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Private equity fees at pre-recession levels in 2011

Private equity related banking fees were higher in 2011 than they have been at any point since 2007 according to a new report. Mark Spinner (pictured), partner at international law firm Eversheds, comments on why 2011 has been such a good year for the industry…

The ongoing economic uncertainty and concerns over the eurozone bailout plans has led to a contraction in the debt markets which has had an impact on the way in which the private equity industry funds its deals. With even less supply than previously available, demand – particularly for acquisition debt – is significantly outstripping supply and consequently banks are able to ease up margins and fees and still win the deals. Equity is traditionally considered the highest risk and consequently the most expensive form of finance so most borrowers would prefer to borrow debt, even at a higher margin, than take on the more expensive equity which is available.

Banks are also still in a balance sheet rebuilding phase and this, combined with the increasingly stringent capital adequacy requirements of Basel III, means they cannot afford to take any further impairments on debts advanced to their clients. As a consequence bank credit committees are looking a lot more critically at credit risks and pricing such risk into their terms and/or reducing the amount of credit that they are prepared to advance. The cost of capital to the banks themselves also has an impact upon the terms upon which the banks are able to provide debt. All of this in turn results in private equity investors being required to ‘over equitise’ deals in order to get them away.

The lack of debt from the banks has also led a number of corporate and private equity investors to turn their attention back to the mezzanine providers in order to complete their funding package for deals. Mezzanine providers are prepared to provide a subordinated strip of debt funding, typically ceding all controls to the senior lender, in return for an enhanced level of return, often up to 10% higher than conventional banking sources.

Since the private equity model relies, at least in part, upon securing leverage for its transactions in order to generate the returns expected by the Limited Partner’s, the more (within reason) debt a private equity investor can secure the better. If the private equity investor gets it right, it can make a much better return for its investors by securing more debt and paying higher fees at the outset rather than having to inject additional equity.

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