The market where less equals more

Sponsorless deals hold out the prospect of a return premium for those prepared to roll up their sleeves.   

The growth of sponsorless finance in Europe – a market where private debt funds provide finance directly to companies in transactions not backed by a private equity firm – can be traced back very clearly to the beginning of 2013.

According to a chart produced by Deloitte in its Alternative Lender Deal Tracker report, there were no sponsorless deals at all in Europe in the first quarter of that year: the private debt market in the region was, to put it another way, 100 percent dominated by sponsored deals.

The sponsorless transaction then very quickly accelerated from zero to hero, reaching a peak of 30 percent of the overall private debt market in the fourth quarter of that same year. Since then, however, the sponsorless market has plateaued in Europe – ranging between 16 percent of the overall market back up to 27 percent by the end of last year, but never quite overhauling the mark set two and a half years ago.

In our upcoming sponsorless finance supplement, which accompanies the June issue of Private Debt Investor , we have engaged with numerous fund managers and advisers in an effort to understand more about the dynamics of the space.

One of the observations, which is informative in light of the uptick in sponsorless deals by the end of last year, is that competition to finance private equity-backed deals is increasingly intense.

Some funders may view this level of competition with pragmatism, perhaps sacrificing a little return in exchange for a steady and reliable flow of deals, and where the thorough due diligence processes typically undertaken by private equity firms provide comfort. One contributor to our supplement notably described such due diligence as “all tied up in a nice neat bow”.

The recent numbers suggest some migration away from sponsored to sponsorless, but it's a relatively small movement (to date, at least). Through our conversations, we gained some insights into why caution remains.

Because of the absence of existing due diligence, deals are likely to be harder and take longer to transact. They can also fall over more easily: financing a private equity deal means financing a deal that you can normally rely on to complete in a short timeframe. By contrast, owners of businesses without PE backing may like the idea of some extra finance – perhaps to support their growth plans – but they don't necessarily need it. The likelihood of walking away from the deal is higher.

To take a step back, there is also the difficulty of sourcing such deals. With the universe of companies potentially needing finance almost limitless, it's hard to know where to look. To even have a chance of effective sourcing means having a large number of boots on the ground in multiple locations. For many, this may be a challenging, or even entirely unrealistic, ambition.

Then there is the continuing dominance of bank lending to European companies. While there is much talk of constraints on the banks, the reality is that leveraged lending has not moved out to the private debt universe in Europe to the same extent as it has in the US (where regulatory enforcement has been more thorough). Banks are keen to preserve client relationships and many companies will prefer to stick with what (and who) they know.

For all this, the overall trend in the private debt market is towards differentiation and niche approaches. Furthermore, those who prioritise sponsorless deals say they offer a significant return premium over more vanilla deals. The trend is here to stay – and may even gather a little more momentum.