How PE firms can work with banks to navigate the current investment climate and future proof themselves

It’s been over 12 months since Liz Truss and Kwasi Kwarteng hosted their emergency budget which led to a chain of events which undermined confidence in the UK economy, and saw interest rates rise at a faster rate than they’ve ever done previously.

At the start of 2022, private equity had been riding the wave of cheap money – both from return hurdles from LPs, and from banks – which meant they had cheap leverage, thus boosting performance and returns for their investors and themselves. However, that cheap money no longer exists – the cost of debt has increased disproportionately, and many companies that were highly levered from a cash perspective are now struggling.

Private equity firms are therefore having to get their houses in order – a number of them are very good at this having experienced multiple economic cycles in the past. The smartest sponsors are working closely with their bank partners to resolve the challenges, being upfront about the challenges that lie ahead and the support they’re going to need to help them overcome them. This support can take several shapes and sizes: help with covenants such as interest cover covenants to give them some breathing space, raising NAV facilities so they can put more money in to their portfolio companies to help them through the current storm and pay down their debt to reduce their interest bill; raising capital to acquire more companies and de-lever through earnings as opposed to paying down debt; or a combination of all these things.

What’s clear is that there are a number of sensible things going on in the background, demonstrating that the industry has learned from the ’08 financial crisis. Of course, there’s still a skills gap given a lot of people at private equity firms started in the industry during the start of the bull market which ended up lasting 13 years, so they’ve only ever known the good times. But even so, there are a lot more open conversations happening, and innovation to find solutions and a way forward vs what we saw in 2008 where it was every person for themselves, and a “that’s your problem, not mine” mentality.

At OakNorth, we’ve been fortunate to work with a number of leading sponsors over the years, but we’ve always been clear that too much leverage is dangerous, so we’ve been disciplined and consistent in our approach. For example, when we underwrite a deal, one of the questions we always ask is whether the sponsor would be willing to follow their money if ever a situation arose. We’re also very proactive in our monitoring - if we can see there’s going to be a potential situation such as a liquidity squeeze in six months’ time, we have the conversation now, not in six months’ time as it’ll be too late then.

Relationships are defined in the tough moments like the current economic downturn, so we want to work together to collectively find a solution. We also appreciate that downturns can create opportunities – ’23 could be a great vintage to buy for a private equity firm that’s got deep pockets and long-time horizons – so we want to work with them to ensure they have the capital available to take advantage of these opportunities.