Distressed & special sits report: Capzanine on Europe

Special situations offer many advantages over traditional distressed or turnaround debt, but success requires a bespoke approach, explains Emmanuel Bonnaud, managing partner with Capzanine Special Situations.

Emmanuel Bonnaud

Q What is your perception of special situations in the French market?
Special situations require a discrete tailor-made approach. During the past 20 years distressed debt in France has failed to deliver on its promises. So, entrepreneurs and investors alike have become wary of the asset class. The former are reluctant to engage with lenders until the situation becomes desperate, while the latter have been disappointed by the performance of the asset class over the past decade. The market and the investors are clearly looking for a dedicated special situations fund, which offers attractive returns, efficient financial support and the ability to deploy funds on a sizable scale.

Q What kinds of situations might the strategy involve?
We provide financing in three situations: to underperforming companies that do not have access to traditional lending; for complex transactions or unusual structures; and for important strategic moves – large investments or acquisitions – that will put the company at risk for some time. The funding covers investments and will help to decrease the level of stress on the balance-sheet and the liquidity. That may happen through refinancing, debt repurchase, or debt/equity re-restructuring, in an amicable and negotiated way.

“Many of our LPs are very keen to provide capital to help companies continue to recruit, invest and come back to growth. This is an important part of our activity”

Q Can you explain how you work with entrepreneurs?
We accompany companies and entrepreneurs on their journey to growth. The firm has a very collaborative approach and in the case of special situations, we are there to help entrepreneurs during complex or challenging periods. Our aim is to better understand the issues entrepreneurs face and propose solutions that will help put the company back on track, without being too dilutive. We spend as much time as needed with the entrepreneurs before our investment, to make sure we build a strong relationship with them, build our own confidence and are convinced that our investment will be instrumental to the firm.

Q What do company management need to understand about this kind of strategy?
Managers first must recognise that their company is no longer investment-grade, which can make attempts to get traditional funding challenging. At the first sign of that happening, the management should consider talking to a private debt investor.

They must also understand that we will look at whether the company has a robust business model, and how it can come overcome its current issues. Which makes us more demanding in terms of due diligence. We have a very educated and senior team – three partners with 20 years’ experience each as investors, managers, consultants – which provides senior insight and can see through unstable situations and understand the challenges that entrepreneurs face. The key word is flexibility: we provide a mix of debt and equity to build mid-term stable financing that is aligned with the company’s need to rebound and create value.

Q Is investing new capital a sufficient means of turning a company around?
If providing new financing was sufficient to bring any company back to its growth path, we would see very few closures. Unfortunately, this is not the case. New financing can provide the space, visibility and restructuring needed to help turn a company around, but robust business plan and execution are key.

The main purpose is to keep the ability to invest in equipment, know-how, people and innovation for long-term growth and profitability. The financing can be used for various purposes: funding a restructuring plan; investing in marketing; designing products for new markets; improving the efficiency via strategic or tactical investment; reducing overall leverage and improving cashflow.

Q What is your target return, and how does it compare with private equity investing?
The fund has a double-digit IRR target return through a combination of contractual and equity linked returns. We also seek to create additional value through direct equity and fully benefit from the company’s recovery.

We offer below equity-like returns but this is linked to the fact that we are not always in a controlling position, and that we use a significant portion of debt. Our risk profile is generally smaller as we can get efficient protection tools as collateral to our debt instruments.

The track record of similar strategies in other geographies is indeed very strong with a low default rate, high recovery and high return well above target through equity. We are the first pure player in the market but the few individual deals done locally by international players follow this pattern of return.

Q Do you think more investment firms will enter the space?
Some are doing it on an opportunistic basis, specifically large international players making $30 million plus investments, but it is not the case for the €5 million to €20 million investments we provide in special situations. If we had a downturn, the situation might change and the competitive landscape may increase for distressed debt trading. Having said that, the dealflow would also be much more important and the opportunity set per manager may not change much to the current situation.

Q Is there much awareness of this strategy among LPs? What questions do they typically have?
This is a very active asset class. GSO has just raised a $7 billion for the strategy that targets a different segment of the market but has a similar approach. Metric Capital is now investing out of its third fund.

LPs like the asset class because it is not cycle dependent like turnaround or distress, and it’s not bank dependent like subordinated debt. Many of our LPs are very keen to provide capital to help companies continue to recruit, invest and come back to growth. This is an important part of our activity as a citizen of our community.

The main questions LPs ask are about the risk we take and whether we can obtain seniority or super seniority. Our ability to diagnose and fund the right projects to de-risk the asset, and our ability to get downside protection are also key to LPs.


This article is sponsored by Capzanine