Direct Lending’s Evolution: A look into sponsored versus non-sponsored

TED

If you look at the universe of sponsored companies and just industrial companies that are known by a private equity sponsor, what are some of the subtle differences between the two?

RON

Yeah, it's a great question. You can look at the entirety of direct lending, and simplistically in into one of either sponsored or non-sponsored. And today I would say at least 70% of all direct lending is sponsored. So why is that. And what are the differences. Well sponsored by its nature you know, means you're working with a private equity firm, a private equity sponsor.

And the attraction of doing deals with private equity sponsors is number one, they bring governance. They bring sector expertise; they bring the best practices. And most importantly, they invest significant sums of equity in these businesses in front of your debt. And if you look at it, we talk a lot about loan to value right.

And in our case and I think most of the market typically, loan values today are running in the mid-40s. And so, what does that mean. It means if you're aligning with some of whom you think are the smarter private equity investors in the US and you're lending senior secure debt, they're providing more than half the value of these businesses in first loss equity.

When you think about it from a risk perspective, things have to go pretty bad before your senior secured loan starts to be at risk for being impaired. And typically, what happens when you work with a sponsor if a company does have some type of operating performance challenges, unless these are truly dynamic where the business is permanently impaired, your sponsor is going to come up with a solution.

They're going to figure out a way to fix the problem because they've got to protect their significant investment. Now you contrast that with a non-sponsored deal. So typically, you're dealing with private companies, family-owned businesses. There is no equity coming in beneath you. There is no private equity firm sort of providing oversight.

You are the lender. And if something goes wrong, you are the entity that's got to fix it, that's got to solve it. So why would you do that? Well, there's a couple of reasons you do that. Number one, because you're probably going to get a better return because you're not facing off against a very sophisticated private equity investor who's very, very savvy in terms of exactly what terms of clearing in the market and how to how to negotiate that.

And equally, you're probably structuring your deals. You're probably getting a tighter document. Maybe, perhaps leverage is a little bit lower. The terms are a little bit tighter. And so, I've done both in my career. They're very different. I think there's opportunity for both, but certainly for my perspective and from our perspective, from a risk [perspective].

When we think about risk and we think about capital preservation, we love doing deals with private equity firms, we love firms that we love to partner with, firms that we've known forever. We know how they're going to behave when things don't necessarily go according to plan. And again, for us it's all about risk mitigation.

But the opportunity to pursue non sponsored deals in the market is significant. And for the right type of investor, you know you can do very well there. You just need to make sure you've got the resources to be able to support it if things don't go well. And that can be very resource intensive.