Turn the clock back pre-covid and there was one issue dominating discussions around private debt: deal terms and conditions, and particularly the way the balance of power in negotiations had shifted firmly in favour of sponsors and borrowers and against lenders. Given the world-changing events that have occurred over the last couple of years – the pandemic itself, the onset of an inflationary environment and now a European war – that talking point has been heard less.
Which doesn’t mean it’s gone away. This week, the ever-alert European Leveraged Finance Association drew attention to two developments that it highlighted as worrying. One was the apparent erosion of creditor voting rights in the Advent International-sponsored buyout of Caldic, the Dutch speciality chemicals firm. With these rights capped at 15 percent of total commitments, ELFA claimed that “no single investor [in the deal] would be able to enforce contractual covenant protections, even in the event of a default”.
The second example was the prevalence of so-called reverse factoring among borrowers, whereby a financial institution commits to pay a company’s suppliers at an accelerated rate in exchange for a discount. The liabilities owed by the company to the financial institution are accounted for as payables rather than debt, potentially creating what ELFA describes as a “blind spot” in relation to the true amount of debt a company has.
Thus, reverse factoring adds fuel to the fire of existing concerns around borrowers’ ability to disguise or manipulate their debt burdens. One of the major controversies up to now has been cleverly constructed methods – such as through the use of EBITDA addbacks – of allowing companies to take on increasing amounts of debt and make themselves more vulnerable to a downturn. Reverse factoring may be a new consideration in this context, but the issue itself goes way back.
ELFA’s attempts to draw attention to these areas serves a useful purpose. While the focus has understandably been elsewhere, the fact remains that last year was record-breaking in terms of the number of private debt deals being completed. In Europe, for example, Deloitte recorded “the most active year for direct lending since we began tracking private debt deals in 2012”. It’s only right that, in a period of explosive growth of M&A activity, someone should be keeping a close eye on who wins and who loses when the deals are signed and sealed.
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