Private Equity Deal Financing – How Are Sponsors Adapting To Changing Debt Dynamics? – Acquisition Finance/LBOs/MBOs

With the debt markets tightening in response to rising interest
rates and economic volatility, Ropes & Gray partners Michael
Lee, David Hutchins, Patrick Dorime and I have examined how private
equity sponsors are finding alternative ways to secure debt to
finance deals.

High yield bond and leveraged loan issuances for U.S. buyouts
and M&A are increasingly hard to come by, making it more
difficult for PE sponsors to fund deals on terms and leverage
levels available in 2021. This contraction is largely due to
volatile stock markets and climbing inflation, which also has
contributed to a spike in borrowing costs.

While these forces have deterred many PE borrowers from seeking
out new deals, some sponsors are looking for creative ways to
finance deals in both the mid- and mega-markets.

Private debt. Backed by US$1.2 trillion of dry
powder (at the end of 2021), private debt funds have been a
reliable source of funding during this period of uncertainty.
Working with private debt managers has enabled sponsors to reduce
syndication risk and ensure certainty of execution.

The contraction of the syndicated loan market has been a boon
for direct lenders, which are able to win more deals at attractive
prices while being selective about their deal commitments. In turn,
sponsors are less able to rely on one or two providers to
underwrite a deal—rather, they are now having to assemble a
club of direct lenders for any meaningful commitment.

Niche products and strategies. In addition to
direct lenders, sponsors are considering more and more niche
products and strategies to finance deals, including term loan A
commitments and annual recurring revenue loans. Sponsors are also
using preferred equity, payment-in-kind loans and other junior
capital options, as well as seller debt. Some sponsors are
providing equity underwrites to finance deals up front and then
returning to market post-deal to raise debt financing. Niche debt
sources are also playing an increasingly important role in
refinancing existing portfolio company debt structures.

While debt markets will likely remain tight in the near term, PE
sponsors will have to continue to find creative ways to put
together financing to get deals done. By adapting capital
structures, exploring alternative funding sources and relying on
key relationships, PE will have options on the table to secure
acquisition financing.

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