Why Private Equity Should Prioritize Debt

Back in 2007, Harvard Business Review stated that the “Strategic Secret of Private Equity” was the ability to buy, improve and sell businesses swiftly alongside an “aggressive use of debt.” At the time, there was concern for cheap debt drying up and seasonal interest rates. Now, nearly a decade later, private equity professionals are not just concerned with securing debt, but with securing it from the most strategic source, with the best possible structure.

“The Great Recession changed the mindset of many in the private equity space as traditional bank loans dried up for companies in PE firms’ portfolios,” said Eric Myers of Diversified Lenders, Inc. “PE companies got educated in alternative lending and benefits of fewer covenants, more liquidity, and approvals for their transactions.”

Many more established firms or those investing out of their second or third funds have reliable sources of debt for a deal. The majority of the time, the deal works out between the two and the deal closes as planned. But in other instances, a fund manager’s M&A rolodex falls short for a more complex deal, and new lending relationships are necessary in a hurry.

“Obviously it is important to work with lenders who are supportive of a borrower’s growth strategy, but it is critical to work with lenders who have the experience and flexibility to work in a cooperative way when things don’t go as planned,” said David Shapiro of Marquette Capital Partners.  “We all know that deals rarely move in a straight line, and it is likely that lenders entering a transaction on the most aggressive terms will be even more aggressive if a deal hits a bump in the road.”

While buyout volume has been low across the market so far in 2015, debt structuring remains a valuable skill for private equity investors to possess. But looking past financial engineering, best-in-class funds and their operators are placing emphasis on new lending relationships by making more time for introductory calls, knowledge-sharing, and meetings during business travel or industry conferences.

With firms feeling the pressure to be more specialized and to get deals closed faster, what should a PE firm, family office or investor look for when creating new lending relationships? An aggressive approach, experience and adaptability are among the most important indicators of a potential debt partners in a deal. When courting a new lender, it should be best practice to ask about their most recent unexpected bump in the road, or their team’s trickiest transaction.