How Private Credit Funds Are Reshaping the Acquisition Financing Market

Posted on: February 10th, 2023

acquisition-financing

Acquisition Financing has long been the province of banks and mezzanine debt funds. In the early 2000’s, business development companies, essentially non-bank lenders who are public, arrived and began making inroads in the acquisition financing market. Their proficiency in raising capital and offering an income stream to the public market spurred their growth into large, multi-line credit platforms with billions of assets under management. They brought a higher level of capital flexibility to the middle market in part due to their ability to benchmark their loans to high yield bonds. This ultimately helped the market become more accommodating to the credit needs of fast-scaling companies that need acquisition financing.

Acquisition Financing Funding

As these funds have evolved, they have created an elevated awareness of the attractiveness of the middle market private credit asset class. All in risk adjusted returns have been strong through a variety of credit cycle conditions underscoring the durability and resiliency of the asset class. This has led to capital rushing into the market in the form of private credit funds backed by hedge funds, family offices or institutional money managers. These private credit funds have a more transactional approach to middle market acquisition financing than other participants and are usually led by people with big investment bank wall street experience. They have large fund sizes, generally over $500 million, and can make swift decisions and move quickly.

As the syndicated leveraged loan market dried up in 2022, private credit funds absorbed most of the liquidity. They now account for 20% of the leverage lending market, up from 2% in 2012, according to a Bank of America Report. As private credit funds continue to penetrate the acquisition financing market, they will continue to search for yield and move further into the middle market and migrate to the lower end. This will bring significant capital availability to an end of the market that banks and traditional funds have traditionally eschewed in favor of bigger companies and bigger deals. Long term, this development will bring more capital options for capital starved companies and help them attract capital more efficiently.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.