Liquidity Crunch: Too Dry to Fly?
The IPO market looked set to recover after a rather lackluster year. However, the market took a downturn last week after shares in the German shoemaker, Birkenstock tumbled in its initial debut. Now called “one of the worst IPOs in recent history” by Reuters, Birkenstock is trying to get back on its feet after a rocky start, leading some companies to rethink liquidity goals, especially small caps.
While IPOs can be a lucrative opportunity for investors as well as companies, not all IPOs (or revenue for that matter) are created equal. Birkenstock, alongside other major companies to IPO this year, including SoftBank-backed Arm (ARM), Instacart (CART), Cava (CAVA), and Klaviyo (KVYO), are all trading below their IPO offer price. It's not just a handful of unlucky companies who were aggressively-priced that are flubbing: studies show that companies going public through IPOs, especially smaller and newer companies, often face higher failure rates compared to larger, more established firms. In fact, some 90% of the companies in a 2022 study by the OTC Markets Group got stuck with money-losing returns. Many of these smaller companies are in desperate need of capital for growth and expansion in the public markets, yet struggle to attract investors, leaving them with insufficient funds to execute their business plans.
Some lack market savvy, resources, and the financial stability needed to be a publicly-traded entity. Additionally, they struggle to gain visibility contributing to low trading volumes, and ultimately, liquidity.
During periods of rising interest rates, the allure of going public may not be the answer to their liquidity dreams. To meet the reality of our new high interest environment, some are turning to a little-known financial tool known as the double-dip loan. These loans, while not yet a widespread practice, are starting to gain traction as businesses seek to refinance short-term debts and bolster their liquidity.
The recent surge in interest rates has left companies with speculative, floating-rate debt facing a conundrum. They are now burning through more cash than they were just 18 months ago when interest rates were at historically low levels. Traditional methods of raising new debt or refinancing have become increasingly difficult, leading to the emergence of double-dip loans as an alternative.
Double-dip loans work by creating a subsidiary company that issues new loans and then lends the proceeds to its parent company on a secured basis. This means the loans are backed by collateral. The parent company also guarantees the new loans, creating a second claim on assets. New lenders often receive collateral that existing lenders do not have claims to, hence the name "double-dip." Initially used by multinationals to move money internationally, these double-dip loans are now finding favor among a wider range of cash-strapped companies.
While double-dip loans and IPOs may extend a temporary lifeline to companies facing liquidity pressure, the slug of cash won’t last long, nor address the underlying fundamental issues of the business: too much leverage. No amount of cleverness can change that, except aggressive debt paydown.
- Harbor Access