Comvest Capital: Where others fear to tread – US direct lending

 

Boasting more than 27 years of experience in the lower mid-market, initially as a merchant bank and later as a private equity firm, Comvest's leadership realised that direct lending was a natural extension of its business. After recruiting professional lenders who had spent their careers in the mid-market and marrying them with a group well versed in sourcing deals, Comvest Capital raised its first debt funds. Comvest Capital is now investing its third fund, which recently closed with $450 million in equity commitments. While most business development companies (BDCs) and other lenders have been aggressively chasing deals for sponsored borrowers with EBITDA of $25 million or more, Comvest has taken a very different approach.

 

Comvest has focused on non-sponsored businesses in the lower middle market, with EBITDA of between $5 million and $20 million.  Lending to such businesses comes with a different risk profile, but it is a much less crowded market, allowing for better structures and pricing for the lender willing to do the work. With Comvest's expertise in structuring these deals and doing the additional due diligence required, the firm has carved a niche where its qualifications give it a competitive edge.

 

Q

 

What is your view on the current state of the market?

 

There's been a strong increase in fundraising activity the last few years by private credit funds, BDCs and CLOs, to replace more conservative banks as the leveraged lending guidelines leave a gap. Banks are responding by lending to larger, sponsored businesses in industries with better credit characteristics. As a result, many companies and transactions that previously qualified for bank lending are turning to alternative lenders. But CLOs and BDCs rely on relatively high levels of leverage to generate the returns they target for investors, and that leverage often comes with significant restrictions. For instance, they tend to require that borrowers generate EBITDA in excess of $15 million; are controlled private equity sponsors; or operate within non-cyclical industries. Most alternative lenders cluster around these mid-market sponsored deals, leaving a large universe of underserved companies that are non-sponsored and/or generate less than $10 million of EBITDA.

 

Q

 

 What attracted Comvest to the lower mid-market?

 

It's much less crowded than the middle market, which enables us to really differentiate ourselves, while providing a better risk/reward profile. Over our history, we have built the resources specific to the lower mid-market, allowing us to bring more alternatives to these borrowers. We have a dedicated in-house business development group that evaluates over 1,000 deals per year, many of which are overlooked by banks and our competitors because they are not large enough or do not have a traditional sponsor.

 

Q

 

 How do you address risks inherent in your market?

 

Regardless of size, there are inherent risks in any deal. But it's imperative when working with smaller companies to use structures and covenant packages to create consistent outcomes that align interests. We work with our partners to understand the business and its needs and create structures that lead to predictable outcomes for borrowers, sponsors and investors. We certainly find situations where that makes us less competitive, but we've found that discipline allows us to be a better lending partner to our borrowers, while providing adequate protections through the economic cycle.  A broad and robust origination effort is critical to providing the widest set of opportunities to choose from. We continue to find attractive opportunities to deploy by emphasising three elements of the strategy we've honed over the years:

 

Origination : We have built a business development team and database of contacts, transactions and activity that give us an advantage in identifying sources of deal flow. Few groups have our combination of long-term institutional experience, relationships and data from sourcing deals in the lower middle-market over many years.

 

Structure: Consistency and predictability are important in aligning the interests of lenders, borrowers and sponsors. While loosening structures gives the borrower/sponsor more flexibility, it can lead to less constructive behavior when lenders realize they don't have a voice. In difficult circumstances, lenders may become irrational and unpredictable when co-operation is needed. Our borrowers understand that having an active dialogue and keeping the lines of communication open gives us the opportunity to be prepared to handle the challenges that arise. We also keep leverage profiles modest so we have time to work through challenges together.

 

Edge/Resources: As part of a private equity platform with a long history, we have developed operating resources and experience investing in the lower middle market, particularly in our industries of focus – technology/BPO, financial services, transportation and healthcare. This allows us to offer sponsors and management teams access to resources, which differentiates us from other lenders. This shifts the focus from being just about maximizing leverage and minimizing structure/pricing, into a discussion about mutually beneficial partnership.                                                                                                                                                                  

 

Q

 

 So why do borrowers choose Comvest?

 

We find we compete best in situations that require speed, flexibility and/or a deep understanding of a business. Our long history of investing up and down the capital structure gives us unique perspective on how to best meet a borrower's particular capital needs. With our private equity platform, we have experience in several industries. A good example is a loan we led for a global online travel service company. We were competing with much larger lending platforms, but management understood that our long history of operating and investing in the travel space, including two airline investments, gave us insight into their business. Those resources and expertise allowed us to lead a successful syndication of the $100 million dollar facility.

 

Q

 

 What does all of this mean for Comvest in the near-term?

 

We've seen increased competition on margins in our focus area, non-sponsored lower mid-market, but nothing like the sponsored mid-market. We respect many of the groups that have built businesses in that market, but current market terms will keep the workout groups busy through the next downturn. Our history as an opportunistic investor/lender gives us the flexibility to provide capital when needed in a restructuring cycle and we remain poised for opportunities to help companies restructure their balance sheets. In the meantime, we remain focused on remaining disciplined.

 

We are always looking for market dislocations that create opportunity. For example, lower interest rates have spurred rapid growth within the BDC space, creating an influx of capital into the mid-market, primarily for sponsor-backed deals. But during the last 18 months, a number of those publicly-traded BDCs have traded below net asset value, limiting their ability to raise capital. This has allowed us to pivot into the sponsored space and compete in pockets of the market where we have not previously focused. The members of our senior investment team are also experienced in the sponsored market, so we have begun competing for those deals.  Our versatility allows us to operate in both spaces and win deals regardless of the market cycle.