Valuations are creeping down1 so people will be more controlled and considered around equity cheques on transactions. The returns they get from those will be in a new economic environment, and as that normalises, lower equity cheques will mean lower debt packages and a renewed focus on the cost of capital.
We expect to see a move along the spectrum towards more accurate pricing for the risk and better terms. We won’t move back to the incredibly lender-friendly terms of the early 2010s, but we have absolutely seen the reinforcement of the value of covenants and cleaner earnings metrics (so less EBITDA adjustments). This “purer” debt financing helps to give early and accurate warning signs of distress that provides lenders with the chance to sit around the table earlier, where optionality is at its highest, and to make plans alongside the business to unlock better outcomes for all capital classes. This covenant-loose cycle has seen firms fall into distress too quickly as the warnings were too late and breach leverage too high. Looking ahead it’ll be a more rigorous and differentiated market where some of the softer values of lending are coveted.
It's also never been more important for a borrower to trust their lender than it is today. They should diligence providers as much as lenders are diligencing them. It should be about taking a longer-term lens on partnerships, and this will lead to a flight to quality rather than worrying about the last inch of negotiation. We believe in this approach and the benefits of building authentic and trusted partnerships and we have seen first-hand how borrowers and sponsors rate this. For example, we have provided repeat financing for over 65% of investments in our Private Debt Fund I and have worked with over 80 sponsors since 2010, backing over one third of these, two or more times as they look to grow their portfolio companies with a committed financing partner.
1Source: Pitchbook, Q3 2023 Global M&A Report.