Traditionally, price discovery — determining a company’s fair value price — is based on the interactions of buyers and sellers in a marketplace. The publicly quoted share price demonstrates how capital markets value a company, and it’s the basis upon which the company issues debt and equity. It also helps determine how the company allocates capital towards paying dividends, buying back company shares, compensating employees, paying down debt or reinvesting in the enterprise for future growth.
But today, five trends are colliding to distort how markets are pricing companies. The dangers of this distortion, especially at a time of buoyant stock markets, is that company executives and investors use these incorrect valuations as a basis to enter unaffordable M&A transactions and/or overleverage the company. The five trends are:
1. Low Interest Rates
Historically low interest rates, massive stimulus in response to the global pandemic, and the rising threat of inflation are leading to questions on appropriate discount rates to value a company in its entirety — its equity and its debt, including its pension obligations.
Low interest rates are also fueling enormous money flows into private capital, as are lower expected returns from public markets. Private equity investors are sitting on approximately $2.5 trillion in cash, according to Preqin. That is the highest on record and more than double what it was five years ago. Looking ahead, venture capital and private equity combined ware predicted to more than double their assets from $4.4 trillion at the end of 2020, to $9.1 trillion by 2025.
Capital flows to private equity have been accompanied by a decline in publicly traded companies. According to the Wilshire 5000 Total Market Index, the number of publicly listed U.S. stocks peaked at a record of 7,562 in 1998. At the end of 2020, there were fewer than 3,500. This decline means there are fewer public peers for business leaders to value their companies against, and less liquidity for companies as capital drains from the public capital markets.
2. Shift Towards Passive Investing
Another shift occurring across the investor landscape that can affect company value is the trend away from active investing toward passive funds. From 1995 to March 2020, passive funds grew from 3% of equity markets to make up 48% of assets under management in equities as of March 2020, according to a paper by the Boston Fed.
As of 2019, passive funds are estimated to be around $4.3 trillion, and they’re expected to reach parity with active funds with each totaling $13.4 trillion in assets by 2025, according to Price Waterhouse Coopers.
The growth in passive funds can materially improve stock price stability in the markets, reducing volatility in the shareholder register and potentially in the stock price itself, because passive funds strictly track benchmarks, only sell stocks that leave the benchmark, and are therefore considered long-term, permanent capital. These data suggest a shift which should aid in a better price discovery process – more price stability from permanent capital.
However, the shift towards passive investors tips that balance of power toward a small number of dominant investors, which could create additional complexity for companies. For example, the three biggest passive investors by volume — BlackRock, Vanguard, and State Street — own around 20% of the shares of the typical S&P 500. These three funds combined own 18% of Apple shares, 20% of Citigroup, 18% of Bank of America, 19% of JPMorgan Chase, and 19% of Wells Fargo, according to Bloomberg.
In practice, this means these passive investors wield enormous power – and potentially could find themselves on both sides of, say, an M&A transaction, not only unveiling conflicts that have to be cleared but also potentially impacting the price of a deal. Specifically, the same passive investors would be important shareholders and voters on both sides of a merger between two companies. When the vote comes on whether to accept a bid, investors on both sides of the trade might be willing to accept a lower price than those who solely own shares in the company being sold.
3. The Rise of ESG Investing
ESG market trends, purported to be worth $45 trillion in assets under management in 2020, are creating a quandary for how global corporations think about fair value for their companies and price discovery.
On the one hand, ESG trends impose additional costs of compliance, which can reduce revenues by shutting down products and business lines, as well cutting operations in certain jurisdictions. This creates a risk of undervaluation compared with companies from countries where ESG expectations and costs of compliance are lower.
On the other hand, there is increasingly a risk, particularly in Western capital markets, that companies without strong ESG credentials could see their valuations marked down. These conflicting ESG forces add opacity to the price discovery process.
4. Nationalism, Protectionism, and Other Global Cross-Currents
Fourth, the risk of greater deglobalization promises to impact all manner of how companies do/operate business. Rather than benefit from the synergies of a global business – such as centralized logistics, supply chains and procurement – companies face financial loss as they navigate a series of threats, including:
- Curbed trade in goods and services due to protectionist policies
- Limits to investment and repatriation amid capital controls
- Barriers to global recruitment under restrictive immigration policies
- More balkanized intellectual property platforms as a “splinternet” pits a China-led platform against that of the U.S.
- The breakdown of global cooperation – so that global standards and multilateralism take a back seat to national interests.
The collision of these trends suggests price discovery itself is at risk of becoming a more balkanized and less transparent exercise. In a more siloed world, a company’s valuation could suffer from the risk that the sum of its parts may not be equal to, and could be lower than, the whole.
