As an active player in the market, describe the opportunities you see to provide non-sponsored financings.
Paul Echausse: There are three situations that frequently warrant capital in the non-sponsored space. One is growth financing, where the company is growing faster than the local bank can provide capital. The second is a recapitalisation, where shareholders active in the business will have an opportunity to repurchase the equity of inactive shareholders. The third is probably the most akin to private equity where you have a company that is looking to grow through acquisition.
How do you source non-sponsored deals?
PE: As a general rule you need to have stronger sourcing, structuring expertise, diligence skills and relationships to source non-sponsored deals. It’s a large, attractive opportunity, but it’s harder to access.
Non-sponsored deals come through commercial banks, local banks, regional accounting firms, law firms, and investment banks. You must look at a lot more deals to find a diamond in the rough: a quality business with a quality management team. Additionally, the owners of these businesses – often families – should feel comfortable with their new financing partner as well. It’s more relationship oriented.
Is there a favourite among those entities that non-sponsored lenders often turn to, or do they all give non-sponsored lenders a fair amount of deals?
David Scopelliti: It’s pretty balanced. I don’t think there’s one versus the other that has a particular edge. It’s often based on relationships with the business owner – who are his trusted advisers? It could be a law firm, or an accountant. It could be a wealth manager, like BNY Mellon. It comes from a variety of sources.
We’ve received a number of referrals where a regional commercial bank has told us, “We had a really good experience with you providing junior capital in a past transaction, and we’d like you to look at another deal where we’re the senior lender.” So one good experience typically begets another.
Why do you need to source more deals to find preferable non-sponsored transactions?
DS: I think part of it is the prep that is required for a business to be at a level that is acceptable to an institutional capital provider like Alcentra. We manage money on behalf of others, so our level of diligence is more robust than a local bank.
The level of sophistication and the timeline to get a deal done is often different because the owner or entrepreneur moves at a different pace than private equity. In a situation where you have a growth financing or a recapitalisation, it can take a little longer to agree on the source and nature of the capital. What you find in these businesses is that there are probably two or three core individuals that are running the business, and for them to be able to focus on a capital raise while running the business, typically slows the process.
What are the challenges of executing non-sponsored deals versus sponsored deals?
DS: Typically, these companies have a controller or treasurer versus a CFO. So, the accessibility and quality of financial information is often not as robust as when a sponsor is involved. It takes more time to gather and analyse the data. That’s the financial piece. The other challenge is the sales and marketing organisation might not be as developed. We often find that the CEO is also the de facto chief marketing officer. There is also a certain degree of education; socialising the principals with the process and reporting requirements post-closing.
Is the criteria for non-sponsored deals different than for sponsored deals, or are a lot of the same factors at play there?
DS: I think they’re comparable in the following sense: what’s the company’s competitive advantage, how does it go to market, how good is the management team? But there’s a higher level of due diligence with non-sponsored deals because in a private equity-backed deal there is another deal team running a process. They’ll drive consultant studies, quality of earnings reports. Typically on non-sponsored deals, we’re the ones driving that process. We take a private equity-style approach to our lending and benefit from an increased level of control of the process.
Branko Krmpotic: The other major difference is from a governance standpoint. We don’t control the board of directors of the company in the transactions where we’re lending money, whereas the private equity sponsor does have governance rights. Therefore, we have additional underwriting criteria and more robust reporting requirements in addition to more frequent in-person meetings with the management.
So why go through the extra work to do non-sponsored deals? What are the benefits?
BK: We’ve been focused on lending to lower-middle market, growth companies for almost two decades, and we’ve been able to achieve significantly higher returns and lower leverage than what you see in the overall market and for larger cap sponsor-related deals. Our clients are often family or management-owned businesses with huge skin in the game, and are relatively conservative with their capital structures. They are relationship oriented with their capital providers and less transactional.
In addition to better absolute and risk-adjusted debt returns, do you get to participate in equity upside?
BK: We have a long history of equity co-investing and benefiting from capital appreciation as our portfolio companies grow. It also provides an alignment of interests and creates a long-term relationship, setting the stage for repeat financings.
How competitive is the non-sponsored market?
DS: As time has gone on, there are more players that have entered the space – typically smaller Small Business Investment Company funds or other smaller funds that might be more focused on junior capital or minority equity. But I would say as a broad comment, while there are more folks in the market it’s less competitive than the sponsored market. Sourcing, structuring and due diligence capabilities are higher barriers to entry versus sponsor related lending.
Have you been seeing the number of non-sponsored borrowers increasing, decreasing, or remaining the same, and what do you attribute that to?
BK: I think by sheer number there are more non-sponsored opportunities. First, companies are more comfortable and interested than ever, raising capital from non-bank lenders. Second, with more independent sponsors in the market, you’re seeing more opportunities. Previously businesses had to sell to a strategic or a private equity sponsor, or try a recapitalisation. Independent sponsors, who typically have a focus on a specific industry, geography, or expertise have increased the number of financing options to the business owner.
This article is sponsored by Alcentra. It appeared in the Non-Sponsored Finance Special supplement published with the May 2017 issue of Private Debt Investor