private debt and private equity Flashcards
Private debt refers to
loan capital
issued by companies
that is not publicly listed and traded
on a stock exchange.
is a debt capital market transaction that
generally has covenant features similar to a bank loan and
is often used as an alternative to bank funding.
Covenants are
requirements or restrictions
placed on the borrower
when a loan is undertaken.
Covenants aim to:
provide a degree of security for the lender and
may involve either:
1 a requirement
⁃ to do something (a positive covenant),
⁃ eg to meet specified financial or non-financial criteria
2 a requirement
⁃ not to do something (a negative covenant),
⁃ eg not to sell certain assets used as security for a loan or not to borrow from third parties.
Typical features of private debt
Unlike a traditional public debt market transaction private debt is not actively traded.
marketed to a much smaller number of long-term “buy and hold” investors,
with the deal eventually being distributed to between 6 and 12 interested parties.
generally a lot less marketable than publicly issued debt,
as it is neither widely held nor actively traded.
reinforced by the issue sizes involved,
which are typically smaller than in the public debt market.
Private debt is typically issued by small and medium-sized companies,
usually in their first forays into raising additional finance.
can be issued in any major currency,
most issues are fixed-rate US dollar-denominated transactions.
Private debt is issued for a range of long-term maturities longer than three years for amounts ranging from £10m to £300–400m.
When weighing up investment opportunities, private debt investors tend to be very focused on
covenant protection since illiquid markets mean
they may be unable to sell their private debt investments
in the event of a credit downturn.
may therefore demand a number of covenants,
both imposing requirements and
restricting the activities of the borrower,
in order to safeguard the security of the loan.
Reasons for issuing private debt
private debt issuer is able to issue capital market debt
without acquiring a formal long-term debt rating.
(A formal rating from at least one recognised debt-rating agency is required for most public debt issues.)
A key issue influencing the choice between a public or a private issue is the relative cost involved.
From a treasurer’s perspective,
the private debt market represents a major capital source with relatively competitive pricing.
Accessing this market also allows the treasurer to
free up credit lines with relationship banks – ie the company’s main providers of banking services.
In other words, the private debt market offers an alternative to borrowing from a bank.
the vast majority of private debt transactions are undertaken by
treasurers
who want to refinance existing term loans from banks,
but who would rather not go to the trouble and expense of obtaining a credit rating.
However, a treasurer may be able to
improve his covenant bargaining position (or improve his pricing)
by obtaining a private rating from an external rating agency.
This obviously depends on
the relative sizes of the cost of obtaining the rating and
the saving in borrowing costs.
In the sterling market,
a financial covenant is required for any issue with a maturity greater than ten years
or a credit rating less than a single A.
Covenants in the sterling market vary according to
the maturity of the deal and the industry sector of the issuer.
Financial covenants relate to
requirements that the borrower meets specified financial criteria.
Although the administrative costs associated with issuing debt privately are lower, what is likely to be a disadvantage of doing so compared to a public issue?
A key disadvantage of a private debt issue compared to a public issue is
likely to be the additional cost arising from
the higher return required by investors
to compensate them for the greater risks involved –
due to a lack of information and marketability.
In communicating to the bank or banks for private debt, the treasurer will need
to make clear the purpose of the funding.
This will enable the treasurer to
determine the levels at which
the all-in cost of private debt makes economic sense for the company
relative to borrowing from relationship banks
(given that the company usually has a choice between the different sources of funding).
The purpose of the funding is always
one of the key items of information
hat a lender will require
before agreeing to buy any debt.
Private debt funding is generally
medium-term to long-term (in excess of three years).
Although private debt can be repaid early, will require the issuer to make a costly “make whole” premium
(usually around 50 basis points) –
to compensate the lender for the earlier than anticipated redemption.
For this reason, private debt will usually run until its final maturity.
Exact details of any “make whole” premium will be included in the legal documentation issued with the debt.
medium-term to long-term (in excess of three years).
Give 3 possible examples of financial covenants that might be required for a private debt issue.
Possible examples of financial covenants include:
1 a minimum ratio of current assets to current liabilities
2 a minimum required level of interest cover on the particular issue of private debt and/or on all outstanding debt
3 a limit on the total level of higher or equal ranking borrowing
4 a limit on the total level of total outstanding debt – as any problems with lower ranking debt may also lead to problems with the higher ranking debt
5 limits on the payment of dividends, so as to retain sufficient funds to service the debt.
Private equity is
the provision of equity capital
where there is no immediate exit route via the secondary market.
So, private equity is
investment in unquoted companies
that are not listed on a stock exchange.
Instead
their shares are issued and traded privately.
Private equity comes in two main forms:
venture capital leveraged buy-outs other forms: development capital restructuring capital
venture capital
capital for businesses
in the conceptual stage or
where products are not developed
and revenues and/or profits may not have been achieved.
Venture capitalists rarely just “silent partners”,
investing their capital and then having no involvement in the operation of the business.
Rather, provide expertise, their guidance, and p ossibly their contacts, are often crucial to the success of the business.
some degree of involvement in the management of the private company
is often a precondition to investment in the first place.
leveraged buy-outs is
–equity capital for acquisition or refinancing
of a larger company.
–differs from an ordinary acquisition
–because the shares of the acquired company no longer trade on the open market;
–instead,
they are held by the private equity investors.
–acquisition funded largely by borrowing, particularly if the buyers have insufficient personal funds to finance the entire purchase themselves.
–Management buy-outs:
form of leveraged buy-out
in which the existing management buy-out the existing owners of the company –
ie buy their shares and
hence a controlling interest in the company.
–a management buy- in
occurs when the buyer is an external management team.
–Typically such a buy-out is highly leveraged (hence leveraged buy-out), as most of the money raised to buy control is obtained by the borrowing.
–resulting capital structure is thus highly leveraged or geared,
with the bonds issued typically having non-investment or “junk” status.
–After the buy-out or buy-in,
the management of the private company typically has a substantial equity stake in the company and
so should have a large incentive to try and ensure that the company is successful.
A management buy-out often involves replacing
the existing public equity of the company
with new private equity,
in which the buy-out team
own a controlling interest.