5. Cryptocurrency and Other Global Financial Innovations
Finally, fundamental changes in the global financial architecture — whether the rise of cryptocurrency or the threat of China’s efforts to unseat the U.S. dollar as a reserve currency — could also materially affect the price discovery of a company depending on how it is exposed and positioned.
With respect to cryptocurrencies, issues of volatility and speed lead skeptics to wary of its effects. With customers and suppliers adapting to their use, companies should consider the effects of placing cryptocurrencies on their balance sheet — and the potential impact on company valuation. For instance, Bitcoin’s volatility would make it harder to calculate the true value of a company at any given point. Bitcoin’s three-month realized volatility, or actual price moves, is 87% versus 16% for gold according to a February 2021 report by JPMorgan.
Meanwhile China is now the largest trading partner, foreign direct investor and lender to numerous developed and developing countries around the world. It’s also the largest foreign lender to the U.S. government. Through expansive cross border efforts, such as the Regional Comprehensive Economic Partnership (RCEP) trade agreement, the Belt-and-Road Initiative and its use of derivatives in trading contracts, China is stamping its imprimatur on the globe. But perhaps most crucially China is backing its own digital currency, a virtual yuan, which, although not a peer-to-peer cryptocurrency, could challenge both Bitcoin and the U.S. own attempts at a digital dollar.
Corporations will have to weigh up the risks and benefits of crypto and digital currencies and decide whether to hold them as assets and liabilities on the company balance sheet; a decision that will affect the company’s value.
Business leaders are constantly managing risks and opportunities in an uncertain world in the hope that their companies will continue to operate and appreciate in value. Yet, quite clearly, there are a number of trends that could left unchecked, undermine and harm a company’s valuation — many of which remain widely overlooked by consensus views.
Business Loan vs. Line of Credit: Which Is Right for You?
Business loans and business lines of credit are different forms of business financing. With a business loan, you’ll receive a lump sum of money and pay it back over time. A line of credit is a pool of money that you can keep dipping into, up to a limit.
In general, business loans are the better choice when you need a significant amount of financing for a major purchase or expansion. Business lines of credit are better suited for evening out gaps in your cash flow or floating your finances through an emergency.
What is a business loan?
A business loan is a lump sum that you receive from a small-business lender and then pay back over time with interest. Business loans are best when you need financing for a specific project, investment or acquisition that will help grow your business.
You can usually borrow more with a loan than you can with a line of credit.
In most cases, you’ll receive all your loan funds in one upfront payment.
What is a business line of credit?
A business line of credit can help you get access to working capital whenever you need it. Lines of credit work in a similar way to credit cards — you can borrow as much money as you need up to your credit limit, and then pay it back over time. Lines of credit are best for businesses who want ongoing access to financing to even out their cash flow or to tap in emergencies.
Lines of credit can be used for any business expense.
Some lines of credit are unsecured, meaning you won’t have to provide physical collateral.
Lines of credit tend to be smaller than business loans.
Business line of credit vs. loan: How to choose
In general, business loans are best suited for financing specific projects. Lines of credit are more like business credit cards, making them useful if you want to tap into working capital on an as-needed basis.
The best choice for your business depends on how much financing you need, what you want to use it for and what you can qualify for.
Business line of credit
How much financing do you need?
Varies widely, but loans usually offer more financing than lines of credit.
Varies widely, but lines of credit are usually smaller than loans.
What do you need financing for?
A specific purpose. In your loan application, you’ll have to explain what you plan to do with your loan funds.
Can be used for any purpose.
How do repayments work?
Installment credit — you receive a lump sum and pay it back in regular installments over time.
Revolving credit — you can carry a balance that accrues interest and pay it back as you’re able, then borrow more.
Do you have collateral?
Almost always requires collateral.
Unsecured lines of credit do not require collateral.
What product can you qualify for?
Tends to require good credit, multiple years in business and more annual revenue.
Usually easier to qualify for than business loans.
Where to get a business loan or line of credit
Many banks and online lenders offer both business loans and business lines of credit.
Bank business loans and lines of credit
In general, bank loans are the hardest to qualify for, but they also tend to offer the lowest interest rates and most favorable terms. If you have multiple years in business and good or excellent credit, seek bank financing.
National banks offering business loans and lines of credit include:
Bank of America: Business loans and lines of credit. Bank of America offers a wide variety of business loan products with competitive interest rates, but they can be difficult to qualify for, and the application process requires a meeting with a lending specialist. Read NerdWallet’s Bank of America business loan review.
