The availability of capital from private credit lenders, structured equity funds and family offices has suddenly become critical for the survival of many companies. Many traditional banks may be running short of liquidity, as large corporations and institutions draw on lines of credit to help fund operations and create cash reserves. Fortunately, many private lenders and structured equity funds have raised substantial capital since the Great Recession and, along with the rapidly growing group of family offices doing direct investing, are primed and ready to provide a diverse array of financing solutions to small and mid-sized businesses.
The Coronavirus had led all of us into uncharted waters that must be navigated together by banks, companies, shareholders and all relevant constituencies. The entire risk equation has been turned upside down by the sudden impact of the dramatic changes caused by the global crisis.
However, unlike 2008, capital is available.
Many large businesses with hard assets, like airlines and cruise-line operators, have received new rescue-loan packages in the last two weeks and the high-yield junk bond market is showing signs of a rebound as well. YUM Brands recent junk bond offering was oversubscribed 2.5x and increased from $500 million to $600 million.
So what are the options for the small and middle-market business that may need to tap a new source of capital without access to the public markets?
As stated in The Economist, “An alternative is to turn to specialist private-credit funds. These are vehicles backed by long-term investors, such as insurance firms, sovereign-wealth funds and university endowments, which lend directly to companies, much as a bank would. Some will have discrete distressed-lending or “special-situation” arms. Many more are prepared to put up capital when others won’t. And everything is a special situation now. So the mindset and methods of these specialists will need to be broadly applied.”
Private credit funds offer total debt solutions that may include both senior and junior capital facilities in one package. These funds are a good option for companies that need to be refinanced out of their current bank and have a steady operating history in a stable end market.
Structured equity funds offer a hybrid debt/equity vehicle that can provide maximum capital with flexible payment terms using preferred securities, dividend payments, warrants and other creative financing tools to meet a company’s needs. In return for downside protection, this option can provide an owner with a vehicle to maintain equity and flexible payment terms.
And private equity firms, that used to require control positions, are now taking minority stakes in stable companies with long track records of profitability and solid business plans. These firms offer significant operating, financial and strategic expertise alongside their investments and some can close in less than a month.
For those companies that may be in dire straits because of the sudden change in the economy, special situation lenders are private credit funds with a focus on providing capital in times of crisis. Several of these larger funds with over $1 billion to lend are actively seeking new credit opportunities across industries and geographies. They offer excellent remedies for companies that fall out of compliance with bank covenants and lose all borrowing capacity. Credit terms are typically more flexible as these lenders don’t usually require covenants and payments can be deferred for six months or longer.
Some key lending factors may include:
- Strong management teams with excellent leadership that see the path and have a plan to operational recovery
- Level of fixed expenses
- Cost savings plans
- Solid fixed asset base
- Track record of historical profitability
- Diversified supplier and customer base in defendable niche markets
Our firm has talked with many lenders including national and regional banks, mezzanine funds, BDC’s, and private credit funds in the last week. A common theme is that a new lender will want to control the “capital stack” as much as possible. One way in which this can happen is when a debt fund provides a unitranche loan that combines senior and junior debt into one package to refinance the existing facility.
By doing so, the lender clears the way for it to move to the head of the line in the unfortunate event of default. This works well in times of crisis because the new loan package can be negotiated quickly with only two parties (the new lender and the borrower) involved and no need for subordination agreements. Some lenders can close in two weeks if necessary.
Price transparency is difficult during economic turbulence with high levels of volatility. The cost of non-bank debt is generally higher than a typical bank loan and depends largely on the characteristics of each situation. The increased pricing is generally a “trade-off” which allows the borrower to seek higher financial leverage and/or lowers the required principal amortization.
Most companies seeking emergency capital are less concerned with price and have two primary concerns: cash preservation and certainty of close. Private credit and structured equity funds, family offices and select private equity firms can provide flexible and efficient solutions that meet both of these objectives without a change of control.