Slackening Investment Indicators​

By Jake Rickman​

What do you need to know this week?

The Financial Times reported on Tuesday that US companies are finding it increasingly difficult to raise financing.

The volume of cash raised through equity sales is 88% lower compared to last year, which is the slowest start to the calendar year since 2009. The article identifies the increased volatility in the equities market as a primary factor for the dampened equity market, observing that the average company in the Russell 3000 index — which is more reflective of the wider US market than other indices like the NASDAQ — has lost over 30% of its value in the past three months.

For debt financing, increasing interest rates means that the cost of borrowing becomes more expensive. For debt investors such as large investment banks, there are signs that they are becoming more hesitant to lend to companies that they perceive as riskier, such as abandoning ongoing loan deals.

Why is this important for your interviews?

It remains to be seen how entrenched these trends are, and how long they may persist. That said, this could be an early indication that the era of frothy capital markets that has defined the past two years may be ending. If you are interested in corporate finance, this could have profound implications.

Companies primarily raise money in two ways: by offering shares (equity financing) or issuing debt securities (debt financing). The past two years have seen record rates of both: the stock market has had one of its biggest bull runs ever and there were record numbers of high yield bond issuances in 2021.

Why? Central banks cut interest rates at the start of the pandemic to encourage companies to borrow money that they may not have otherwise borrowed (because it became cheaper). This increased the amount of cash circulating in the economy, enticing companies to fund improvements (such as building new factories) or acquire other companies (M&A deals).

The knock-on effect is that companies became more valuable on the stock market because, by investing in their company, the value of their assets increases (which drives up the price of a company’s shares). This is why the equity market also did so well: more people wanted a piece (shares) of the action (in the stock market).

However, factors like Russia’s invasion of Ukraine, surging energy prices, inflation, and supply chain issues has spooked the stock market, which makes it harder to raise equity financing because there are fewer buyers. The threat of increased interest rates (to tame inflation) is likewise disrupting debt capital markets.

How is this topic relevant to law firms?

Given that for every M&A deal or bond issuance, there is a team of lawyers advising the parties, the more financings there are, the more money law firms make. This explains why, in the past two years, City law firms are bringing in record-breaking revenue and trainee and NQ salaries are soaring.

A slowing investment market will likely mean City profit margins get slimmer.