Chase: Business loans and lines of credit. Chase offers small loans — business loans of as little as $5,000 and lines of credit with limits as low as $10,000 — which can be easier to qualify for than large loans and help you build business credit.
Wells Fargo: Business loans and lines of credit. You can get a secured or unsecured line of credit from Wells Fargo. The bank has discontinued many of its term loan products but still offers SBA loans.
Online business loans and lines of credit
Online lenders can be a good resource for newer companies or business owners with fair or bad credit. They also tend to fund loans more quickly than banks can, sometimes within a day. But their interest rates tend to be higher than those offered by banks.
Online lenders offering business loans and lines of credit include:
OnDeck: Business loans and lines of credit. Business owners with fair to good credit may be able to qualify for OnDeck loan products, but their interest rates can be high. Read NerdWallet’s OnDeck review.
Kabbage: Lines of credit only. Kabbage lines of credit are a good fit for business owners with fair credit who want fast access to capital, but their fee structure is complex. Read NerdWallet’s Kabbage review.
Funding Circle: Business loans only. Funding Circle tends to offer lower interest rates than other online lenders, but loans are more difficult to qualify for and take slightly longer to fund. Read NerdWallet’s Funding Circle review.
Bluevine: Lines of credit only. Bluevine lines of credit are available to business owners with as little as six months in business, but you may need to make frequent repayments. Read NerdWallet’s Bluevine review.
5 financial tips for millennial business owners
This content should not be construed as financial advice. Always consult a financial professional regarding your specific financial situation.
In 2017, I wrote an article about financial tips for millennial business owners. Five years later and two years into the ongoing COVID-19 pandemic, I was surprised to find that most of the original advice still holds true today. However, some changes are worth noting that will better empower millennials to succeed personally and professionally with their finances.
Five financial tips for millennial business owners
Here are five things today’s millennial business owners should consider. We will look at each tip in more detail.
- Pay down and pay off outstanding debt.
- Work alongside a financial adviser.
- Observe the money moves of Gen Z.
- Build an emergency fund.
- Establish Plan B.
1. Pay down and pay off outstanding debt
My original article emphasized the importance of getting out of student loan debt. I mentioned suggestions for managing that debt, like lowering student loan bills through better repayment or refinancing plans and making loan payments on time. Hopefully, doing these things would make it easier for millennial business owners to financially plan to start a business.
However, according to Bank of America’s Better Money Habits Millennial Report, student loans now only account for 25% of millennials’ debt. The Winter 2020 report examines the precarious balancing act that millennials have with outstanding debt. And this debt is no longer limited to student loans.
The reason? Millennials are no longer twentysomethings. Millennials began turning 40 in 2021. The report shares the various types of debt that millennials carry in middle age, including auto loans (40%), credit card debt (37%) and mortgages (36%). Each makes up a higher percentage of debt than student loans.
Further, the report addresses the worries that millennials have surrounding their debt. Those surveyed say that having debt keeps them from reaching professional and personal milestones. Millennials today feel like they can’t or can’t yet fulfill the following goals:
- Buy a first or nicer home (42%).
- Save for the future (40%).
- Welcome children or grow their family (21%).
- Get married (21%).
- Start their own business (19%).
Despite these grim percentages, millennials are not giving up.
The COVID-19 pandemic has impacted the American workforce with the Great Resignation. Millions of workers are quitting their jobs, with a January 2022 study from Cengage Group citing 38 million workers who resigned in 2021.
Quitting does not mean millennials do not plan to work again. Instead, they are taking back their power. Ninety-one percent quit their jobs to make more money, 82% are reconsidering priorities amid the pandemic and 81% wish to pursue another passion or career path and are reskilling appropriately.
For many millennial business owners, relying on traditional financial tips like refinancing, budgeting, and making on-time payments isn’t enough to get entirely out of debt. Resigning from a job where you feel stagnant, or experience stagnating wages is a critically important next step for paying off debt and revitalizing your career trajectory.
2. Work alongside a financial adviser
No matter your stage in running a business, every small business benefits from working with a reliable financial adviser.
What can a financial adviser do for you? These advisers assist millennial business owners in making sound financial decisions. An adviser is well-versed in financial literacy and understands planning in certain and uncertain times of economic stability. Many also work with niche-based entrepreneurs, like those within the FIRE (financial independence, retire early) and HENRY (high earner, not rich yet) communities.
Best of all, millennials can even work alongside a millennial financial adviser if they choose.
If you’re currently on the hunt for one, check out this roundup on Business Insider of the 23 most influential financial advisers for millennials.
3. Observe the money moves of Gen Z
Millennials and Gen Z “allegedly” don’t like one another very much. Something about a TikTok dance? I digress. Millennials can learn from individuals at all stages of entrepreneurship, including the class of creators that makes up Gen Z.
