16 IP-backed loans
Providing financing solutions to companies, universities and law firms that own or manage valuable intellectual property is growing.
Managers such as Soryn IP Capital Management target companies with limited access to traditional sources of capital.
This could include partnering with universities to back intellectual property developed in early-stage research or leveraging intangible goodwill in patents at a start-up firm.
Other managers with credit-oriented strategies targeting this market gap include hedge fund manager Fortress, which has an IP credit fund and Aon, which is currently raising capital for a debut IP credit fund.
There’s a clear gap in the market, says Edward Truant, the founder of Slingshot Capital, citing recent reports showing that intangible assets represent around 90 percent of S&P 500 market value compared with around 30 percent in 1985.
“Just as private debt funds take different shapes and sizes, so too does an IP credit fund,” says Truant. “Where the underlying IP and/or associated rights or income streams can be assigned predictable licensing, monetisation and/or sale value, various transactions can be structured to leverage or maximise the value of the associated IP.”
IP credit involves highly structured, privately negotiated financial contracts of varying types. Counterparties are often companies possessing valuable IP portfolios, which are underserved by the capital markets. Investment types within the private credit strategy include senior loans, loans secured by IP, loans secured by legal judgments, loans secured by insurance policies, convertible debt instruments, highly structured preferred equity, common equity and warrants.
17 Data-driven insights
When Tingting Zhang founded TerraCotta Group in California in 2004, she wanted to bring a quantitative and scientific perspective to commercial real estate credit underwriting. By working to shift the focus away from human intuition and into analytics that could explain and predict change, she has built a data warehouse that allows firms to leverage that data.
TerraCotta uses its large volume of data for predictive analytics to assess, forecast and stress test property values and cashflows through market cycles, and has not suffered a single credit loss since inception.
Zhang says that is just one benefit from the investment the firm has made in the collection of data and creation of algorithms: “From our perspective, the quantitative methodology powered by technology is indispensable,” she says. “Our system goes through 200 variables to understand the risks of any commitment. That is done in two hours, allowing us to issue a letter of credit the same day and close our transactions in two to three weeks. This approach significantly cuts down the timelines and creates certainty from a borrower point of view, giving us an advantage in sourcing and in pricing.”
From an LP perspective, that translates into better yield and better risk management. The volume of data available to private equity managers doubles every year, but still there are few firms following in the footsteps of TerraCotta to use quantitative data to underpin investing.
“We see more of this technology and data adoption in the operational area, to improve efficiency of pipeline management and asset management,” says Zhang. “Looking forward, what is certain is that no asset manager can survive without using data, but we are still very early on that path. Data itself is a commodity and it is how you take the information out of the data to inform your underwriting methodology and embed it in your processes that will be a differentiator for quite some time.”
In real estate credit, investors have been able to make use of mobile phone data to track tens of millions of people on a daily basis to see where they visit, where they live and where they spend money. Previously, people were using traffic data, and in the future credit card data will be more of a feature.
“There are a lot of possibilities with AI,” says Zhang, “and information on the internet. Plus, more companies are using data as a revenue generator, so we are seeing data getting into the market that we never thought possible. The credit card companies are selling data with privacy shields so we can see what a cluster of consumers in a certain demographic is doing. That information is really powerful in understanding which tenants are sustainable.”
While data-driven insights will undoubtedly underpin far more private credit decision-making, there is still far to go. “I am told by our LPs and consultants that we are still a bit of a lone wolf in using significant substantive data to drive underlying investment decisions,” says Zhang. “The next generation of private credit investors will be younger, more technology-savvy and more data-driven. They may expedite this.”
18 Venture debt
European start-ups raised a record €8.3 billion of venture debt in the first eight months of 2021, topping the previous record of 2017 and a dramatic increase on the €1.6 billion raised in 2015.
Data from Dealroom shows the growth rate for venture debt in Europe is double that of the US at a time when more and more high-growth companies are realising there are alternatives to venture capital backing on both sides of the Atlantic.
