Buyout private equity firms are having difficulty offloading companies and returning cash to investors, with direct lenders including Blackstone, Goldman Sachs Asset Management (GSAM) and Neuberger Berman Group swooping in to provide cash, according to a report by Bloomberg.
Many private credit lenders are making preferred equity — a hybrid of debt and equity — investments in the firms’ companies, which gives them a place in the repayment chain, senior to the private equity firms but junior to existing creditors.
The deals, which allow sponsors to avoid setting a valuation for the company receiving the investment, are structured as payment-in-kind, which also allows for the deferral of interest payments, and can provide the direct lenders with returns of between 13% and 15%.
The PE firms meanwhile, can use some of the funds raised to pay cash back to investors at a time when IPOs and asset sales have stalled due to higher interest rates and valuation disagreements.
New York-based private equity firm American Securities will receive a $600m preferred equity investment from GSAM to fund a dividend, having made a similar agreement with Koch Equity Development in January.
Last November, Chicago-based private equity firm Waud Capital Partners’ Health & Safety Institute received a $300m preferred equity investment from Neuberger Berman Capital Solutions, also for a dividend.
The report quotes David Lyon, Head of NB Capital Solutions at Neuberger Berman, in revealing that middle-market private equity shops have particularly struggled with fundraising “as many of their limited partners are looking for some money back from their investment before they re-up into the next fund”.
Lyon said: “Many sponsors have been unwilling to part with their best assets at, in their minds, suboptimal valuations — making them open to hybrid forms of capital.”
The report also cited Peter Sluka, a Partner and Global Vice Chair of global law firm Latham & Watkins’s hybrid capital practice, who explained that the rise in preferred investments to fund dividends was due to a lack of other exit options for sellers.
Sluka said: “This gives preferred investors more power to negotiate for downside protections and board seats, far better than what you are seeing in broadly syndicated and even private unitranche deals.
“As a new preferred investor in a dividend deal, you are helping the existing sponsor return money to their investors faster and so it’s an easy argument that you should get a priority on the next equity dollars out.”
Beat Cabiallavetta, Global Head of Hybrid Capital at GSAM, added that sponsors would need more options to monetise their investments due to fewer of those businesses going public or being sold, noting a “desire to return cash to limited partners really pick up” in the last quarter.
