The Emerging Importance of Private Debt
What is Private Debt?
Private debt, often referred to as private credit, involves the provision of loans to companies from private funds, instead of the more traditional banks or public markets. Institutions active in private credit include specialised credit managers, insurance and asset managers, superannuation funds and family offices.
Private debt has significantly increased the pool of capital available for potential borrowers, with traditional banks scaling back lending due to regulatory capital requirements. This shift has opened a gap in the market, one that private debt lenders are effectively filling. They offer an alternative capital solution when access to traditional bank debt is limited, catering to a wider array of businesses and offering a broader range of funding solutions across the risk spectrum. Analysis by Preqin highlighted that Australian focused private debt grew during the pandemic with AUM (assets under management) tripling between the 2020 and 2021 and steadying over the past few years. As of June 2023, AUM stood at $1.8 billion.
Private credit lenders are typically accessed when traditional bank lending appetite does not meet the needs of the borrower. Usually, this arises when there is a complex funding scenario, or there is difficulty borrowing from banks because of limited appetite to fund certain sectors or if certain credit metrics are outside bank credit underwriting criteria. Additionally, private credit lenders can also work alongside banks and provide syndicated loan options. Moreover, private debt plays a crucial role in a business’s evolution. It allows for refinancing and the ability to switch capital providers as the company’s risk profile changes. This flexibility ensures access to more affordable capital options as the company’s creditworthiness improves over time.
Types of Private Debt
Private debt lenders encompass a wide range of funding options. Here are some different types of private debt:
- Direct Lending – Direct lending involves providing loans directly to companies, bypassing traditional financial intermediaries such as banks. This type of private debt often offers more flexible terms and customised financing solutions.
- Senior Debt – This is debt that holds the highest priority claim on a company’s assets in case of liquidation or bankruptcy. It is typically secured by collateral and has lower risk compared to other types of debt.
- Mezzanine Debt – Mezzanine debt is a form of financing that can include a combination of elements of debt and equity. It is subordinated to senior debt but ranks above equity in terms of payment priority. Mezzanine debt can include features such as warrants or ‘equity kickers’, providing potential upside for lenders.
- Distressed Debt – Distressed debt refers to debt instruments of companies that are in financial distress or facing bankruptcy. Investors in distressed debt aim to purchase the outstanding debt at a discounted price with the expectation of a turnaround or restructuring of the company.
- Convertible Debt – Convertible debt allows lenders to convert their debt into equity at a predetermined conversion price or ratio. This type of debt provides potential upside if the company’s value increases significantly, as lenders can convert their debt into ownership stakes.
- Asset-Based Lending (ABL) – ABL involves providing loans secured by the borrower’s assets, such as inventory, accounts receivable, or equipment. These loans are backed by specific collateral, reducing the lender’s risk.
- Real Estate Debt – Real estate debt includes loans and financing provided for real estate projects, such as mortgages for commercial properties, construction loans, or real estate-backed securities.
- Structured Credit – Structured credit involves complex debt instruments that are often tailored to specific risk-return profiles such as securitisation. These instruments may include collateralised loan obligations (CLOs), collateralised debt obligations (CDOs), or other structured products.
- Private Placements – Private placements involve the issuance of debt securities directly to institutional investors or accredited investors, bypassing public markets. These placements often offer customised terms and are not subject to the same regulatory requirements as public offerings.
- Venture Debt – Venture debt provides financing to early-stage or high-growth companies, often in conjunction with equity investments. It is structured to align with the company’s growth trajectory and milestones.
Each type of private debt has its own risk-return characteristics, terms, and purposes, catering to different investor preferences and capital needs across various sectors and stages of a company’s lifecycle.
Navigating Through Different Business Cycles
The relationship between capital management and private debt is particularly pronounced during different stages of business growth and economic cycles. Private debt lenders provide businesses with access to capital that can support different stages of business growth, from early-stage expansion to maturity and even distress.
Private Debt Across Business Cycles
Broadly, business cycles consist of periods of expansion, contraction, and recovery, each affecting investment decisions and financial management strategies.
Economic Expansion
During the economic expansion phase, both senior debt and credit opportunities tend to be attractive to investors due to their inherent structural protections and the earning generation capacity of the borrower.
Late-Stage Expansion
While senior debt and credit opportunities are likely to be the source of funding during late-stage expansion, distressed credit may need to be accessed to provide businesses with the necessary capital to navigate through potentially challenging times as growth stalls.
Contraction
During contraction, lending appetite from traditional banks may be limited, making capital from private credit more attractive to borrowers. Depending on the degree of sectoral contraction, funding may need to be accessed from distressed credit providers.
Early Expansion
In the early expansion phase, private credit funding options such as venture debt can provide funding for start-up or high-growth businesses with a strong forward trajectory.
The Strategic Approach of Aberdeen Capital Debt Advisory
Capital Structure Benchmarking Analysis
At Aberdeen Capital Debt Advisory, we conduct an in-depth analysis of your capital structure, benchmarking it against industry standards and best practices to identify areas for improvement and optimisation.
Financing Options Identification
We utilise advanced analytics and strategic insights to identify the best financing options suited to your company’s strategic and funding objectives.
Cost-Benefit Analysis
We evaluate the potential costs and benefits associated with the chosen financing option to determine its impact on your company.
Conclusion
The increasing prominence of private credit funders in Australia provides an expanded range of funding options available to prospective borrowers who may not be able to access funding from traditional bank lenders. There are various private credit funders who provide different types of debt lending enabling businesses the potential to access capital across business cycles.
At Aberdeen Capital Debt Advisory, we are committed to helping you optimise your capital management strategy, providing you with the necessary tools and insights to navigate through the complex world of debt capital management funding. Get in touch with us today to learn how we can help you unlock and optimse value through expert capital management and strategic funding advice.