Jon Barlow, co-founder and CEO of New York-based credit marketplace Finitive, says: “We have really seen an explosion in venture debt interest in the past year – it wasn’t an area we focused on initially. So much liquidity has come into the venture capital sector over the last few years that it has made venture debt lenders more comfortable that the VC community will support portfolio companies. So, venture debt is starting to play catch-up on the large volumes of venture equity that has been raised.”
Low rates are pushing investors into higher-yield asset classes and revenue-based loans are creating more opportunities for company growth and investor return. With revenue-based loans, the key metric is annual recurring revenues and borrowers are not tied to prior valuations. Instead, they can use loans to invest in marketing to grow sales and return the lender a portion of revenues until the loan is paid off.
The market looks set to continue on a strong upward trajectory. “This is moving from being a niche esoteric asset class to becoming mainstream – it’s in a transition process right now,” says Barlow.
“The number of financial market players now educated on the asset class and understanding how to do a venture debt loan has just exploded.”
19 Aggregated pools of capital
As LPs seek exposure to larger managers at lower costs and new investor bases seek access to the private credit asset class, the benefits of aggregating pools of capital are coming to the fore.
LPs must weigh up how much flexibility they want versus the pool of capital that is available in which to buy assets.
Donna Yip, managing director at Antares, says: “We find that investors might start off with a fairly bespoke set of requirements, but once we help them understand the asset purchase power that comes with larger funds, they are more willing to let go of a little bit of flexibility.”
Such aggregated pools of capital also offer the potential to open the asset class to far more investors, including high-net-worth individuals.
Jess Larsen, founder and CEO at placement agent Briarcliffe Credit Partners, says: “Private credit offers some unique fits to high-net-worth individuals that you don’t necessarily get from private equity, which is why we are seeing aggregating platforms that allow smaller wealth managers and independent financial advisers access into institutional funds.”
An example is Titanbay, an online platform that launched last year to provide access to allocations in leading private equity funds for small and medium-sized institutional, and professional private, investors. Such platforms remove the barriers to entry of high minimum commitments and onerous processes that can put off smaller investors.
20 Regional expansionism
Regional expansionism isn’t new. The allure of a growth market like Europe for US managers has always been strong.
The likes of Ares, Blackstone and Carlyle have been present and active in Europe for many years – the record-breaking €11 billion direct lending fund closed this year by Ares was testament both to a longstanding presence in the region and investors’ belief that the firm has made a success of it.
Nonetheless, a new wave of US/Europe strategic partnerships appears to be forming. Since December 2020, at least four US managers have linked up with European counterparts: Monroe Capital with Bonaccord Capital Management; Bain Capital Specialty Finance with Pantheon; Candriam with Kartesia; and Churchill Asset Management with Tikehau Capital.
Europe is just one prong in the diversification of US funds worldwide. Witness Ares Management’s acquisition of a majority stake in Asian lender SSG Capital Management as a ‘platform for expansion’ in Asia in 2020.
Part of this is simply to do with the perceived growth opportunity Europe and Asia are believed to represent, compared with a much more mature and competitive US market. However, it also speaks to a general movement towards pan-regional, multi-strategy managers that can do many things under one roof. Our PDI 50 ranking has consistently shown the big are getting bigger – and, as they get bigger, expansion is inevitable.
The global health crisis has favoured consolidation, says John Bohill, a partner and member of the private debt team at StepStone Group. “The groups that had large and diversified portfolios through covid were somewhat insulated from difficulties,” he says. “Smaller firms which had concentrated exposure to more exposed sectors maybe struggled a bit. There was a perception of strength in numbers and that’s attracted capital to the bigger players.”
The pressing question is not whether these firms will expand regionally, but how they will do it. “We definitely think that having devolved decision-making with a senior local team is better,” says Bohill. “You might have a European team originating transactions and they get on the phone every week recommending deals to a New York-based investment committee who don’t really have a connection with what’s happening on the ground, but the local team can’t decide for themselves. That’s not a sustainable situation.”
There is also a certain degree of scepticism to overcome from investors about the motivations of fund manager expansion. Is it little more than an empire-building exercise that will end up enriching the GP but not necessarily the LP? Managers undertaking such moves need to have well-rehearsed arguments as to why they are necessary.