How large is the sponsorless market in Europe, and is it likely to grow larger?
At the moment, sponsorless deals account for roughly 25 percent of total deals. I think that figure will go up. In the US, the figure is about 40 percent, so I think there is a big opportunity. One reason for that is that, if you look at the European mid-market, there is generally not an awareness by borrowers of the alternative lender solution, so there needs to be more education. I think, as there will be increasingly more alternative lender deals completed in Europe, a larger share of them will be sponsorless deals, given the larger number of founder family-owned businesses in mainland Europe.
Why is this kind of financing typically required?
When you see sponsorless deals, they are never for normal working capital type needs. There always needs to be a reason for more expensive finance. It may be for transformational acquisitions, new shareholder alignments (taking out minority shareholders), or where companies just haven't got the track record to raise bank debt.
Why might using alternative lenders be attractive for borrowers?
The attractiveness of alternative lenders is that they can do senior risk all the way through to equity risk. Private equity firms can only offer one product, which is majority-control equity but alternative lenders can play anywhere between the senior debt and equity spectrum, and there is a big opportunity to provide growth capital for sponsorless companies which don't want to relinquish control or dilute their equity stake and are looking for passive partners.
Are there misconceptions around when alternative lender finance is applicable?
Private equity typically uses alternative lenders to increase leverage and obtain more flexible structures. It's a slightly different ball game with founder/family-owned businesses.
If we speak to sponsorless companies, they are not familiar with alternative lenders. They are not aware of the due diligence requirements, the analysis of risk/return, and the actual cost and time associated with transactions.
In particular, for fast-growing private companies which are looking to consolidate the market, they are now able to fund their acquisition strategy with alternative capital without the support of private equity.
What have market conditions been like so far in 2016, and what about the rest of the year?
In quarter one, activity was down. A lot of people were putting things on hold. In quarter two, things improved. The level of M&A has come down due to the Brexit issue, but there is still a lot of refinancing being done and once you have the outcome of the UK vote things will pick up – probably in September, as then we'll be through the summer months.
Why might sponsorless transactions be attractive to direct lenders?
One of the key drivers of why direct lenders are keen to tap into the sponsorless opportunity is because the private equity transactions are very competitive, with 10 alternative lenders often being involved in a debt raising. If you can source deals in the sponsorless market and/or in Europe, you may well benefit from a higher hit ratio.
Are more fund managers moving towards the adoption of sponsorless strategies?
It's a slightly different strategy. Most funds are willing to look at sponsorless deals but not many are skewed towards these deals as you need to be more risk tolerant. The main issues with sponsorless transactions include governance and not having the insurance premium of a deep-pocketed PE sponsor who can provide more follow-up equity in case of need. More mainstream direct lending funds still prefer private equity deals.