Businesses will need new capital to help in the recovery phase of the crisis, bankers say

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Businesses suffering in the novel coronavirus pandemic will need new and different injections of capital to survive a period of prolonged physical distancing, according to the chief executives of Quebec’s two largest financial institutions.

Federal and provincial governments have rolled out relief programs guaranteeing billions of dollars in loans to small businesses, including interest-free $40,000 loans that are partly forgivable. “But most of that money ... has been debt,” said Louis Vachon, chief executive officer of National Bank of Canada.

Mr. Vachon spoke to The Globe and Mail in an interview after the bank’s annual meeting, which was held virtually on Friday. Desjardins Group CEO Guy Cormier, who leads the country’s largest financial co-operative, echoed his concerns about companies’ mounting debt loads in a separate interview.

“It’s really shifting the balance sheet of many of our companies," Mr. Cormier said. “They won’t be able to support this level of debt even with low interest rates that we’re having right now."

Many small- and medium-sized businesses, especially those that provide discretionary services – from barber shops and gyms to restaurants and luxury goods retailers – could suffer from the effects of physical distancing long after lockdowns are lifted across the country. And as financial institutions emerge from several intense weeks of launching emergency relief programs, a realization is growing that businesses will need less burdensome, more patient forms of funding to stay afloat.

Some larger companies can access capital markets, but most businesses can’t, and executives at financial institutions have struck up discussions with government officials and institutional investors about how to provide bridge funding that doesn’t fit the profile of traditional bank debt, Mr. Vachon said.

He said “a more permanent form of capital” is required, while Mr. Cormier stressed the need to “invest more equity” in companies, and both CEOs are exploring possible tools at their disposal.

In some cases, that could mean bringing together venture capital firms, financial institutions, large pension plans and even family offices to invest directly in businesses. A Desjardins subsidiary, Capital régional et coopératif Desjardins, already invests $2.3-billion in assets in small and medium-sized enterprises. “This is something that I’m not scared of,” Mr. Cormier said. “We’re investing in companies as investors with a seat on the board. We’re trying to see, can we do more?”

Mr. Vachon added that not all businesses want direct investment. Entrepreneurs are often “very reluctant to dilute themselves too much, to give too much of the upside." So he proposes that financial institutions could offer junior debt as an alternative, which is subordinate to the senior secured debt that makes up much of banks’ lending. That carries a higher interest rate to compensate for the added risk of its subordinate position, but would allow entrepreneurs to keep firm control of early-stage companies.

Mr. Cormier said mezzanine loans, which start out as debt but can be converted to equity later, are another option.

“You need that middle segment – subordinate debt, participating debt, something that’s obviously higher-return than a secured bank loan, but something also that’s not too costly and too demotivating for the entrepreneurs in this country,” Mr. Vachon said.

Some of the loans or investments might need to be backstopped by government, or include a forgivable component, to manage the risk to financial institutions, Mr. Cormier said. “The government could be there just to match sometimes or just to invest a small portion,” from 10 per cent to 25 per cent of the funds.

Institutions such as the Business Development Bank of Canada and Investissement Québec have years of experience in providing these types of support, “so we’re not starting from scratch here,” Mr. Vachon said. “But I think that segment may need to be expanded over the next three to six months.”

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