Debt advisory: Building bridges between sponsors & lenders

Debt has always played a key role in the negotiation of a sponsor-backed buyout, but the once sporadically used debt adviser is now flourishing in the mid-cap space. "A few years ago, people were quite derogatory about debt advisers. We thought all they did was hand out terms and keep score," says one direct lender. "But since the proliferation of alternative lenders and the increasing creativity of the debt markets, the role has expanded and advisers actually have a proper job to do now."

Indeed, it is no longer the case that mid-market private equity houses have a group of relationship banks they blindly go back to for repeat business. The market is more sophisticated and comparing the myriad proposals is not as easy as it once was, with offerings varying immensely – from a lowly leveraged and relatively cheap ABL facility to a highly leveraged and very expensive unitranche offering, and everything in between.

The large-cap sponsors even use them at times for some of the heavy lifting, though, as a rule of thumb, these players tend to have their own dedicated in-house debt professional with regular contact with the leverage desks of the banks.

Good debt advice is not about the most debt for the lowest price, but about the right debt product, structured well and in the right amount

"Sponsors recognise that the calibration of the debt offering is just as important as the equity and that the debt isn't just a plug with the same relationship bank," says Gurjit Bedi of Marlborough Partners. "I don't think many [private equity houses] need to be convinced of the usefulness of a debt adviser any more, and even localised sponsors in the more insular markets (Benelux, Scandinavia, Italy and Spain) use them regularly compared to even 18 months ago."

For those on the continent, the disparity in terms and structures between what local banks offer compared to international ones and private debt funds is clear, and sponsors recognise the need to find a competitive solution.

But there is still a minority of private equity houses that are still figuring out the debt advisory proposition and are slightly resistant to doing a deal away from their traditional group of lenders. Understandably, some think, "If it works, why change it?" explains Bedi. However, the attraction of using a debt adviser is clear once the investor breaks away from their usual lenders, says Bedi. "We find it typically takes just one principal within the firm to take a side step from their relationship banks and see what is out there before they are convinced."

This reticence can also extend to lenders at the other end of the table. "The natural concern from a lender's point of view when a debt adviser is involved is that they just want the largest debt package for the lowest fees, and in a competitive market you worry that you'll just get stuffed with a whole load of terms and have to swallow them just to deploy capital," says a UK bank lender. "I guess that is the art of the deal."

Tailor made
But as one debt adviser purports, good debt advice is not about the most debt for the lowest price, but about the right debt product, structured well and in the right amount.

For the mid-market sponsors especially, the right structure and the right terms are key when acquiring SMEs. Even if a bank is keen to give the right quantum of borrowing, a private equity house may plump for the same amount offered by a direct lender despite the lofty fees.

This is because the loan agreement of a unitranche-type loan allows for much more flexibility and often comes with few to no covenants, explains a debt advisory source. So, for a business plan that has earmarked cash from the balance sheet to go towards acquisitions in the first 12 months, having to comply with stringent EBITDA-related covenants in the first year could be unduly necessary given the figure is forecast to drop, not due to underperformance but due to a buy-and-build strategy, the source explains.

Since the advisers are out in the market every day, they know precisely what the appetite is [for pricing and leverage], so it frees up more time for you to spend with management and actually appraise the business itself" – Sean Dinnen, CBPE Capital

The debt adviser is key to navigating these options and making a judgement call on their deliverability.

CBPE Capital managing partner Sean Dinnen says his team rarely used a debt adviser five years ago, but now invariably hires one for every process in which it takes part. "For a relatively efficient sum of money, you can effectively outsource a key part of the process," says Dinnen. "And since the advisers are out in the market every day, they know precisely what the appetite is [for pricing and leverage], so it frees up more time for you to spend with management and actually appraise the business itself."

For any given deal, a sponsor could have offers from up to 20 debt providers. Good communication with the sea of lenders is key, which an adviser can provide. Not only can they suggest the most suitable structure and terms, but they can also advise on the feasibility of a proposal, since it is the advisers that have the best relationship with the banks and credit funds, and know their track record and their position in the fundraising cycle. They can also keep on top of the new private debt funds that keep springing up.

For a lower-mid-market firm doing only two-to-three-deals a year, it makes even more sense to tap into the expertise of an adviser who is transacting around 15 deals a year, says Dinnen.

Daniel Morland, partner at debt advisory firm Tomorrow Partners, says: "The direct lenders see many books – your job as the adviser is to discern if they are properly engaged and whether they are likely to deliver."

But sponsors do well to foster a relationship with only a select group of debt advisers, since the efficiency is lost if the adviser is not familiar with how a GP works, Dinnen says: "You are outsourcing a part of your internal term and if you don't get it right, then you might as well have done it yourself."

And for an adviser, getting the deal right means there is likely to be plenty of repeat business for the same asset, such as refinancing, dividend recaps, additional acquisition debt and, if the portfolio company is less than successful, a restructuring. A buyout is often just where the relationship begins.

Conversely, if the debt adviser has not met expectations, there are plenty to choose from for the next round, as the number of professionals has swelled in recent years in tandem with the direct lending community. Not only are there the pure debt advisory shops such as Marlborough Partners and Tomorrow Partners, but traditionally M&A-only advisory businesses have boosted their teams in London to incorporate the service, such as GCA Altium and Gleacher Shacklock joining the likes of Hawkpoint, DC Advisory, Rothschild, William Blair and RW Baird. The big accountancy firms have debt teams, too.

Check back tomorrow for part two of our series on the growing  prevalence of debt advisers in European private equity

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• Marlborough Partners
• Close Brothers Private Equity (CBPE)