Banking’s Reckoning Presents a Dilemma—and Opportunity—to Middle-Market Private Equity

While eyes remain fixed on the early-stage tech sector following the collapses of Silicon Valley Bank and Signature Bank only days ago, startups and their venture capital backers aren’t the only ones caught in the crosshairs of recent bank failings: Middle-market businesses and private equity investors are also facing fallout amid an already uncertain growth and M&A dealmaking environment.

The bank failures—the largest since the collapse of Washington Mutual in 2008—continue to send shockwaves of  panic throughout the business and finance world. In the middle market, businesses and PE firms are now tasked with ensuring their current cash is secure, while reassessing their banking relationships and financing agreements for the future.

Karan Kapoor, managing director and co-head of Kroll’s Technology M&A practice, says government measures to backstop depositors’ cash have alleviated any cash management and liquidity issues in the near-term. But, he tells Middle Market Growth, long-term liquidity questions persist. “That, to me, is the big outstanding question that will permeate itself through the middle market,” he says.

Yet as the situation unfolds, some analysts see potential for private equity dealmakers to ride a wave of M&A opportunity in the aftermath of the current chaos.

Some analysts see potential for private equity dealmakers to ride a wave of M&A opportunity in the aftermath of the current chaos.

Midmarket Businesses Caught in the Crosshairs

Even as the U.S. Treasury, Federal Reserve and Federal Deposit Insurance Corporation took extraordinary measures over the weekend to protect deposits at Silicon Valley Bank and Signature Bank beyond the $250,000 insurance limit, business customers fretted over the possibility of losing immediate access to cash to pay employees or suppliers.

Headlines Monday were dominated by stories of tech startups caught in this predicament, but the debacle reaches into the middle-market business community, too.

Companies like Boston-based real estate and forestry management company LandVest were uncertain about their ability to pay workers and vendors heading into last weekend. The company’s president, Joseph Taggart, recently told The Street about the importance of acknowledging everyone impacted by the situation, not just Silicon Valley startups.

“While I’m not interested in any vindication here, I would like to see some equity for the many ‘non-tech-VC’ companies who have been affected by this,” he told the publication. “The whole narrative seems to be around Silicon Valley here, but there are some boring old New England companies that have been devastated by all this.”

LandVest, with annual revenues of about $60 million, pulled a portion of its deposits from SVB last Thursday as anxieties over the bank’s viability began to mount, reports said. Yet with payroll due Friday, Taggart told The Street some cash had to stay in the company’s SVB account. Luckily, its transactions went through, but Taggart described the situation as “extremely frustrating.”

“When you look at all the corners on a daily basis in terms of markets, volatility and risk, thinking that our bank was going to fail was not one of them,” he said.

While the company faced disruption from the current banking crisis, LandVest expects to emerge mostly unscathed thanks to its decision to diversify its capital across several blue-chip institutions—a strategy whose importance has been made painfully clear in recent days.

“Every business should continuously evaluate their capital structure and their funding sources,” says Kroll’s Kapoor, noting that while the current situation is “unprecedented and atypical,” it’s also a “wake-up call” that even established, blue-chip institutions are not immune to disruption.

Private Equity’s Dilemma…

That wake-up call extends to the private equity firms now taking stock of their own banking relationships following the recent collapses.

PE was big business for both SVB and Signature.

At SVB, more than half of its $73.6 billion loan portfolio was made up of fund financing for VCs and PE firms, according to Bloomberg reports, citing the bank’s most recent annual report. Much of that was in the form of subscription credit lines, which the publication noted have become a “staple” for midsize PE investors, allowing them to access capital for investments without requiring their limited partners to provide the cash.

Signature Bank, too, built much of its lending business on the foundation of private equity. American Banker reported in 2021 that PE was instrumental in growing the institution’s commercial loan business, pushing the bank’s total assets beyond $100 billion in the year’s third quarter.

With these financing arrangements now up in smoke, Kapoor says the same long-term liquidity concerns of the banks’ middle-market business customers will be felt by PE clients, too. Reports say private equity clients are now searching for replacement financing arrangements, with contagion fears leading them to shy away from smaller, community banks and turn toward large incumbents.

Analysts say this could signal a widespread shift in banking relationships across the business and finance spheres. “Unfortunately, one of the first consequences of SIVB’s collapse is probably that it will cause a flight of uninsured deposits from smaller, less diverse banks to larger, more diverse ones,” said Chris Kotowski, analyst at brokerage and investment bank Oppenheimer & Co., in a note to clients, Reuters reported.

PE Firms have a golden opportunity that should result in more options to buy good businesses.

Karan Kapoor

Kroll

…And Potential Opportunity

It’s too soon to tell just how deep the ongoing banking crisis will impact the middle-market private equity ecosystem. Yet as is often the case in times of turbulence, PE investors are also digging through the rubble to find opportunity.

With economists anticipating continued shake-ups across smaller institutions, some analysts foresee a wave of M&A activity in the banking sector ahead.

“Don’t be surprised to hear about a lot of midsized bank merger talks in the coming days, with private equity standing by to participate,” predicted Dan Primack, business editor at Axios, in his Monday, March 13 Axios Pro Rata newsletter.

Indeed, there are signals that PE is already jumping in: Investor General Atlantic reportedly agreed to buy $500 million in SVB common stock following the bank’s share sale announcement last week prior to its takeover by the U.S. government (though the deal is unlikely to go through, considering it was contingent upon the close of another common stock offering).

Kapoor says that the long-term liquidity concerns facing former SVB clients are likely to open up a swath of M&A opportunity beyond the banking sector itself.

With middle-market PE funds sitting on so much dry powder (about $700 billion in the U.S. alone, according to analysis published in January by consulting firm RSM Global), PE equity financing could be a vital lifeline to the businesses and VC firms, already facing high interest rates, whose debt and venture-debt financing options have suddenly dried up.

“That’s a clear opportunity for private equity,” says Kapoor. “To come in with equity financing, whether it’s to recapitalize a business or buy out VC investors in need of liquidating their positions, PE Firms have a golden opportunity that should result in more options to buy good businesses.”

Carolyn Vallejo is ACG’s digital editor, based in Los Angeles.