How exactly does watching the entrepreneurial moves of Gen Z translate to financial advice?
Gen Z came up in a world where many cheaper tools are at their disposal. They are natural social natives that utilize digital platforms to build their brand.
Watch which tools they use to build their business and how they save money through using them. A good example is observing the platforms they use, like Square to accept payments and Etsy for creating an ecommerce presence. These tools are cost-effective and allow Gen Z to focus on their business. Take a few notes if you haven’t started already, millennials.
4. Build an emergency fund
If business owners have learned anything from the COVID-19 pandemic, it is the importance of having and maintaining an emergency fund.
Emergency funds are exactly what they sound like: three to six months’ worth of expenses set aside to be used in the event of an emergency. This emergency can be anything from a pandemic to a natural disaster. Having an emergency fund means having the ability to cover an unexpected expense without taking out a loan or using a credit card with a high-interest rate.
Three additional pro tips I have for building an emergency fund are below:
- If you withdraw a certain amount from your emergency fund, remember to pay it back. Ideally, do this as quickly as possible.
- Use this fund only in the event of an actual emergency.
- Add to an emergency fund regularly. Treat it as you might a retirement fund. Strategize with the help of a financial adviser as to what this fund’s maximum contributions might look like every year. Then, add to the fund accordingly. Too often, emergency funds are viewed through a one-time lens. Business owners should set up the fund in a safe space like a high-yield savings account and keep contributing funds to it over time.
5. Establish Plan B
Plan B was in the original version of this article, and I’m using it to conclude this updated list of financial tips for millennial business owners.
Having a Plan B is essentially creating a backup plan for your life. The phrase is often used negatively as if to say that because a particular business venture didn’t work out, you can’t be an entrepreneur again. That’s not true. Having a Plan B means having a safety net for every good and bad “what if?” scenario.
If something doesn’t work out now, you have options, and Plan B will help you find and pursue them.
This content should not be construed as financial advice. Always consult a financial professional regarding your specific financial situation.
How Digital Currencies Can Help Small Businesses
Over the last few years, the development of blockchain technology brought us new types of digital assets such as stablecoins and cryptocurrencies. These innovations offer the foundations for building new payment rails that can move value across the globe not only in real-time but also at a much lower cost. Unlike cryptocurrencies such as Bitcoin or Ethereum, stablecoins are significantly less volatile as they are typically pegged to a fiat currency such as the U.S. dollar. Stablecoins also pushed governments to accelerate their exploration of central bank digital currencies (CBDCs). While cryptocurrencies rely on decentralized networks for their operations, CBDCs would run on public sector infrastructure and represent a direct liability of the central bank — essentially “digital cash.”
There’s major potential here: digital assets and cryptocurrencies can support new services and create more competition in financial services. For one, they promise lower-cost payments for both domestic and cross-border transfers. They can also facilitate real-time payments, overcoming a significant shortcoming of the U.S. payment system. Moreover, these new assets support programmability, which can be used for conditional payments and more complex applications such as escrow.
At the same time, these technologies — and how they threaten traditional financial intermediaries — has ignited a heated debate. For example, a recent, widely anticipated paper by the Federal Reserve Board acknowledges the significant benefits of digital currencies, but also raises concerns around privacy, operational, cybersecurity, and financial stability risks. Similarly, Gary Gensler, Chair of the U.S. Securities and Exchange Commission, recently nearly doubled his crypto enforcement staff to crack down on what he calls the “wrongdoing in the crypto markets.” The recent collapse of UST, Terra’s Stablecoin — one of the largest stablecoins — illustrates how a failure in one of these systems can cascade throughout the crypto ecosystem. While many stablecoins derive their value from being fully backed by reserves, that was not the case for UST, which instead relied on an algorithm and a second currency, Luna, for stability.
While recent events underscore that the risks cryptocurrencies entail cannot be ignored, it is also clear that the status quo does not provide a satisfactory answer. The question is who carries the burden of an expensive, outdated, and slow payment system. This article surfaces the potential impact on small and medium businesses, which embed significant consequences for economic growth and stability.
Small businesses — including restaurants, plumbers, and dry cleaners — play a critical role in our economy. They employ roughly half of all working Americans, amounting to more than 60 million jobs. They created 65% of net new jobs from 2000 through 2019, represent 97.5% of all exporting firms in the U.S., and account for 32% of known exported value. Moreover, small businesses are also an essential vehicle for intergenerational mobility and social inclusion, offering upward mobility and economic opportunity, particularly for underrepresented groups such as minorities and immigrants.
