During the next year, middle-market companies will see accelerating changes in their businesses resulting from globalization, including changes to how they deal with their lenders, investors and even professional advisers.
Globalization of economies is now an immediate actuality for U.S. middle-market companies. Because of the broader global availability of information, expanded communications technology and reduced restrictions on cross-border investments, both business operations and investment capital now flow across national borders freely in search of higher returns. Drought or component supply interruption in Russia or China immediately and materially affects food and product markets in the U.S. and elsewhere. Weakness and disruption in the economies of Ireland, Libya and Egypt are felt directly in the operations and investments of U.S. companies through commodity prices, credit availability and interest rates. Such weaknesses also affect stock market trading, the confidence of investors and the availability of equity capital. Flows of components, products and capital can change the dynamics of national and local business operations and investing.
Historically, U.S. domestic middle-market companies have been only tangentially affected by foreign events due to the size of the U.S. economy and the limited foreign encroachment into U.S. markets, and because flows of capital and business operations have generally been outward from the U.S.
However, according to the 2011 Statistical Abstract from the U.S. Census Bureau, U.S. companies with a value of $63.5 billion were acquired or established by non-U.S. owners in 2003; that number was $86.2 billion in 2004 and $260.3 billion in 2008; more recent data will likely show continuing and accelerating increases.
More non-U.S. companies are now able to compete globally. Think Nokia Corp., BP plc, Toyota Motor Corp. and News Corp., but also consider the last vegetable you ate, the last movie you saw or the last household product you acquired; chances are you either bought or could have bought one that was foreign-sourced.
Further, President Obama recently told a meeting of U.S. and Chinese CEOs discussing investment in U.S infrastructure projects at the 2011 World Economic Forum Annual Meeting in Davos, Switzerland, that the "United States is open for investment and would welcome it" from Chinese companies.
Global exposure of U.S. middle-market companies will continue and accelerate in 2011. More non-U.S. investors will expand their business operations in the U.S. and elsewhere through acquisitions, joint ventures and head-to-head competition with U.S. middle-market companies in overseas markets that have historically been served by U.S. entities.
Huge amounts of capital remain on the sidelines, investors bemoan low returns and throng to hot stocks and sectors, but expansion capital for U.S. middle-market companies will likely be tight as U.S. lending and private-capital financial markets remain sluggish through 2011. Blame increasing inflation, U.S. political uncertainty over deficit and regulatory initiatives, and increasing discomfort about developing investment bubbles in technology, commodities and healthcare. And don't forget Middle East turmoil.
As a result, U.S. middle-market companies will have to expand their sources of loans, equity capital and business partners to include nontraditional and foreign entities, pushing changes in historical U.S. models for lending and investment transactions. Due to the operational practices of the new non-U.S. financing sources and increasing inefficiencies in U.S. dispute resolution processes, watch for non-U.S. participants in the U.S. middle-market financing industry to move the historical U.S. transaction model to one that is more business information-driven -- shorter documents, less reliance on multiple and overlapping representations, warranties and financial covenants, and more specifically targeted reporting of business operational data.
Capital providers and investors will demand more direct operational input that allows for earlier change of control without materially disrupting business operations, as is more common outside of the U.S. And if you are an outside adviser, look for loans and capital transactions to be more streamlined and directed, with participants less willing to engage and pay for the more expansive services previously used. The new global economy is more action-oriented and less adviser-driven than in the past, resulting in significant oversupply in professional advisory firms.
There are lots of opportunities and risks for those who are nimble and bold. But don't think business as usual.
Todd R. Eskelsen is a partner in the Washington office of Schiff Hardin LLP.