Working with debt

It’s tempting to view debt finance as simply numbers on a balance sheet. But for borrowers, living and working with debt is a daily issue. That’s why putting together an appropriate capital structure is so important.

Of course, the obvious question is, ‘Appropriate for who’? A borrower’s set of priorities will be very different to an issuer’s. But the true skill lies in tailoring loan products to suit the needs of both. It’s in this regard that private debt funds can really distinguish themselves from traditional lenders.

Banks often view loans (and by ‘loans’ we’re really talking about leveraged finance instruments) as a means to an end, the end being persuading the borrower to pay for a host of other services. Many will syndicate loans and retain very little, if any exposure, so the income is derived initially from the arranging fees and then later from those other banking services.

By contrast, non-bank lenders will typically hold the debt they issue to maturity. As a result, skilful managers will look to structure the debt to provide the desired protection and of course returns, whilst giving the borrower the flexibility it needs to grow.

Financial sponsors are increasingly aware of the value-add non-bank lenders can bring to the table. More bespoke financing solutions play well with private equity firms, although pricing will always be an issue.

Inappropriate debt structures are in no-one’s interests. What looked like a sensible capital structure in 2006, for example, probably didn’t look quite so clever five years later. For a sponsor-backed business, operating under a too-onerous debt burdens is counter-productive; oppressive leverage will simply curb growth and at worst lead to default. That’s not in a lender’s interests either (unless you’re a loan-to-own player, in which case, that’s exactly what you’re after). Banks are ill-equipped to own businesses, and would much rather sit back and reap loan interest payments than manage a company directly.

Today’s market is more than ever based on relationships. Whether it be sponsor / portfolio company, or borrower / lender, a consensual, flexible approach appears to be the new norm. For private debt fund managers, such a shift is welcome.

In the May issue of Private Debt Investor magazine, we discuss these issues (and many more) with Permira’s Max Biagosch. And in future issues, we’ll look to explore what it means to work within different capital structures, reflecting the viewpoints of a variety of different stakeholders, from sponsor to CFO.