What is Private Debt?
When a Private Equity firm buys a company, they will typically require some form of a loan to complete the transaction.
Private Debt funds do what banks used to do – they make loans to high quality, established companies with the intention to generate interest on those loans.
These are large companies, typically with revenues well in excess of £50m, often far higher.
Why do Private Debt Funds exist?
Since the financial crisis, banks have found themselves unable to lend as much as they used to. This is a problem for private equity investors who rely on debt to finance their investments.
As a result, there has been a sea change in the way private equity owned companies borrow money. In both Europe and the U.S., banks have continued to retrench from the lending market
Source: European Banking Federation, Federal Deposit Insurance Corporation
Private Debt funds have emerged to fill the gap left by the banks
Understanding the Capital Structure
Any investment in a business with real value is made using a combination of equity and debt. One way to visualise a company is to think about the capital structure; of the total value, how much is financed by debt vs. equity.
Note: For illustrative purposes only. Actual capital structures and returns will vary by deal.
Private debt funds therefore offer a lower risk, lower return than private equity but more stable returns with most funds paying income quarterly.
This is a big market, lending to big companies, managed by professionals
Globally, we estimate that there are 400 companies dedicated to making private loans to Mid-Market companies. This is not a small industry. Investment professionals are highly skilled and paid to understand the risks a company presents, model their cash flows and stress test the business.
Source: McKinsey Global Private markets Review 2018, Preqin Quarterly Update Private Debt, Q2 2018
Why invest in private debt?
1. Income Generating
Private debt offers an attractive income compared against most other forms of fixed income. Income is typically paid quarterly. Note that the risk level of the investments shown below varies.
Note that risk level varies by investment type.
Source: Private Debt: Ares Management, European Unitranche and 2nd lien target yields, 2018; FTSE 100 Yield: Siblish Research, December 2017; Buy-to-Let: Property Partner, weighted average rental income yield; Corporate Bonds: Yield to Worst of Blackrock UK Corporate Bond Fund, August 2018
2. Consistent Performance
For over a decade, private debt funds have performed consistently, achieving stable, attractive returns. Note past performance is not indicative of future returns.
Source: Preqin Quarterly Private Debt Update Q2 2018. Performance is of all Private Debt funds, including North America and Europe
Most Private Debt funds focus on managers that make senior secured loans. Having security over the assets of a company ensures that lenders should be protected in the event of a default and should receive some or all of their money back first.
4. High quality, large companies
Private Debt Funds lend to large, well-established and professionally managed companies. Most lenders will only lend to businesses typically with revenues of at least £50m, often in-excess of £100m.
5. Lending alongside Private Equity firms
Most Private Debt funds are making loans to companies being acquired by Private Equity firms. This generally ensures professional corporate governance and oversight, so that the business properly executes its growth plan.
What type of companies are being lent to?
Private Debt funds focus on lending to companies with the following characteristics:
Note: For illustrative purposes only. Actual company characteristics will vary by deal.