Richard Foote, Regional Managing Director at Secure Trust Bank Commercial Finance discusses how partnerships have evolved.
In the dynamic landscape of modern finance, partnerships have become the cornerstone of innovation and growth. One such relationship that has been gaining momentum and evolved considerably over the last decade is that between asset-based lenders (ABLs) and private equity (PE).
Historically, PE would have looked to use ABL specifically for refinancing or turnaround. However, ABL has, through the economic cycles, proven its versatility and suitability for a range of situations such as M&A, funding growth, refinancing, investment, operating within multi layered capital structures, and turnaround.
The flexible and asset-centric nature of ABL means that ABL lenders have been able to better support borrowers and PE through the 2008 financial crisis, Covid years and the subsequent growth. ABL is inherently less sensitive to volatility in profit and loss (P&L) allowing it to remain supportive of its borrowers for longer. An ABL facility is typically revolving in nature, meaning borrowers haven't been burdened by rigid and unaffordable repayment structures. This has allowed PE and management teams the time and support to execute strategy and drive value and returns for stakeholders.
The days of hesitance and scepticism are fading, replaced by an appreciation for the strategic and tactical advantages that an ABL partnership can bring to the deal-making table.
The changing face of asset-based lending and private equity
The evolution of ABL has been marked by a shift towards proactive use by companies seeking to optimise their capital structure and facilitate growth. The more modern ABL solutions go beyond traditional collateral assessments which focus on the accounts' receivables, instead adopting a more holistic evaluation of the company to deliver a structured solution encompassing multiple asset classes and sometimes including cash flow loans.
The increased sophistication of ABL products has been pivotal in altering its perception and utility. While ABL can often be the sole debt product in a capital structure, increasingly PE is seeing the benefits of integrating ABL alongside more traditional financing facilities to create more tailored financing packages particularly for borrowers in the mid-market. This can optimise the balance between risk and leverage and is a structure that has gained significant momentum in the last three, or so, years.
A notable trend is the use of ABL in larger deals involving PE, including acquisitions of mid-sized and even larger companies. This reflects the recognition that ABL can be a versatile financing product for a broader range of businesses and situations.
Parallel to the advancements in ABL, PE has also evolved considerably. PE firms, once almost exclusively focused on leveraged buyouts, have diversified their strategies to encompass a broader array of investment opportunities such as corporate carve outs and special situations.
PE's affinity for risk, reward and stability of capital structure aligns well with ABL's approach to financing. ABL's structured approach and understanding of its collateral and assets provides PE investors with a measure of security, making it an attractive option for funding transactions. This synergy has enabled PE firms to engage in more creative deal structuring, leveraging ABL to mitigate risk whilst enhancing potential returns.
Factors driving the partnership
The financial landscape, market dynamics and regulatory environment have changed considerably in recent years resulting in greater complexity, risk and operational challenge for business and PE to navigate.
The flexible, stable and supportive nature of the ABL product helps PE mitigate and manage the risk and uncertainties it is confronted with making it a valuable tool. The size of an ABL facility is typically a function of a company's asset base rather than the P&L. Inherently a company's balance sheet is less volatile than the P&L, thus providing a supportive and stable debt structure for a company to manage liquidity.
Following a fall in inflation, there is increased expectation that interest rates will follow suit - albeit not to the levels seen post financial crisis. Consequently, capital efficiency has emerged as an important driving force within the partnership between ABL and PE. The interest rate charged for an ABL facility is typically lower than for traditional unsecured debt products given the underlying asset security.
Furthermore, the speed in which ABL's can arrange and execute complex leveraged finance deals or structured debt solutions alongside their commercial approach to leverage or gearing multiples is well suited to the PE market. ABL allows PE firms to maintain operational control of the target company, as it does not typically involve the same level of equity dilution or covenants as traditional leveraged buyouts.
At Secure Trust Bank, we're structured in a way where our Relationship Directors manage a small portfolio of clients, allowing them to truly understand the opportunities and challenges that each borrower faces and tailor the support required accordingly.
The dedicated relationship and partnership approach, alongside the access to decision makers and short and efficient credit processes, has fostered trust amongst our PE partners. This is evidenced by the fact that more than half of our client book currently involves some level of PE sponsorship, representing a material change within the last five years.
Situations where the partnership thrives
As the financial landscape evolves, this alliance has proven its resilience, weaving itself seamlessly into diverse business decisions, be it acquisition, or strategic realignment.
Beyond being a catalyst for growth, ABL's significance also extends to scenarios of concern. Companies facing financial challenge often require an injection of capital and expertise to navigate through uncertain economic times. ABL can provide the necessary liquidity to stabilise operations, while PE investors bring the strategic guidance needed to implement effective turnaround strategies. Together, they can drive operational improvements, optimise cost structures, and position the company for long-term success.
The convergence of ABL and PE represents a powerful partnership that leverages operational expertise and strategic insight. As businesses navigate the complexities of today's marketplace, this alliance offers a potent solution to capitalise on opportunities and drive sustained growth. Whether in times of crisis or during expansionary phases, the ABL-PE partnership is a testament to the enduring power of collaboration in shaping a stronger, more dynamic corporate finance market.