Future returns: families occupy a niche in private debt markets

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Families have found a way to earn extra returns in a low interest rate environment by lending to private companies.

Private debt – or business loans by individuals, families, and non-bank institutions – has grown significantly over the past 15 years, reaching more than $ 1 trillion in assets under management globally by the end of 2020 , according to Preqin, a London company that tracks the alternative investment market.

Most of these loans are made through structures that resemble private equity or venture capital funds. But wealthy families also lend directly to small and medium-sized businesses, numbers that are not factored into that $ 1 trillion total.

Today, these families are responding to unmet market needs as traditional lenders deal with a massive backlog of loan applications, says Jonathan Tunner, director of private investment opportunities at the Family Office Exchange, or FOX, a network world of wealthy families based in Chicago. and their advisers.

Conventional lenders, such as community banks, are now looking for opportunities that “hit their plate a year ago,” Tunner says. “You have this pipeline of needs that still haven’t been met. ”

Families who lend directly may charge banks a premium interest rate because they can act quickly, and the terms they offer may be more flexible than those offered by conventional lenders or private debt funds, Tunner explains.

Penta recently spoke with Tunner about the private debt market and why it has gained traction among families.

Fill a gap

Private lending developed as an alternative to bank lending as financial institutions withdrew from lending to riskier credit and small businesses amid the global financial crisis of 2007-08.

A flood of funding from central banks and governments has allowed many companies to avoid seeking loans during the pandemic – contrary to expectations, according to Preqin – but private debt assets under management have further increased by around $ 145 billion. dollars in December 2006.

Companies that manage large private equity and venture capital funds often also offer private debt vehicles. In terms of assets raised, the main funds in 2020 monitored by London-based PEI Media’s Private Debt Investor are based in Los Angeles.

Arès management,

Based in Paris

AXA

IM Alts, and based in New York

black stone.

These funds provide capital to publicly traded companies and private companies in a number of ways, including direct lending, buying distressed debt (from financially troubled companies), and providing mezzanine debt, which is a hybrid. equity and debt. When these funds come to market, they look for deals that match their designated mandate, Tunner explains.

High net worth individuals and families invest in these funds, although a “top decile fund with a waiting list to enter” may be selective and only accept investors capable of putting in up to $ 25 million. US or more. The more typical minimums for an “everyday generic fund” range from US $ 1 million to US $ 10 million, he says.

For fund investors, private debt can generate higher single-digit or double-digit returns. The median net internal rate of return for private debt funds created from 2014 to 2018 was 8.9% in North America, 7.5% in Europe and 12.3% in Asia, according to a June report by Preqin. In a second quarter report, the company noted that the biggest spreads in the industry were deals involving private lower-middle-market companies.

Leave funds behind

Many families avoid funds and extend credit directly, often alongside other families, a strategy that gives them and businesses more flexibility. Their approach to lending “mimics what you see in a fund, except that a family has the discretion to do what they want to do,” says Tunner.

At the heart of the pandemic, families began to take more interest in private debt, with 23% of families polled by FOX saying they plan to allocate assets to this sector amid tighter bank lending standards. and insufficient access to federal paycheck protection program dollars. In 2019, 13% of families surveyed said they were doing private debt transactions.

The families also wanted to make sure that the companies in which they had stakes survived the crisis. Instead of another injection of equity, these families provided credit, like a working capital line, says Tunner.

“When you own a portfolio of businesses, the first thing you want to do is make sure everything is safe,” he says.

The pandemic was a trigger, but this type of loan from families to holding companies “has been around forever,” Tunner adds. “It’s just been better defined in recent years. “

Flexible structures

Small and medium-sized businesses look to families for financing because they can get funds faster and because families offer more flexible terms and can be opportunistic and creative when it comes to negotiating terms.

Bitcoin’s mining business, for example, had been viewed solely as an equity game, as companies sought capital to start their businesses. But mining cryptocurrency takes a lot of computing power, and supporting these startups has become a game of funding for hardware, Tunner explains.

“The families stepped in and said, ‘We will act as a rental agent for your equipment,” he says.

Some private credit deals made during the pandemic were quite creative, including lending funds to professional athletes when they couldn’t play – or receive a paycheck – for a period of time.


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