The art of (financing) the deal

The role of private capital

The bigger story, however, has been the continued rise of private capital in financing M&A activity.  In mid-market leveraged finance deals, almost all debt is provided by private credit, often in a highly competitive process. This is a direct consequence of fewer M&A deals in the market. In some sectors, notably financial services and TMT, it is common to see more than 10 private credit providers in the initial stages; and a sponsor may choose a club of lenders, rather than one which could provide all of the debt, in order to maintain its relationships with lenders and mitigate over-exposure to a single private credit fund. 

Private capital lending often includes an accordion feature (also known as additional facilities) or committed delayed-draw term facilities, to provide flexibility for the longer term for bolt-on acquisitions and capex. However, because of their structure and funding mechanisms, private credit providers are traditionally not able to provide revolving credit facilities (RCF) which are essential for working capital purposes. Negotiating a separate RCF to sit within the capital structure may take time, particularly given the intercreditor arrangements which would be required.  Accordingly, some private credit providers have risen to the challenge and will underwrite a bridge RCF facility with the intention of that piece being refinanced before or shortly after the acquisition has been completed with a long-term solution provided by a traditional RCF provider. This, together with recent downwards pricing trends and pricing incentives to refinance with existing lenders, shows how private credit providers are constantly looking at ways to cement their position as a mainstream option in the market.

In the investment grade corporate market, acquisition processes are almost always bank funded, often as a bridge to a bond.  However, private credit providers have made some inroads in funding cross-over corporate debt in sectors where bank funding is more challenging, such as retail, even where leverage is not high. This has been helped by the reduction in pricing of private credit and the lack of pricing flex giving greater certainty.

Equity financing

Some acquisitions were funded solely through equity and retained cash in the business – with a view to refinancing in the future, whether by way of a distribution or repayment of shareholder loans, when the interest rates environment and general debt market has improved. 

Where a private capital sponsor fully equity underwrites a transaction at completion, with an intention to refinance at a later date, typically the portion that will be refinanced is provided as an additional tranche of shareholder debt. Shareholder loans can easily be repaid by upstreaming the proceeds of a subsequent refinancing. 

Management reinvestment on a private capital-backed buyout is generally excluded from this tranche and instead applied to the tranches of strip securities intended to remain in place post-refinancing, as sponsors are keen to maximise management investment in the business going forward. Where a subsequent refinancing is conducted for less than the full amount needed for a complete refinancing, and a portion therefore is left in place, the outstanding portion can be later capitalised into strip securities to hold going forward alongside the sponsor's and management's other strip securities.

We are also seeing a growing trend in private equity serving as a source of capital to listed companies by means of equity joint ventures over ring-fenced pools of assets within a listed group.

Vendor financing

We have also seen an increase in vendor financing where the seller provides some form of financing to the buyer to help close the deal. This can take a number of different forms, including a loan note or deferred consideration. This can also help where there is a gap between the buyer's and seller's valuation expectations, which is no doubt one of the reasons we have seen an increase in its use recently. The use of vendor financing brings with it additional work, for example, the seller is likely to want to conduct due diligence on the buyer and/or seek other forms of comfort that it will be repaid in full, but it can provide a neat solution to help get a deal over the line.

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