Private Credit: Debt Investing Similar to Equity
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In corporate finance, there has been a radical shift in the incentives and structure of investments. You ask, why is that?
In recent times, particularly during the global financial crisis (GFC) of 2007–2008, there have been significant shifts in the corporate finance markets. First off, there is a record amount of corporate debt. The amount of corporate debt worldwide peaked in 2022–2023. The macroeconomic environment that persists and the banking crisis of 2023 emphasise the significance of borrowed capital as the lifeblood of business.
Second, there is now more rivalry between banks and private credit funds, which are not subject to the same regulations as banks, according to post-crisis banking regulations (such as Basel III and The Dodd-Frank Act of 2010). Private credit funds have become more powerful, hungry, and experienced. They don’t use any middlemen and instead give money to businesses directly. Direct lending, asset-based financing, mezzanine financing, and distressed and opportunistic debt are among the best private credit techniques.
Third, because of the increased interest rates, modern debt offers exceptionally attractive yields (e.g., 12% on senior secured, or more than 20% for opportunistic and distressed debt). Private credit was first seen as Wall Street’s new rival, but it has now spread to the UK, the rest of Europe, and the Asia-Pacific and Middle East areas. The two largest private credit transactions to date were announced in 2023: Finestra received $4.8 billion in funding, while Adianta ASA received €4.5 billion in financing. Preqin estimates that the private lending market, currently valued at $1.6 trillion, will grow to $2.7 trillion by 2027.
What I call a “quantum leap” in corporate finance has likely been facilitated by the more seasoned private credit funds, like Ares, Apollo, Blackstone, and Oaktree Capital, who have offered multi-billion dollar unitranche club financing in addition to net-asset-value (NAV) and payment-in-kind loan options. They have even begun lending money to publicly traded global corporations including AT&T, Air France, and Wolfspeed Inc.
In a recent work, I explore the development of private debt in the corporate finance markets following the Great Financial Crisis, taking into account this quantum leap. I contend that the function of debt and how it interacts with equity within the company, The corporate financing markets have seen substantial changes as a result of the GFC. As far as I am aware, this is the first scholarly legal article that examines private credit funds and compares, from the standpoint of corporate governance, their unique business model to that of banks. My argument challenges the established legal and financial framework surrounding corporate finance and corporate governance. It demonstrates that contemporary debt providers are interested in maximising the firm’s profits, engage in capital growth, and acknowledge that there isn’t always a conflict between the interests of debt providers and equity holders. Furthermore, corporate loan financing agreements are frequently subject to renegotiation. In light of changes in the corporate finance markets,
Debt has grown to be a significant part of the company both inside and outside of times of financial hardship, and the processes for managing it are and will continue to change. I create a taxonomy of contemporary debt governance methods, building on the advancements in corporate finance markets. The taxonomy highlights both significant variances and a number of commonalities:
Private credit funds arm themselves with a dynamic picture of the firm’s valuation (an ongoing view and active voice) by actively seeking board participation on the borrower-firm’s board and gaining full access to its management team. Additionally, this aids private credit funds in achieving their investment plan. Debt’s function in corporate governance is explicitly addressed by this managerial feature.
Furthermore,
In addition to charging an illiquidity premium, private credit funds lend to businesses that have a long-term horizon (e.g., 5-7 years) and are adept at functioning in an illiquid market. Long-term bilateral collaboration with businesses establishes the groundwork for a framework of mutual trust and cooperation between the company and its loan investors. The return of relational finance
Furthermore, debt investors seek value maximization by negotiating for a minimum return (similar to quasi-equity) on their debt investment and a carry. There is a significant equity component to their relationship with the company, thus they frequently negotiate for an ownership upside and are lead investors in the transaction. In contrast to conventional lenders who are concerned with preserving the firm’s worth,
In contrast to conventional lenders, who priorities the preservation of the company’s value, private credit investors make long-term investments with the goal of capital growth and profit maximization. Their goal is to earn a return on their debt investment in addition to the principal amount owed plus interest. Because they are investing in equity as well, these new debt investors are particularly concerned in “non-default governance” concerns.
Furthermore, private credit funds negotiate for stronger covenants—including maintenance covenants—than bank financing and offer financing based on a floating pricing mechanism (floating interest that is re-priced every 30-90 days). Debtors’ power over the company is mostly derived from how often debt is priced and reprised, which gives them the ability to (i) interact and influence the company.
continuously and before it experiences financial difficulty, (ii) to have a dynamic perspective on the firm’s valuation, which frequently reflects interest rates, and (iii) as a result, to create an evergreen financing structure. Interest rate increases make it harder for borrower-firms to service their debt.
Repricing debt affects how debt financing is understood in general and loan financing in particular. Because debt financing is dynamic, it is expected that loan agreements will be broken, ex-post repriced, and renegotiated. The study also seeks to demonstrate how private credit funds’ dependence on private negotiation might enhance economic efficiency.
Owing to shifts in the corporate finance markets as well as factors other than financial crisis, debt and equity governance frequently work best together; they cannot coexist in isolation. The relationship between equity and debt has grown increasingly complex, particularly in private companies. For example, when debt providers also hold equity in the same company or when a deal sponsor and a private credit fund are connected, the interests of shareholders and debtholders are more closely intertwined.
All things considered, debt has seen tremendous change throughout time, and due to the revolutionary advancements in corporate finance, contemporary debt now resembles equity. We must reconsider the function of debt in the company, its connection to equity, and the implications of this radical change for the conventional economic and legal structures for business governance and financing. Is this investment genuinely “equity” or “debt”? Does it make a difference at all? Perhaps it’s simply money!
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