Private Credit - the Borrower perspective

[target audience - private company business owners, CEO's, CFO's, entrepreneurs, accountants, lawyers and advisors to private business owners looking to borrow between $15m-$50m for an operating business].

Reading time = less than 10minutes

1.????? Quick Background

There’s been lots of press and promotion around Private Credit over the past few years, much of it targeted at investors and their financial advisors, understandably, as Private Credit Fund Managers chase investor funds to deploy in their lending activities and support their fee-earning business models. The pitch to investors, mainly targeted at qualified wholesale investors, is typically consistent with emphasis on cash paid yield, security and returns uncorrelated to equity markets.

Against this background, the Private Credit market is extremely diverse, with lenders targeting different borrower profiles and markets with a varying range of loan offerings. The diversity of providers is also a function of the sources and size of funding that each provider is capable of raising and deploying, with some being more capable and successful at raising and deploying larger pools of capital from their investor base.

Whereas much focus has been on the private credit in the property sector, our focus in this article is on corporate borrowers we roughly describe as SME+, being a commercial borrower (not a property developer) borrowing $15m-$50m for a private business, typically for an acquisition, expansion or refinance.

Having said that, we will touch on some other aspects of the market, for context.

2.????? What’s the investor profile for Private Credit?

If an investor qualifies as a wholesale investor there is a long list of Private Credit funds that would happily take their money (subject typically to a minimum investment threshold). Retail investors have also been served up some options more recently, based on the same themes of yield, security etc. In a relatively low interest rate environment and where bank deposits are still relatively low (albeit generally bank guaranteed up to $250k!), the proposition to retail is clear. Magnify this with all the funds held by institutional investors and fund managers also playing in the space (not wanting to be left out). Interestingly there are many fund-of-fund style offerings. Anyway, I digress.

3.?As a borrower, why do I need a Private Credit Fund for my business funding requirements?

A good question. We typically suggest that if you want the cheapest funding, the best place to start is one of the big four banks, as they have the lowest cost of capital and the biggest capacity to lend. However, they have rules (internal & external) and processes to follow which can sometime result in them not being able to provide the funding needed. The reasons why will vary based on each different scenario. In most cases (not all) it will be linked to risk related items, leverage, debt servicing capacity and more recently, ESG factors. Don't fret, this is where the Private Credit funds may be able to help. Our process will always look for the lowest cost, but also the most appropriate terms for the scenario. Often the best terms (think amount, security, covenants, tenor) don't come with the lowest cost. Banks though are always a good place to start.

Often in the process this is where we start having open discussions with the borrower explaining how the cost of debt from a Private Credit Fund is going to be higher than a bank. We also generally simplify that discussion with our catch phrase "you can have the money you need for your business at the market rate from the Private Credit Fund................, or you can have no money from the bank at the cheaper rate". It's that simple.

4. For the borrower, how is the Private Credit Fund experience different than dealing with a bank ?

There are two experiences. The first is the journey to financial close. The second is the journey when the borrower draws down the loan and becomes an actual client. Let's focus on the journey to financial close, as this is probably the most important in the eyes of the borrower.

Generally speaking, Banks typically have delegated approval authorities which are tiered and linked to the size of the proposed loan and the credit profile of the applicant. In some banks, this delegated authority can see a loan of up to $30m being signed off by two people, one in a credit role and the other in a business development/origination role. In a Private Credit fund, typically the pathway will normally involve a trip to a formal credit committee whose members may not be client facing and can also include independent members. Manging that journey will be an origination team member, who is the person who the borrower (&/or their advisor) deals with through the process. As a general statement we would say that the connection to the decision makers is closer with a bank, again generally speaking.

Noting the differences in the approval pathway, the process to approval differs in relation to the credit assessment and information requirements of the Private Credit fund, which in our view tend to be more extensive. This in part is due to their selection process or which deals to chase. Let's put that into context. A Private Credit Fund might have a loan book of $1.0billion (give or take) from which the manager of the fund is charging fees for management and performance. They have fewer staff and need to allocate their resources accordingly. A Bank on the other hand might be running a loan book of $3-4billion in one suburban business/commercial banking office (of which there are many, for each bank) without the direct pressure of meeting investor expectations (at the office level that is). What this means is that the Private Credit Fund is likely to be more selective about the deals they want to look at and take through the entire approval process. If you are one of 6 deals they are looking at, they may only want to do 3.

