Questions CFOs should ask when considering private debt funds

Private debt can be an attractive source of funding for corporate borrowers. More leverage, flexible terms, fast execution and a one-dimensional relationship between Borrower and Lender. Debt in exchange for debt service, no strings attached, no cross-sell lingo. When considering a private debt alternative, what questions do CFOs need to ask? To both themselves and to the prospective debt fund? This SERRA Market Observation makes a few suggestions …

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What funding desire can private debt satisfy that my banks cannot?

The short answer to this question is more debt or debt with fewer strings attached. Private debt looks as if it were designed for companies with a transaction driven mindset of either spending excess cash on acquisitions or on shareholder distributions. Less eventful companies have less to gain from the leverage and flexibility private debt is offering. They may experience that private debt funds have little to offer as they cannot provide LCs, cannot finance your equipment or your day to day working capital needs.

What about ticket size?

Minimum size requirements are one of private debt’s largest shortcomings. Most funds of the > 150 debt funds active in the EURO zone will look for EUR 20m plus ticket sizes, while some do not even want to mobilize their expensive apparatus on deals under EUR 50m. Return on effort is at least as important as return on credit, it takes a similar amount of time to analyze, structure, negotiate and document a EUR 10m debt deal than a EUR 30m transaction, why go for the small one? Banks are much better equipped to deal with small ticket sizes. Competition among the many private debt providers may bring down the minimum ticket size slightly but fundamentally private debt is ill-designed for large SME / small mid-caps.

How will the fund respond when I need to make amendments to my loan agreement?

Most debt funds will see any amendment, for better or worse, as a unique opportunity to increase the return profile of their credit investment. Banks may occasionally be demanding and bureaucratic when it comes to dealing with changes in the loan agreement but tend to be less pre-occupied with fees and margins.

Are private debt funds more inclined to sell their exposure to a third party as compared to banks?

Many will be and this is a question that needs to be asked to any fund. Most funds active today will not be there in the same form when the loan matures in 5 or 7 years-time. Desks close, portfolios consolidate into bigger ones or managed passively. As part of this process the fund and people met at inception of the deal will may not be there in the future. This can have an impact on possible amendments and the fund’s ability to participate in an increase of the facility.

What is the fund’s approval process?

Like banks, the people you meet will not be the people that approve your credit. But unlike most banks, many funds have their dealmakers quite far away from their credit investment committees. This distance may be physical (New York committee for London based fund) or metaphorically, meaning that the credit approving team may have limited affinity with the company being assessed.

My company faces some financial difficulty, can private debt be of any help?

Some private debt can, some cannot. The background of private debt providers is often an indication of their risk appetite. The risk appetite of a direct lending desk of an insurance company tends to be limited. On the contrary, a private debt manager that has set up a primary debt vehicle alongside existing secondary (distressed) debt funds will actively seek higher risk in order to find higher returns. Such funds can provide an attractive way out for a company that is either in financial stress or emerging from it. The house bank is often not very eager to increase credit lines to rebounding companies. In such special situations, a filmish term used by some funds, private debt can add a lot of value. Flip side is that such funding will be expensive and underperformance to plan will be punished. Sometimes mild punishment in the form of a step-up in rates and fees, sometimes more severely by a forced sale of assets or (partial) transfer of control.

SERRA can help when raising private debt. Tailored assistance. On the fore front or at the background. Strong network and capital placement competency. Flexible engagement terms, large or small teams, senior advisors only. Financial modeling with purpose. International DNA, multi-language, multi-cultural teams.

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See also www.serrapartners.nl/team to reach out.