M&A debt finance in the mid-market
A decade or so ago, when the credit crunch hit, the general view was that leveraged finance employed to facilitate M&A transactions had all but come to the end of the road. Experts predicted that the UK would see a shift in the availability of debt finance from traditional lenders to alternative lenders. In line with these predictions, as interest rates have remained low for a prolonged period, the volume of capital being raised and distributed by alternative debt funds has been on the increase.
Debt fund assets under management have tripled from £159bn in 2007 to £495bn in 2017. This has largely been due to the attraction to institutional investors of higher yielding returns from debt funds when compared to traditional fixed income lending. Hence, many institutional investors have switched allocations from traditional fixed income to private debt. The number of alternative investment banks has also been on the rise, increasing the lending competition further between high street banks and other debt centered funds. Furthermore, there has been an increase in financial institutions investing in the growth of their leveraged finance teams. So the pundits have got the first part of their thesis correct.
However, the second thesis, that traditional lenders would vastly reduce commercial debt funding has not been quite so accurate. During this time, high street banks have also played their part in the lending spiral by increasing the amount of capital available for UK M&A transactions. Consequently, as liquidity has soared, the debt options for financing mid-market M&A deals have significantly increased.
The increased availability and amount of debt funding available has produced a constantly shifting environment where the market rapidly changes as new niche players emerge. This has created the opportunity for new funders to support deals within the mid-market space, in aggregate making the debt market a borrower’s favourite.
The high level of competition has also contributed to more favourable debt pricing and terms. Bullet repayments at the end of loan terms have become more common, in contrast to the previously favoured amortisation method. Where covenants accompany the funding, headroom has typically increased. To protect lenders, debt covenants take a more nuanced approach and are more maintenance-based and aligned to the respective sector in which the borrower operates.
Not everything is rosy in the garden however. Lenders have become far more prudent than they were previously. The credit crunch has left deep, lasting scars in the industry. As a result, poorly performing businesses continue to find it very difficult to source funding as lenders remain highly selective, even in today’s highly liquid market. The success of debt funds relies on their taking a considered approach, given that their capital is far more in danger when poor or aggressive financing decisions are made.
Despite the positivity surrounding the debt market, there has also been some recent push back. Yields have started rising in some parts of the market, particularly at the larger end of the deal spectrum, and there is some speculation that this could soon spill over into the mid-market space, adversely impacting covenant structures.
However, the alternative view is that the current liquidity in the market may delay this process for some time to come. This is great news for borrowers in the mid-market who are looking to finance an M&A related transaction or to refinance existing debt. Now is without doubt an opportune time to look at the numerous debt options out there and act accordingly in the interest of your business and its stakeholders.
Written in response to the ‘Debt is a four letter word’ article published in ICAEW Corporate Financier Magazine, April 2018.
So if you and/or any of your contacts would like to discuss funding options, M&A strategy, succession planning or business valuation then contact Corporate Finance Partners, Laurence Whitehead and Robert Kidson, or another member of our award-winning team, for an initial, no-obligation consultation.