Creative Financings in the Post-Golden Age Era

Over the past decade, the combination readily available capital, low cost of financing and a favorable regulatory regime ushered a Golden Age in private equity, with record fundraising and M&A transactions across investment strategies, time horizons and structures. But as they say, all good things must come to an end. The past year has seen the Fed embrace a policy of monetary tightening to combat persistent inflation spurred on by supply chain disruption, tight labor markets and rising commodity prices. With rising interest rates and concerns over a global economic slowdown, the financing markets for buyouts have been pushed into dislocation. Following $1.1 trillion of financing in the high yield bond and leveraged loan markets just last year, both markets are off their record highs 77% and 62% in 2022, respectively. The risk-off mood has left banks holding buyout debt and incurring losses. These numbers are sobering, and lead to the obvious question: How will the current backdrop impact M&A activity and buyouts?

Last month, my panelists noted we are likely to see firms go back to basics: focus on business fundamentals and operational playbooks, while dusting off financing solutions and strategies that have been sitting on the shelf during this era of easy money. First, cash will be king. Private equity firms are sitting on $1.2 trillion of dry powder that can be deployed, and we can expect to see higher equitized transactions, rollover equity by the target or existing investors as well as co-investments by limited partners. To offset the current constraint on traditional banks and the syndicated capital markets, alternative lenders, such as private credit funds, and structures (e.g., seller’s note) are already in play. Finally, we are likely to witness a rise in the number of deals that utilize earn-outs, payments-in-kind, asset swaps or other creative approaches. The recent investment by Blackstone in Emerson’s climate technologies business utilized a blend of many of these tools, including equity and debt financing, and a seller’s note and rollover equity by Emerson.

As we enter 2023, there are opportunities for deals to be made in the year ahead. The valuation reset we have seen of late should make transactions more actionable, narrowing the bid ask spread between buyers and sellers. No matter what path firms choose, it is clear financing will drive key considerations such as purchase price, transaction structure and return analysis.

Even as financing markets stabilize, other considerations remain, including the uncertainty of the macroeconomic backdrop and increasing regulatory scrutiny out of Washington. In 2021, we had a market environment that saw a rising tide lift all boats, making it difficult to discern between the haves and have nots. The emerging challenges we are likely to encounter in 2023 will bring an end to this, allowing for differentiation and exposing outperformance by those that can capitalize on dislocation with creative approaches.