Private Credit Options – Keeping the M&A Wheels Turning in Turbulent Markets

by John F. Herubin, Managing Director

How do you get an M&A deal financed when international banking, stock markets, and global trade are oftentimes changing hourly?  Not an easy question by any means, but one solution has been increasingly used to address this issue despite the financial turmoil of recent years, and that solution has been the emergence of Private Credit.

Private Credit has increasingly become a financing source in multiple arenas since the 2008 Global Financial Crisis (senior debt, subordinated capital, and special credit situations).  Regulatory compliance and stricter credit scrutiny have greatly increased for traditional bank lending sources since then.  As resilient markets often do, a niche category of funding sources have arisen to meet the need for financing that falls outside of the traditional bank lending criteria.

The factors mostly contributing to the expansion of private credit include:

1. Bank Regulation: Post-2008 financial reforms such as Basel III and Dodd-Frank imposed stricter capital requirements and risk controls on traditional banks, reducing their appetite for leveraged and middle-market loans.
2. Low Interest Rates: For much of the 2010s and early 2020s, low interest rates drove institutional investors to seek higher yields, fueling capital inflows into private debt funds.
3. Increased Fundraising: Private credit fundraising has surged amongst a growing and more sophisticated investor base, with assets under management (AUM) in the space surpassing $1.5 trillion globally as of 2024, according to Pitchbook. This war chest has enabled funds to participate in larger and more sophisticated deals.
4. Demand from Private Equity (PE): Private equity firms have increasingly relied on private credit to finance buyouts due to its flexibility, speed, and willingness to accommodate higher leverage ratios.

Although Private Credit has been utilized to finance a number of traditional financing needs, it has increasingly been impactful in the M&A world.

Examples of Private Credit impact on M&A transactions includes the following:

Increased Deal Flow and Execution Speed

One of the most immediate impacts of private credit on M&A markets is the acceleration of deal timelines. Unlike traditional banks that may require weeks for credit committees to approve financing packages, private credit providers often deliver term sheets and close deals within days. This agility is especially valuable in competitive auctions for private equity firms or time-sensitive situations such as take-private transactions or distressed acquisitions.

As a result, buyers backed by private credit financing can often outmaneuver competitors who are reliant on more traditional, slower-moving sources of capital.

Customized and Flexible Financing Structures

Private credit funds are known for tailoring debt packages to meet the specific needs of a deal. Whether it’s a complex corporate carve-out or a sponsor-backed roll-up strategy, private lenders can structure financing with bespoke terms, including delayed draw facilities, payment-in-kind (PIK) interest options, and covenant-light or covenant-free structures.

This flexibility allows dealmakers to pursue creative strategies that might not be possible under the constraints of traditional lending. It also opens the door for financing transactions that may have previously been deemed too risky or unconventional.

Facilitating Higher Leverage and Valuations

Private credit has played a role in pushing up both leverage levels and enterprise valuations in M&A deals. Direct lenders often accept higher leverage ratios than banks, which can be attractive to financial sponsors aiming to maximize returns through debt.

While this may raise concerns about systemic risk, the closed-end nature of most private debt funds (with locked-up capital and no immediate redemption pressure) provides some insulation against sudden market volatility. Still, the increased leverage enabled by private credit does pose risks in downturn scenarios.

Supporting Middle-Market and Sponsor-Backed Deals

Private credit has been especially influential in the middle market—typically companies with enterprise values between $50 million and $1 billion—where access to syndicated debt or capital markets is limited. Private equity sponsors targeting these businesses often find that private credit offers a streamlined, relationship-driven approach that suits the nuances of middle-market transactions.

In many cases, lenders and sponsors develop long-term relationships, facilitating repeat transactions and smoother negotiations. This dynamic has contributed to the flourishing of buy-and-build strategies and sponsor-to-sponsor (secondary) transactions.

Challenging Traditional Bank Syndicates

As private credit has grown in both size and sophistication, it has begun to compete directly with syndicated loans and high-yield bonds for large-cap transactions. Unitranche loans, once reserved for sub-$100 million deals, are now regularly used in financings of $1 billion or more. This evolution has made private credit a credible alternative even in the upper middle-market and large-cap M&A deals.

Private credit's growing role is also leading to more competition and innovation among traditional lenders, who must now offer more flexible terms or quicker execution to remain relevant in the M&A financing arena.

As with any financing instruments/transactions, there are always risks to be considered. Despite its benefits, the growth of private credit is no exception.  Some of the more prevalent risks include the following:

• Covenant Erosion: The popularity of covenant-light structures raises concerns about lender protections in case of borrower underperformance which can potentially result in higher default rates.
• Liquidity Risk: Unlike public markets, private credit is illiquid. In times of stress, this could pose challenges for both lenders and borrowers.  These investments often include 7-10 year “lock-up” periods which essentially converts an investment to a “buy and hold” strategy which may not be optimal to all participants.
• Economic Cycles: In an environment of rising interest rates or economic slowdown, highly leveraged companies may struggle with debt servicing, especially if earnings falter.
• Valuation Pressures: Higher debt levels can inflate valuations, potentially leading to overheating in certain sectors or geographies.

Anecdotally, we’ve heard that some private credit funds are looking to opportunistically provide unitranche financing solutions to underperforming companies.  With this strategy, if the company continues to underperform, the equity portion can be exercised to provide ownership to the private credit fund to step in and “rescue” the company and later reap the rewards of the gain from their equity investment upon subsequent sale.

Outlook for the Future

Looking ahead, private credit is poised to remain a powerful force in the M&A market. As sophisticated institutional investors continue to allocate capital to this asset class and private lenders expand their capabilities, we can expect:

• More Large-Cap Transactions: The continued evolution of megafunds and club deals among private lenders will further encroach on investment-grade corporate territory.
• Cross-Border Growth: Private credit is expanding into Europe, Asia, and Latin America, supporting global deal activity.
• Technology Integration: The use of data analytics, AI, and fintech platforms is likely to improve underwriting and risk management, further enhancing efficiency and scalability.
• ESG Integration: As sustainability considerations gain traction, private lenders are incorporating ESG metrics into loan documentation and deal evaluation, aligning financing with broader societal goals.

Private credit has fundamentally reshaped the M&A landscape. By offering tailored, flexible, and fast-moving financing solutions, it has enabled a broader array of deals and empowered financial sponsors to execute more ambitious strategies. While its rise introduces new complexities and risks, the overall impact has been to increase dynamism, competition, and innovation in the M&A market, even during times of market upheaval and uncertainty.

© Copyright 2024 by John Herubin, Managing Director, EdgePoint Capital, merger & acquisition advisors. All rights reserved. John can be reached at 216-342-5865 or on the web at www.edgepoint.com