Hey PE professionals, has this ever happened to you…
You decide to approach the debt capital markets—maybe a portfolio company has hit a rough patch, or is considering an acquisition, or perhaps your firm is seeking a dividend recap—whatever the reason, you reach out to the handful of lenders with whom you have a prior relationship.
Your deal team makes the pitch, and you hear a mountain of positive feedback from your coverage banker. “Sure, sounds great! We can get this done in no time!”
Expectations are through the roof. So you begrudgingly endure a lengthy and sequential process of lender due diligence, until the moment arrives when you finally receive a term sheet.
And it’s nothing like what you expected.
What Went Wrong?
There is a fundamental problem here. It has to do with the incentives inherent in your lender relationship.
You are the lender’s client, which to you—the PE firm—means monthly check-ins, dinner and drink invitations, perhaps the occasional golf outing, and competitive deal terms you can rely on. But to the coverage banker, your relationship is a source of deal flow. Loan originators need to bring deal flow to management, which means that even if the coverage bankers spot a potential pitfall, they won’t necessarily decline your offer or even raise the issue.
Lenders exist to issue capital. No lender wants to sit on a mountain of dry powder.
Remember, one of the guiding principles of your banker is to keep you—the PE client—engaged. So bankers are incentivized to err on the side of cautious optimism and respond positively to your deal, even if at first-glance there are concerns that need to be addressed.
This leads us to another incentive at play—that of the credit committee. Credit committees are incentivized to protect the firm’s principal, which implies a more conservative stance on deal origination than what you’re hearing from your banker (who again, is incentivized to bring in deal flow). Hence, the feedback from your coverage banker will almost always be more optimistic compared to the final term sheet the credit committee approves.
And with uncertainty looming over the broader economy, credit committees and underwriting teams must be extra cautious when considering a prospective deal. That is why, once the DD process is in full swing, the lender looks at your deal very differently… from a Credit Perspective. And that is when questions arise.
- Barriers to entry aren’t as high as they seem, what happens when the big boys vertically integrate?
- The business’ cash flow is lumpy, how sustainable is FCF through a downturn?
- Are we sure this IP is as rock-solid as they say?
Then the term sheet comes back, and it looks nothing like what you expected.
All of this doesn’t mean that lenders are acting maliciously. They are simply managing competing incentives, similar to many firms. Bankers / loan originators are incentivized to ‘put your deal on the board’ and prove to management that all of those fancy dinners and golf outings are yielding results. Credit committees / underwriting teams are incentivized to protect the firm’s principal, which at times necessitates pouring cold water on the coverage banker’s deal flow.
The CAPX Solution
Most deal teams make the cardinal mistake of letting lenders control their risk narrative. PE firms provide the information lenders seek, and then sit back and wait while the lender assesses and positions the risk.
You are ceding control of the deal, and you don’t even realize it.
Instead, PE firms need to develop a ‘Credit Perspective’ of their deal. This is crucial, as it will provide the coverage banker something other than a CIM and management presentation to relay to the credit committee. In crafting the ‘credit story’ of the deal, the PE firm can properly address the risk attributes, develop reasonable downside case projections, and position the business’ mitigating risk factors in such a way that the coverage banker can promote and defend the deal to the more conservative credit committee.
CAPX works with PE firms to develop and refine a Credit Perspective, and maintain control of their deal’s narrative. Our step-by-step approach safeguards your deal team’s time, and ensures that capital is delivered as efficiently as possible. The credit environment is changing rapidly; the only way to guard against failure is to create options for your deal.
We are offering complimentary credit perspectives to PE firms in search of capital.
For help clarifying your lending options, click the button below and set a time to speak with one of our credit experts. CAPX will provide a credit overview of your deal, and walk you through any deal positioning and debt structure questions you may have.
There is no cost for this consultation, and you are under no obligations or commitments to join CAPX. Upon scheduling your free consultation, one of our debt experts will contact you to provide a credit overview of your business.