Private equity and private credit collectively raised $1.3 trillion between 2017 and the first quarter of this year – a massive sum that has driven tighter pricing, looser documents and addback-ridden EBITDA definitions.
Against that backdrop, private equity firms and their lenders are sometimes conducting due diligence in a shorter timeframe.
“There’s no doubt that private equity timetables have accelerated,” one mid-market lender says. “The credit underwriting fits within the private equity timetable, and what you’ve seen is an acceleration of the underwriting. You can’t compromise the diligence you do, but you can put more resources behind the diligence over the shorter period.”
As a result, the lender says, private equity firms will sometimes put in an all-equity bid with the intention of lining up debt financing after it has an exclusivity period locked up. Private equity managers are essentially relying on the market to work.
However, this person adds that private equity firms will generally bring lenders in early on in the process. The lender notes that the type of financing a firm can secure may dictate the bid it submits.
If a sponsor thinks it can get 5x leverage but finds lenders are only willing to provide 4.5x, it may dial back its offer.
The period from an initial look to providing a commitment to support a private equity deal might be three to four weeks, he says.
One lower mid-market credit manager says that when lenders are taking shortcuts on diligence, there is generally a rationale for it. For example, if a lender knows a sector particularly well, it may skip the industry study.
The beginning of the due diligence process, which can include the quality-of-earnings (QoE) report, can last from four to six weeks, a source at an advisory firm said, with the typical sale process taking no less than six months on average.
However, timelines have become compressed when a QoE is included, this person said. This is because the sell-side QoE documents are now available, which expedites overall buyer diligence and facilitates a faster close and a greater certainty about closing.
Attention to details
Due diligence has also become data intensive, this person said. Buyers are seeking detailed information on profitability metrics, suppliers and operating cost structures at a much more granular level as data analytics continue to penetrate the diligence environment.
In addition, this person said there has been a migration toward the roll-up of professional service businesses, such as dental clinics, physician practices and veterinarian care centres.
While emphasising the importance of thorough diligence in all transaction types, the mid-market lender notes that buy-and-build situations sometimes put a greater emphasis on sector dynamics and the quality of potential targets in add-on acquisitions. Another focus is what actions the private equity firm can take under the credit agreement.
The timeframe for add-on acquisitions remains much longer, ranging from six weeks to three months. Generally, the manager structures its loan documents with parameters surrounding acquisitions of up to a certain size. These include requiring the borrower to be in compliance on all loan covenants.