Going where the banks fear to tread

Few debt funds currently invest in European high-growth companies, but the market is expanding as the start-up space becomes more sophisticated.

Like the convenience of shopping online, but miss the personal touch of engaging with a human being? Outfittery might be for you. The German-based online retailer employs a number of style consultants available at a moment’s notice to provide advice to men on curating their fashion style. Its slogan of “We Style, You Decide” appeals to those who do not like shopping, but feel the need to look good.

It’s a simple idea that harnesses the benefits of e-commerce and brick-and-mortar shops, and Outfittery’s position at the forefront of this market explains why it is gearing up for growth. But rather than turn to providers of equity capital to support its plans, the firm has tapped private debt fund Harbert for the next stage of its evolution instead.

High-growth strategies occupy only a small part of the overall European private debt market, but that might be about to change. Harbert and Kreos Capital, another firm managing such a strategy, are increasingly attracting interest from institutional investors and more firms are looking to enter the market.

Investments are typically targeted at companies that are four or five years old, but not profitable. Often with little collateral to offer, borrowers tend to be either disrupting existing markets or forging new paths and have a lot of potential for growth.

While entrepreneurial flair tends to be associated with Silicon Valley, Europe also has plenty to interest investors. Skype and Spotify are two of the region’s most well-known “unicorns”, privately held start-up tech firms that reached $1 billion valuations, and Zalando is Europe’s first listed ‘decacorn’, a start-up valued at €10 billion. “Europe is rich in opportunities and there are mini-tech hubs scattered across Europe. As well as Berlin, London and Cambridge, we’re completing deals in Vienna and Madrid,” says Michael Larsen, senior managing director at Harbert.

Moreover, it’s a space where the banks fear to tread. Applying traditional covenant packages won’t work for companies operating with a negative EBITDA. They need their financiers to remain flexible, and it is here where debt financiers can show their ability to get creative.

However, as the internet continues to break down barriers, so politics threatens to put them back up. Many high-growth companies looking to borrow in Europe have an internationalist outlook and take advantage of streamlined legal arrangements between EU member states. The UK’s vote for Brexit may pose problems on the regulatory front in the long term, while the plunge in the pound is a cause for concern now. “The recent volatility in the value of sterling may have a material impact on their underlying cost base for certain borrowers. It is important that lenders pay attention to this as it may be a relevant credit consideration,” says Faisal Ramzan, a partner at law firm Proskauer.

What is encouraging is that as we enter the later stage of the credit cycle the market appears to have learned the lessons of the past. “In the private debt space, the level of equity is significantly higher than pre-credit crunch. Valuations being pushed up by leverage isn’t happening like in the past,” says Simon Hirtzel, chief operating officer at Kreos.

And, for Outfittery and its backers at least, there will always be a market for men who loathe shopping.