raising capital, Walsh pointed out that companies should be careful because they can no longer blame poor performance on the shocks of the pandemic when presenting to investors.

“I think you’re seeing a separation of well-run businesses,” he explained. “You got 12 months now of the new normal where if your income statement looks strong and you can take people through the story, you’re going to be attractive to any capital provider.”

Vogel then asked if raising capital in 2023 can be compared to 2019 with investors discounting the pandemic’s ‘outlier’ years in between.

Walsh explained that it depends on the sector.

“The pandemic was about consumer products – all the stuff you went out and bought when you were stuck at home,” he said. “Those companies that had record years in 2021, the COVID bump is going to hit them on the way down.”

Unlike businesses affected by the changes brought by the pandemic’s stay-at-home culture, changes brough by its supply chain issues are “tougher to calculate,” Walsh said, pointing to the example of freight rates which are expected to land “somewhere between pre-COVID and where they were at height of pricing.”

With the “better track record of stability” in the post-pandemic economy, Walsh said he thinks 2024 is going to be “a big year for M&A.”

“People understand that interest rates won’t go back to one percent soon,” he said. “However, the big antidote is sponsors have a lot of money to put to work. Funds don’t last forever, and you have a certain period to invest it and most capital investors are not in the business of giving money back to their limited partners and saying, ‘Hey, I couldn’t find anything to do with this money. Here take it back.’ So that clock is still ticking.”

Investors, he added, are looking for businesses that are recession resistant and have a story to tell.

Continuation Vehicles, Cost of Capital

During the discussion Charalambous, J.P. Morgan’s Private Bank Market Director for San Diego, asked how much equity investors are asking for from founders in return for capital.

Walsh said purchase prices on average have come in at 10% to 15%. He added that over the next few years, there will be more utilization of continuation vehicles by larger private equity investors, driven by “venture funds that don’t want to exit a business at a lower valuation than they think it is worth, but they have to put a win on the board to return capital to their limited partners because they want to raise the next fund.”

Continuation vehicles, he explained, allow those smaller funds who need a “win” a chance to “monetize, but not sell” the company for a lower price. The larger private equity firms go to the fund managers and give them the valuation they want, but the company needs “to earn the last 30% in an earn out. Instead of getting all the money upfront, the company has to hit agreed upon metrics.”

Preparing for Uncertainty in 2024

Several audience members asked the panel what J.P. Morgan expects the economy to be like in 2024.

“I think more of what you’re asking is ‘What could go wrong?’ Those are the types of questions business should be asking,” Ryan replied. “I get a lot of founders and CEOs that are trying to put together their projects and they’re really focused on being precise – exactly right – and I remind them that no one has a crystal ball.

“What are the factors that you can control? What are the factors that you can’t control? – and articulate them and quantify them, not to hold you to the number exactly but so that we can all see what some of those toggles are in your business and what some of those factors are and those broad considerations that not enough people spend time talking about.”

In understanding consumer sentiment in 2024, Walsh pointed out that “consumer spending is the place to look at first” and added that JPMorgan Chase has access to one of the largest data sets of credit card balances to gauge consumer spending habits.

Executive Director and Investment Specialist at J.P. Morgan Private Bank Antolin Garza then joined the panel briefly to offer a picture of the year ahead.

Interest rates are accelerating and there is uncertainty, he said, “but that doesn’t mean that a functioning economy and higher interest rates can’t coexist – they have in the past and they will in the future.

“So the nature of that is you have an assumption of how you will navigate your topline growth and at the same time manage your expenses where your durability and cash flow form some kind of earnings profile that remain stable with those uncertainties in motion,” he continued. “That is going to be the ultimate test.”

Garza said the Fed is still “very clear” it intends to continue slowing and increasing unemployment in 2024.

“So far, they have been moderately successful, at best, but ultimately the consumer remains very strong, he said. “As we look at the job market going forward, wages are stabilizing so we’re not seeing that kind of large increase in wage growth. At the same time, we’re not seeing layoffs accelerate. Until we see that, I think we’re going to be this modest, positive growth environment that is muted and hard to read, unfortunately.”

Garza said the “canary in the coal mine” to watch out for is the unemployment numbers and if that is the sign for a contracting economy. “Until then the playbook is to navigate a medium growth environment and control the controllables, from a business perspective.”