In a challenging macroeconomic climate where businesses are struggling with margin pressure and liquidity constraints, borrowers are looking to lenders for more flexibility than ever. Those able to play across the capital structure will be best placed to capitalise on lending opportunities in 2023.

Andreas Klein, head of private debt at European fund manager Pictet Asset Management, says the ability for lenders to provide flexibility will be critical for winning, and adding value in, smaller deals. “There is going to be a big opportunity in the lower mid-market, and flexibility is going to be key to enabling managers to drive growth there,” he says. “That is because corporates with solid businesses don’t want to be crystallising equity value at a low point in the valuation cycle and need flexibility to navigate the potential macro volatility that we are still experiencing.”

A big driver of value, Klein says, will be the ability to provide flexible capital to allow companies to achieve their growth ambitions while minimising dilution in the short term.

“Rather than dilute your equity today, bringing in a private debt provider with medium-term flexible capital, potentially for a hybrid deal, is becoming increasingly attractive,” Klein says. “We are seeing a growing number of hybrid deals in the sponsorless market, where you have solid businesses with strong founders who might not have the capital at present to take their business to the next level and who want to work with third parties.”

Growing options

Klein says that historically, founders chose between equity and bank debt, but that is changing: “Now they can look at a wide range of options from structured equity, preferred equity or flexible loan capital which has opened up to them as a nice middle ground.”

The same demand from borrowers for flexible capital is evident across the spectrum of mid-market deals. Fabian Chrobog, founder and chief investment officer of London-based fund manager North Wall Capital, says: “At the moment, borrowers need flexible sources of capital that sit somewhere between direct lending and distressed funds. Some call that special situations or opportunistic credit, and it can be structured as preferred equity, stretch senior or any number of other capital solutions. 

“That really is where you are going to find the most opportunity at this point in the cycle. The opportunity is there for investors that are able to underwrite the temporary complexity of a very strong business with a broken or unsustainable capital structure.”