Private Equity Benefits
With private equity investment activity on the rise, Asset Based Lending (ABL) is playing an increasing role in funding buy-outs. As ABN AMRO Commercial Finance Regional Director, Structured Finance Patrick Wilkins, explains, ABL offers private equity some clear advantages in terms of cost, reliability and the ability to make distributions to investors.
Private equity activity is on the rise, particularly in the lower mid-market arena of deals in the £10m to £100m enterprise value range. According to a report from the Cass Business School and private equity house, Lyceum Capital, 91 deals were completed in 2011 compared with just 63 in the previous years. The total deal value also rose from an aggregate £2.2bn to 3.4bn.
And private equity has been making the headlines again. Witness the recent collapse into administration of high street retailer Game, an event that put more than 3,000 jobs at risk. Within a few days, OpCapita had stepped in to buy the struggling chain, providing the company with the capital required to go on trading.
All of this is good news. Private equity investors play a hugely important role in Britain’s corporate finance ecosystem. In the wake of the financial crisis, activity inevitably dipped, but as the Cass/Lyceum Capital survey observes, deals in the ‘lower mid-market’ have recovered to pre-2009 levels.
A different world
However, private equity fund managers are working in very different conditions to those that prevailed during the buy-out boom years of the last decade. The biggest change relates to leveraged finance, a source of funding that has withered on the vine due to a reduced appetite for risk on the part of lenders, and changing economic conditions.
In an era of rapid growth it made perfect sense for private equity houses to reduce their own risk by funding transactions in part through debt, which would be assigned to the balance sheet of the target company. The virtue of this approach was that investors tied up less cash from their own funds. Vendors also benefitted, as the easy availability of ‘leveraged’ debt finance contributed to a rise in valuations. It was, however, an approach predicated on rapid revenue growth, allowing the bought-out business to service the debt in its balance sheet relatively easily. Leverage was particularly important at the higher end of the market, but it was also a factor in deals involving medium-sized businesses.
In a low environment, leveraged deals are no longer the norm. Liquidity has dried up and many businesses that were bought out through leveraged deals are now struggling with debt on their balance sheets. Nevertheless, private equity houses still need access to debt finance. As deal flow increases, the ABL industry is coming into its own as a partner for fund managers.
On one level, Asset Based Finance is viewed as a replacement for leveraged finance at a time when sources of the latter have dried up. As an industry we can offer revolving facilities – such as receivables and inventory finance – and term loans secured against assets.
However, ABL shouldn’t be seen as a ‘needs must’ option, as there are some clear advantages over leveraged finance. For example, price is certainly a factor. ABL facilities are generally priced more cheaply than leveraged finance and, in the case of revolving facilities, the amount available will therefore grow with the business while retaining a strong link with the company’s ability to pay.
It is equally important that, provided a business has the necessary assets in the form of a suitable debtor book, inventory, property, plant or machinery, ABL funding is available and reliable. However, it won’t be for everyone: there are some businesses that don’t have the necessary assets to raise the cash they require. But for many companies and private equity investors, ABL offers an available source of finance.
But there are other advantages too. For instance, ABL facilities don’t preclude businesses from making distributions, such as dividends to investors. Let’s say a business has a revolving facility in place, providing all the working capital required. At ABN AMRO Commercial Finance we will have an up-front agreement on criteria to allow distributions to take place. In that sense ABL can offer unrivalled flexibility and versatility.
Clawing back investment
In the current climate, ABL can also be used to allow investors to free up at least some of their investment. The UK economy is making progress but no one would deny that many businesses – including those owned or backed by private equity funds – are underperforming in the face of strong economic headwinds. If a private equity house has underperforming businesses within its portfolio, ABL solutions can be used to leverage money from those assets, allowing the investors to claw back some of their investment, freeing up capital to use in fresh opportunities.
This is new territory for many private equity houses. Historically, ABL hasn’t played a huge role in private equity-backed deals, but over the past few years we have seen attitudes beginning to change, with fund managers seeing some of the benefits inherent in the ABL option.
As most of you will be aware, Venture Finance has now adopted the name and corporate identity of parent company ABN AMRO. But it’s more than a rebranding: in addition to a new name, we have forged a much closer relationship with a parent company that enjoys one of the strongest brands in international business banking. Within this strengthened working relationship we have an increased ability to support private equity-backed deals and, over the coming months, we are looking forward to exploring new opportunities with our colleagues in the private investment community.