The growth of private debt funds in Europe has been nothing short of astonishing since the crisis. Once a small corner of the acquisition finance market, credit provided by funds has become a mainstream product. In 2010, just 20 percent of European mid-market deal financings were advanced by funds, compared with 80 percent by banks. Fast-forward to 2017 and the proportion was 55 percent in favour of the funds, according to figures compiled by EY.

This has led to significantly increased take-up of private debt products among private equity houses. Equistone partner and head of investor relations Christiian Marriott describes his firm’s evolving relationships with private debt funds. “Coming out of the crisis, the banking market was mixed and by 2010 some banks were still not back in the leveraged finance market,” he says. “We did our first transaction financed by private debt in 2011 – we arranged unitranche through Ardian. In that deal, we were up against another house that couldn’t arrange debt. That, for us, was the start and we have used private debt on a gradually increasing basis since then.”

In the UK, the firm’s deals are now as likely to be financed using private debt as bank debt. “We always look at what’s on offer from banks,” he says, “but the private debt funds today seem highly likely to offer what the company needs. They are clearly open for business at a time when we are seeing some banks pull back slightly in what they are offering in leveraged finance.”

It’s a similar story at Silverfleet, a firm that principal Robert Knight describes as “quite conservative with regards to leverage”.

“Our relationship with private debt funds has definitely strengthened and matured over the last few years,” he says. “As an illustration, in our previous fund, all of our investments were senior bank deals; whereas in our latest fund raised in 2015, we’ve thus far invested in eight businesses, of which three have been senior bank deals, four have been unitranche and one has been stretched senior with a private debt fund. We now assess the relative merits of both senior bank debt and unitranche on all deals.”

Meanwhile, at Palamon Capital Partners, the shift has also been significant. “When I joined five-and-a-half years ago, about two-thirds of the deals we did were with funds; now, it’s more like 90 percent,” says partner Philippe Arbour. “We usually need a good excuse to look at a bank deal.”

While this may seem like a difficult development for the banks still in the leveraged finance market, some suggest that the entry of private debt funds has been positive. Scott McClurg, head of leveraged finance at HSBC, for example, says: “We can’t provide all the debt required in the market and we need good, strong competition. Our aim is not to do every deal; it’s to do the right deals. We welcome the advent of increased liquidity to the market.”

The point for private equity these days is getting the right financing deal for the company in question, whether that’s a fund or bank package, with a lender they know and trust. And those with scale and the ability to move quickly will have an added advantage, particularly in today’s market.

“With a dearth of quality assets coming to market, sponsors are looking for debt providers that can move quickly, are able to write a large, single ticket and that will be straightforward to deal with during due diligence by asking predictable questions and sticking to the terms discussed,” explains Fenton Burgin, head of UK advisory corporate finance at Deloitte. “Scale is also important, given that interest rates are on the up – sponsors want to see that a fund’s portfolio isn’t too concentrated so that if there is an issue with a company, the lender can afford to work with the sponsor to deal with the situation.”

Private debt funds have clearly become part of the establishment among private equity firms. And while relationships have yet to be tested on a major scale, some suggest that a downturn may highlight the benefits of private debt and perhaps even strengthen bonds between these lenders and sponsors.

As Marriott says: “When the cycle turns, private debt funds won’t necessarily be scrambling to the take the keys of a business at the first sign of stress. Their borrower-friendly terms, such as looser covenants and equity cure rights, will give us, as sponsors, a longer leash so that we can work with businesses to improve their performance rather than having to take short-term measures under pressure to meet covenant terms.”

Regional variations

While the use of private debt is becoming more widespread across Europe, it’s the UK that has led the charge. Some of that is down to historical and cultural differences in some markets. “On the continent, private debt funds haven’t yet reached the same penetration in the market as in the UK and funds haven’t been operating in markets such as Germany as long,” says Equistone’s Marriott.

“There’s also a difference in the way banks handle difficult situations such as covenant breaches in France and Germany. The banks there have more of a stakeholder mentality in that they work to protect their interests while being cognisant of their obligations to the company.”

And while some markets are starting to open up as private debt funds become more comfortable with local variations across Europe, there does still seem to be a clear preference among some sponsors for banks in certain markets.

“The UK is Europe’s most developed lending market by a country mile, and there is a core of lenders in London that will fund deals in some other European countries, but many funds have geographical restrictions,” says Palamon’s Arbour.

“It’s an evolving picture, though. More are starting to look at Italian credits, for example, and more are becoming more pan-European. But you can’t afford to be lazy. There are definitely conversations worth having on the ground in markets like Italy, especially at the smaller end. In Germany, too. Here, you’re more likely to go with a bank than a fund because the banks are much more aggressive in what they offer.”