The Debt Connection – July 2016

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In the latest Debt Advisory newsletter from Clearwater International, we look at the growth in private debt capital targeting non-sponsored transactions.

The pool of private debt capital may have deepened considerably over the last few years, but much of it remains focused on sponsor-led transactions. As a result, there is an opportunity to provide bespoke financing solutions to high-growth businesses that are not private equity-backed.

A considerable amount of private debt finance has been raised in Europe over the past 5 years, with a notable uptick in the last 2-3 years and 2015 seeing €16.8bn raised by European focussed funds according to Preqin. This has led to an increasing number of transactions and businesses in the mid-market being funded via non-bank direct lenders and debt funds. This funding, however, has largely remained focussed on sponsor backed transactions, where competition in the €50m-€75m lending ticket size is particularly fierce between funds. This leaves an opportunity to provide financing to non-sponsored businesses in the mid-market.

There are now a growing number of funds and direct lenders, who in addition to sponsor backed transactions, are also actively targeting non-sponsor businesses. Some funds have been established specifically to target the non-sponsored market. Research by Deloitte indicates direct lending in the non-sponsored space has grown from 12% in Q4 2012 to 30% in Q1 2016, with potential for further growth. This market is now growing for two reasons:

  1. Non-sponsored business demand for an alternative to bank finance where quantum or conditionality is too restrictive; and
  2. Funds looking for ways to diversify and improve investor returns.

Due to fewer lenders operating in this space, there is naturally less competition compared to the sponsor-backed market and therefore the potential for better pricing/returns for investors.

The non-sponsored space does come with some challenges to recognise and manage, such as a longer lead time required to source opportunities. To access these businesses, funds rely heavily on advisors who know the market and already have relationships established, as typically, the lenders do not have the geographic footprint, employee numbers or local knowledge. Also, there is usually more preparation required of businesses, as they are not already part of a process where advisors have addressed issues and finessed the business.

A mitigant to these challenges is business owner-managers are likely to be more risk adverse than private equity. Leverage, therefore, is often lower and so the risk-return dynamics can be very attractive for certain investors.

We see the market continuing to develop and a greater range of funding options being made available to businesses, with an increasing number of funds targeting non-sponsored businesses going forward. This is noteworthy for a number of owner-managed businesses looking for finance solutions to support organic or acquisitive growth strategies, but are less keen on diluting their personal shareholding as part of this.

Will Brexit have an impact?

The simple answer is it is too early to say what the impact will be, especially whilst there are so many changes in the UK political parties. However, it is important to remember the debt funds have raised committed private capital with returns promised to investors, so they remain keen to support businesses. What we are likely to see though is more competition for the highest quality assets and caution around those businesses with FX risks. The Bank of England has also sought to provide comfort to the markets by reducing Banks’ capital buffer from 0.5% to 0%.

CWI expands its Debt Advisory team further

Market awareness of the role a debt advisor plays in corporate and private equity backed finance raisings has grown considerably over recent years. To meet this growing demand for its debt advisory services, Clearwater International has further invested in its UK team with the hire of Lachlan Dorrity, as an Associate Director in London. Lachlan is a chartered accountant and joins Clearwater International from Grant Thornton, where he advised a number of management teams across a variety of sectors.

Chris Smith, Partner and head of debt advisory, Clearwater International, said: “We are delighted to have Lachlan join the Debt Advisory team in London. He brings strong deal experience and is already actively involved in a number of our cross-border transactions.”