The private equity industry’s push into credit is so well advanced that no one bats an eyelid when the same buyout firm is invested in the debt and equity of the same portfolio company. The question is what happens if that business gets into difficulty — and the interests of owners and lenders diverge.
The €14 billion ($15 billion) buyout of Nordic classifieds firm Adevinta ASA is the latest example of the private capital industry helping to finance its own buyouts. Funds run by Permira and Blackstone Inc. are leading a consortium stumping up the equity, although the sum is reduced by existing shareholders rolling over part of their stakes. Meanwhile, Blackstone credit investors are among those providing the debt. These so-called direct lenders are stumping up some €4.5 billion to help get the deal done. That’s a record in Europe and it’s hard to see that this would have happened even just a few years ago.
Before rates moved sharply higher last year, debt financing for buyouts was easily available in the leveraged-loan market. Investment banks would underwrite the borrowing prior to syndicating it to corporate lenders. With this process broken, credit-focused funds are filling the gap. At the same time, private equity firms have been looking to diversify their businesses and become multi-strategy “platforms.” Witness CVC Capital Partners’ push into credit and infrastructure. Exposure to a range of alternative-asset classes should protect the firm’s fee pool from cyclical dips in any particular one of them (so the argument goes).
Private equity firms have overcome an initial wariness of engaging their rivals as borrowers and sharing sensitive information with them. But having credit and equity funds from the same firm on a transaction raises potential conflicts between the the two sets of fund investors (known as limited partners).
There should be no problem at the time a deal is negotiated: The common goal at inception is to establish an efficient and sustainable debt structure for the business. But things could get sticky if the portfolio company struggles to stay within its covenants, or if a sudden slide in revenue threatens its interest payments and restructuring beckons. Does the fund manager (the so-called general partner) on the credit side use its influence among lenders to cut slack to their equity fund manager cousin? Or does it pull every lever to seize the keys? The perception may be that one set of limited partners is disadvantaged. The private equity firm needs to reassure everyone that’s not the case.
There are checks and balances. First, disclosure. If LPs were aware that a second fund from the same firm could be participating elsewhere in a portfolio company’s capital structure, and they invested with open eyes, then they can’t say they weren’t warned. Second, governance and economics. GPs have a fiduciary duty to the LPs in the fund they run. So long as their financial incentives are aligned with those of their own fund investors, there should be no issue. GPs should then take the same decisions as if they worked for a third-party firm.