Why Private Equity Firms Concerned About a Global Recession are Seeking Greater Portfolio Security with Trade Credit Insurance

The uncertainty around the economy, coupled with the recent rate hikes by the Federal Reserve has affected private equity (PE) dealmaking, exits and fund-raising activity, according to Bain & Company’s Private Equity Outlook in 2023. While PE firms are still finding ways to finance smaller transactions with private credit and larger equity infusions, more than half (51%) of the CFOs/CEOs of PE firms responding to E&Y’s 2023 Private Equity Survey said they were concerned about a global recession.

Figure 1: Dealmaking and exits slowed through the second half of the year, while fund-raising remained below 2021’s peak

The challenges facing PE firms

The recent slowdown presents real and new challenges for PE firms with fund-raising for deal making. For over 10 years – apart from the pandemic - PE firms have had easy access to credit. On the positive side, despite these recent slowdowns, 2022 was still the second-best in PE firm history.

Will PE firms remain resilient in a likely coming downturn? How do higher rates affect the portfolio value of PE firms over the long term? Can PE firms maintain superior returns without relying on the expansion that has carried the industry for years?

Protection against bankruptcy

Trade credit insurance (TCI) is often referred to as accounts receivable insurance, debtor insurance or even export insurance. In a slowdown or economic downturn, some companies have difficulties or face challenges in paying bills and invoices.

Trade credit insurance is a well-established and underutilized insurance product that is a great method for helping to protect one of a company’s most important assets – accounts receivables.?

When a customer of a PE firm’s company files for bankruptcy, the creditor – the PE firm’s client – will generally receive only a portion of what it is owed and sometimes nothing at all. This is especially true for unsecured debts, where the creditor does not have collateral, such as accounts receivables insurance to back up the loan. ?

Banks generally respond to economic uncertainty by cutting back on lending, tightening credit standards, and charging higher interest rates on loans. One of the biggest advantages TCI offers PE firms is the opportunity to use accounts receivables as collateral for bank loans. Bank loans that will enable PE portfolio companies to continue growing and to expand their businesses through access to working capital. Banks will be more confident in lending to companies knowing that the accounts receivables are protected by insurance. The PE portfolio company will have access to the working capital they need to grow.

Here’s how TCI works

The accounts receivables of a PE firm company are covered by insurance and the amount is determined by an analysis of the company’s receivables over time. This coverage - up to the limits of the policy – enables the company to continue to operate, avoiding its own bankruptcy, insolvency, or political upheaval. TCI is available for one company in a PE portfolio or for the entire portfolio.

Companies generally owned by PE firms have the potential to grow and expand their businesses but have not been successful to date because of the lack of management talent or access to working capital. The PE firm’s mission is to help the company realize its potential. Once the company becomes successful the PE firm can exit the business, sell it for a profit and launch a successful business out into the world.

The bottom line is that TCI allows for more asset-based loans, enhances the debt borrowing capabilities of PE portfolio companies, helps mitigate the risks of default by protecting PE portfolio company account receivables, and helps mitigate the risk of a portfolio company going bankrupt and endangering the entire portfolio.

With a better understanding of the benefits of trade credit insurance and by working with insurance partners that have expertise in developing TCI solutions, risk managers in the PE space can turn an uncertain economy into an advantage and help their firms pursue opportunities more confidently with greater access to working capital.

As the journey unfolds, TCI emerges not just as a protective measure, but as a catalyst for PE firms to chart their course amid the waves of uncertainty, making the prospect of a brighter, more secure future a reality.

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Liberty Mutual offers trade credit insurance backed by financial strength, expert underwriters and credit analysis with specialist skills, and a deep experience and understanding of financial risks. And learn more about how we help private equity firms manage their unique risk needs.