Private equity firms are increasingly using structured equity and other hybrid financing arrangements to return capital to investors while retaining ownership of businesses that have become difficult to sell at attractive valuations, according to a report by Bloomberg.
The strategy has gained momentum as buyout firms contend with a prolonged exit backlog. Global private equity managers now hold about $3.8tn of unsold assets, while the average investment holding period has stretched to roughly seven years, according to Bain & Company.
With higher interest rates making conventional debt more expensive and public markets offering less reliable exit opportunities, managers are turning to financing structures that combine characteristics of debt and equity.
Structured equity can provide immediate liquidity to private equity investors without forcing a full sale of the underlying company. It can also allow portfolio businesses to raise capital without taking on the level of additional leverage associated with a traditional debt-financed dividend recapitalisation.
Private capital firms including Apollo and Bain Capital are among the investors providing this type of financing. Returns can reach the mid-teens, considerably above the yields available on conventional debt from the same companies, while the instruments typically rank ahead of common equity if a business runs into financial difficulties.
For private equity managers, the attraction is clear: they can generate distributions and potentially improve fund performance metrics while retaining exposure to companies they believe have further room to grow.
Critics, however, argue that such transactions provide liquidity without solving the underlying exit problem. Institutional investors can also question whether receiving cash today is worthwhile if the transaction ultimately reduces their long-term returns.
The use of structured equity is part of a broader expansion of financial engineering across the buyout industry. Managers have increasingly relied on dividend recaps, net asset value financing and continuation vehicles to generate liquidity as traditional exits have slowed.
Structured equity typically takes the form of preferred securities with fixed dividends and no conventional maturity date. Investors generally receive repayment when the company is eventually sold or floated.
Terms can also include escalating dividends, governance rights, conversion features or provisions allowing investors to push for an eventual exit.
Private capital providers say demand is being driven by companies seeking financing that sits between traditional debt and common equity.