Small businesses are also finding new ways to reach consumers outside their local communities through digital platforms such as Shopify and Amazon, a distribution channel that was vital for them during the pandemic to counter the decline in retail sales.
Nevertheless, they have largely been ignored during the debate over digital currencies. While policymakers, economists, and government officials highlight the importance of ensuring the resilience and growth of small businesses, the way they could benefit from better and more competitive payments infrastructure is almost entirely overlooked.
The Financial Fragility of Small Businesses
Most small businesses operate with razor-thin cash buffers. The typical small business only holds enough cash to last less than a month. This leads to significant vulnerability to economic fluctuations, as illustrated by their collapse during the 2008 financial crisis and, more recently, the Covid-19 crisis. The latter carried devastating consequences for small businesses, forcing the government to issue an emergency Paycheck Protection Program (PPP) to ensure they could stay afloat.
There are many reasons for this, including their limited access to credit and the fewer financial options they have relative to larger firms. Small businesses are often considered riskier for lenders because they struggle to deliver the types of quantifiable metrics large banks expect when evaluating creditworthiness. While small businesses have relied more on community banks, bank consolidations have further limited this source of funding.
One of the most pressing issues for small businesses is payment delays. Large buyers, such as Walmart and Procter & Gamble, commonly use “buy now pay later” practices with their suppliers, with payment delays between 30 and 120 days. When applying such practices, large buyers are essentially borrowing from small businesses, significantly increasing their working capital needs and lowering their available cash buffers. Indeed, survey evidence suggests that almost 70% of small businesses that rely on invoices report cash flow problems linked to these payment delays.
The challenges in accessing credit, combined with delayed payments make it hard for small businesses to maintain healthy cash buffers, increase their exposure to economic shocks, and limit their ability to make investments. Increased competition and innovation in payments could improve their long-lasting resiliency and opportunity for growth.
How Slow and Expensive Payments Hurt Small Businesses
Today, most U.S. consumer payments are made via credit cards, a trend that accelerated during the Covid-19 pandemic. While entirely invisible to customers, merchants pay fees — to card-issuing banks, card-network assessment, and payment processors — that can reach above 3% of the transaction value, and are likely to increase in the near future. Online transactions, mainly through marketplace platforms such as Amazon or Shopify, can be even more expensive. Additionally, it can take several days to actually receive the funds, which increases the working capital needs for small businesses.
This puts small businesses at a clear disadvantage, particularly given their thin margins, limited cash buffers, and expensive financing costs. While large businesses, such as Costco, can negotiate significantly lower fees when accepting digital payments, small businesses do not have much negotiating power. Right now, there are few alternatives to the major card networks, meaning that small businesses operating on small margins do not have a choice but to attempt to pass part of the fees to customers through higher prices, which lowers their ability to compete with deeper pocket rivals.
These problems are magnified when dealing with cross-border transfers, where fees and delays are incredibly high. As of the second quarter of 2021, the average cost of sending a cross-border payment from the United States was 5.41 percent, and SWIFT payments can take between one to five business days. Moreover, fees are unpredictable, and businesses may incur additional costs depending on the number of correspondent banks involved in the transaction. The complexity of the payment chain makes international payments also a lucrative target for scams and fraud, further increasing its costs.
How Blockchain Technology Can Help
To change this, we need a more open and competitive payments infrastructure. To achieve that, critically important public-sector efforts such as FedNow and CDBCs need to be combined with private sector innovation — including permissionless cryptocurrency networks. Public-sector efforts inevitably move at a glacial pace, and there is a real risk that they will be severely outpaced by innovation happening elsewhere, often within “walled gardens” that lock consumers and businesses into non-interoperable services.
But this does not have to be the case. The public sector can take advantage of the technical progress happening within the blockchain and cryptocurrency space to accelerate its journey towards real-time, low-cost payments.
An open payments system will drive competition, lower transaction fees, and unbundle the services that are currently part of all digital transactions — including those related to reversibility and chargebacks, intermediation, transaction risk assessment, and more — helping businesses pay only for what they actually need. Ideally, thanks to new forms of interoperability between digital wallets, banks, and legacy payment and card rails, small businesses would be able to do so without compromising which customers they can accept payments from. Moreover, transferring funds directly through a blockchain would benefit domestic and cross-border payments by reducing the number of intermediaries in the picture.
If this evolution of payments is successful, small businesses would experience not only lower costs but also faster access to funds. This would drastically improve their liquidity and cash buffers, and help them survive negative economic shocks and thrive.
By creating the right conditions for a truly open and interoperable protocol for money to emerge, very much like in the early days of the internet, the public sector can bring back competition to payments, and give small businesses much-needed choice.
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