Mezzanine debt surges and other global private debt trends
Private debt has attracted significant investor interest and raised $94.9 billion in committed capital during the first half of 2023. Direct lending accounts for the largest share of private debt fundraising at 30.2%, followed by mezzanine debt at 27.9%. Special situations funds account for 22.3% of private debt fundraising, while distressed debt has fallen to 2.3%. Mega-funds have grown their share of private debt fundraising activity, accounting for 42.1% of committed capital in the first half of 2023. Emerging managers have also gained a larger market share, increasing from 7.5% in 2022 to 12.8% in 2023. Private Credit has played a significant role in financing LBOs and non-LBO transactions, with traditional syndicated loans expected to recover in the second half of the year.
PE/VC exits in August 2023 were the highest in the last 22 months at US$4.3 billion
In August 2023, the number of deals declined by 27% y-o-y, with start-up investments falling 62% in value. The retail and consumer products sector was the second largest, with US$1 billion across four deals. The venture capital (VC) investment slowdown is due to high valuations, slowing growth, and governance issues in India. Major investors like Tiger Global and SoftBank have reduced their investments in Indian start-ups. This slowdown has implications for start-ups, leading to cost-cutting, business model refinement, and potential closures. VC funds face challenges and opportunities, with smaller firms struggling to raise follow-on funds and some VCs seeing the current environment as a prime investing opportunity. The role of investors is evolving, with sovereign funds from the Middle East financing many deals in India. Despite challenges, India's start-up ecosystem remains resilient, and the long-term outlook is positive due to demographics, talent pool, and market strengths.
Market Opportunity/ Challenges
Private Credit is a $1.5 trillion ray of hope for Investment Bankers
The recent surge in interest in private credit deals has been a bright spot for M&A bankers. Large asset managers like Investcorp, Deutsche Bank's DWS Group, and Janus Henderson Group are looking to acquire private credit firms. The growing market size and promise of lucrative returns are driving established money managers to get involved. Investors in private credit funds are demanding scale, quality, and a track record, pushing mid-tier firms to merge with larger rivals. The private-debt funds raised $103 billion in the first half of 2023, down from $113 billion in the same period last year. Market participants expect consolidation to accelerate as smaller firms struggle to sustain their current situations.
Source: BNN Bloomberg
Private Equity is piling debt on itself like never before
Private equity firms are increasingly resorting to complex borrowing arrangements, including high-cost loans with interest rates as high as 19%, due to a lack of deals and dwindling cash. These loans are backed by assets such as future income promises and have raised concerns among some investors about potential risks to the industry and financial system. Demand for these loans is at an all-time high, with firms like Carlyle Group Inc. claiming they are relatively safe. However, some lenders are adding covenants to enable the seizure of underlying fund assets, highlighting worries about possible losses. The need for extra financing sometimes comes from pressure from investors in private equity funds, requiring managers to make larger commitments to their own funds.
Source: BNN Bloomberg
The evolving landscape of Private Debt: Hurdles and Alternative solutions
The relationship between interest rates and private debt returns is not linear. The current interest rate environment presents tailwinds for lenders, such as higher credit spreads, lower leverage, and stronger documentation. However, these are also offset by headwinds such as a potential increase in technical and actual defaults and more limited deal flow. Although there is some pressure from investors to increase hurdles, so far, only a few managers have opted for this approach. Hurdles should not be analyzed in a silo but rather in combination with other waterfall features such as carried interest and catchup. Managers should see if their terms as a whole are too GP-friendly. If so, they can expect to face more pressure from LPs to increase hurdle rates. There are some merits to floating hurdle rates, but margins must be defined carefully to account for the fact that, at the fund level, very high-interest rates over a defined period do not always translate to very high returns over the life of the fund. Lowering catchups does not correct a large misalignment between the hurdle rate and the target return. However, it can be an effective alternative to a small increase in hurdle. Although there are alternatives to increasing hurdles, these are still not commonly used. The alternative to increasing hurdles is a deviation from the standard private debt terms. As such, they may create friction when marketing to some investors.
ESG incorporation in direct lending: A guide for private debt investors
It highlights the significant advances in ESG incorporation, engagement, and other practices. The research shows that private debt LPs and GPs have made great strides in integrating ESG-related risks into decision-making. The majority of the industry now incorporates ESG factors in some way, and many participants collaborate to improve data collection and reporting. The paper discusses market overview, data collection, engagement, sustainability-linked loans, climate-related risks and targets, and taking action. It provides updates to leading practices in data collection, engagement, and collaboration during each phase of the investment process.
A new era for private Credit - what does it mean for investors?
The private credit market has been one of the fastest-growing areas of lending and a rapidly maturing asset class. It has more than doubled in size since 2015 and is now worth around USD 1.3 trillion. The shift of some longer-term lending from banks to asset managers and investors' search for yield has spurred a rapid rise in private Credit. It can offer investors diversification, low volatility, and predictable and attractive risk-adjusted returns, especially in the current higher interest rate environment. Slowing growth and floating-rate interest payments will put more private credit borrowers under pressure and could result in higher default rates on existing loans, but recovery rates have historically exceeded those for the equivalent-rated publicly traded bonds. For investors with an appetite and tolerance for illiquid investments, private Credit can be a valuable addition to a more traditional fixed-income portfolio.
Source: Lombard Odier
How the venture debt market has grown and developed recently
The UK venture debt market has experienced significant growth and development in recent years, with both traditional banks and specialized debt funds offering venture debt products tailored to start-ups and early-stage companies. This has increased competition and innovation in debt products, leading to more favorable terms for borrowers. Venture debt providers have become more sophisticated in assessing creditworthiness, focusing on growth potential rather than collateral or historical financials. Government initiatives, such as the British Business Bank's programs, have supported the venture debt market by reducing risk for lenders and making it more accessible. Additionally, the emergence of lending platforms and revenue-based financing has further transformed the market, streamlined the lending process, and offered alternative financing options.
Source: Financier Worldwide
Preparing for exit: A buyer’s market is coming for tech assets
The volume of technology deals has slowed since mid-2022 due to factors such as limited debt availability and declines in asset values. This has led to a growing backlog of deals and longer hold times for tech portfolio companies. To add value in this competitive market, investors should focus on growing earnings, improving operational processes, raising efficiency, and seeking new growth areas. Key trends include focusing on margin improvement, addressing weaknesses in the go-to-market model, evaluating AI-driven disruption and efficiency improvements, and considering new growth vectors. Engaging in portfolio activism early and later in the investment process can yield better-than-average returns. Tech investors who improve earnings are more likely to succeed in the upcoming competitive buyer's market.
Source: Bain & Company
Q2 2023/ Midyear Review
Healthcare Private Equity Growth Drivers in Q3 2023
It discusses the outlook and trends for healthcare private equity firms and their portfolio companies in Q3 2023. Key issues include the impact of bank failures on debt financing sources, employee retention tactics, and the importance of ESG factors. Employers are becoming more creative in retaining employees, while funds are engaging consultants and ESG specialists to support their efforts. Physician practice transactions are under increased scrutiny, with buyers focusing on financial and operational aspects. Earnouts are becoming more common in 2023 compared to 2022. Section 220 demands remain popular in post-closing disputes, with the Delaware Chancery Court providing guidance on handling such cases. The report highlights the importance of understanding industry trends and assembling the right team to achieve success in the healthcare private equity sector.
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