Next is the information requirements.

Most borrowers are conditioned to know that banks require a lot of information to assess a loan application. Banks typically have forms to complete as well. Private Credit is a little different. They generally don't have forms, but an expectation that an applicant will provide a concise overview of their business and purpose of funding, coupled with information such as historical financial information and a 3-way forecast, typically with monthly rests and for a 3 year time frame. In many cases, the Private Credit Fund will want the financial model reviewed by an external firm (think 2nd tier Accounting firm). So, if the borrower can't come armed with a well constructed financial model, the process will not go as smoothly as one who does. As a side note, as a business, if you can't prepare a good 3-way forecast you will likely be judged accordingly as it goes to the quality of general business management. [*we know a range of financial modelling providers. Ask us for one that we feel would be suitable for your specific needs. Note, the costs and time involved can vary].

What else?

As a first base, we look to get indicative terms from lenders, be it a bank or a Private Credit Fund. This is a pretty standard approach. To get there requires time and effort from the funders so be patient. In some cases a bank might be better placed at the outset as they may have an existing relationship with the applicant and an understanding of the business and industry in which it operates. The Private Credit Fund on the other hand might need to get up to speed on the business and industry (& people). You'll be dealing with smart people with experience in deal assessment so be patient and let them do their stuff.

Once you get to the Term Sheet stage there is a time to make a decision. Assuming you've negotiated as well as you can to get a deal that looks appealing, the funder, be it a bank of Private Credit Fund, will ask you to commit to a process (& pay a commitment fee) which will take the transaction through a formal due diligence and credit approval process. As we mentioned before, in the case of the Private Credit Fund, this generally involves going to an Investment Committee. To get through that process, there could be a requirement from the fund that there is some external due diligence required in some form, be it financial, commercial, or legal, and possibly a valuation if there is property or fixed assets in the proposed security mix. The need for this will depend on a number of factors which are deal-specific, and also the experience of the team which is running the deal, including past experience in the same industry of the applicant. In general we would say the process with the Private Credit Fund will be more extensive and intensive than a bank, reflecting the risk and also the higher proportion of the loan to their overall portfolio as compared with a bank.

Let's assume the loan is drawn, what is the experience thereafter ?

Bank staff generally manage portfolios of client loans. In the higher end of the commercial sector they may have up to 30 accounts or more for an individual manager to look after and monitor. In our world of Private Credit, generally they will have less loans to manage. Either way, a borrower should expect to provide regular high quality financial reporting to their lenders and also regular updates on the business in general. Loans will typically come with financial covenants and other obligations which will need to be met. In the event of non-compliance or potential covenant breaches, as always best to be on the front foot. Lenders of any persuasion don't like late bad news. In term of the overall relationship, the lifecycle of a Private Credit loan is generally less than a bank loan and typically the objective would be to migrate back to a bank, with a lower cost of capital, within a 2-3yr timeline. This also works well for the Private Credit Fund as they seek to "re-cycle" their capital.

Also note that you will still need a bank for general transactional banking purposes and we encourage borrowers to maintain these relationships as they can be valuable in the future. For FX services, there is now a wider choice of providers including non-banks. Again, its useful to have a variety of relationships.

What does the future hold?

There is plenty of scope for the existing Private Credit Funds to expand their offering in Australia, be it in the upper end of the market and the middle market. They fit well alongside the traditional banks and deepen the pool of available capital. Importantly, the success of the sector will also be driven by continued access to capital from their investor networks, and the ability to manage their loan portfolios through economic cycles. So far this seems to be playing out well and will probably also see some further consolidations and corporate activity as has recently been evident in the Property Private Credit space where a handful of providers have recently been acquired by larger funds management groups.

Want our list of Private Credit funds? Comment "LIST" in the comments section below.