Just Keep Swimming: The Debt Landscape in 2021

Most business owners will turn to debt financing at some point as a source of funding for their operations. In middle-market M&A, debt providers have a number of avenues when working on closing deals and can also partner with other lenders and debt providers. Opus Connect CEO Lou Sokolovskiy spoke with managing directors, business development officers, and other high-ranking associates across a number of industry verticals to take the temperature of the debt market.

The typical biggest challenges of 2020 – adapting to the impact of Covid-19, a global shutdown in travel, and pivoting to digital meetings instead of in-person handshakes were all felt by debt providers. The “lack of viable prospect opportunities,” as Allan Gibbel, Business Development Officer at Utica Leaseco, LLC., was felt throughout all markets, with a lower quality of deals present and the related challenges of PPP loans making debt lending unnecessary for some companies that may have sought out debt financing otherwise. Another challenge detailed by Paul Schuldiner, Executive Vice President at Rosenthal & Rosenthal, is described as “shifting existing portfolio clients with the problems they encountered relative to sales and maintaining profitability in 2020.”

In asking the Opus Connect Community about what deals closed and which were not successful, there were similarities and trends echoed in other industry verticals that we’ve written about on our blog (link out to a previous article or two) in that healthcare, technology/software, and retail via e-commerce were the most successful. However, Allan Gibbel noted a distinct upward trend in “industries that are out of favor with traditional lenders,” such as CBD/marijuana dispensaries that are providing an opportunity for growth as more states legalize.

Tim Davitt, Managing Director at Kayne Anderson Capital Providers, prefers to stick with what has been successful in the past as the markets weather pandemic volatility: “Most of the new things we did were related to the existing portfolio companies or with private equity firms that we knew very well. And in the last quarter, deal flow really picked up.” This strategy can work for some, but not all industries and lenders.

Regarding deals that couldn’t be closed, competitive pricing pressures in the market as well as “a lot of pressure in the banks” were frequently cited. “More importantly, it’s been more difficult for businesses to rationalize our cost to capital,” as Allan Gibbel states. Charles Perer, Co-founder and Head of Originations at SG Credit Partners, echoed the sentiments of other deal professionals: “Three types of deals we cannot close are 1) truly affected industries like restaurants, 2) the companies that were way over leveraged to begin with, and 3) incredible friends and family competition” when it came to seeking debt financing. Several of the interviewees mentioned PPE companies that failed to execute properly and were therefore not able to deliver on promises made fell into this category, demonstrating that with every crisis comes opportunity and demand for impact mitigation, and some companies failed to perform.

To close out this first part on the debt sector of middle market M&A, the below graphic shows which sectors are predicted to have a shortage of capital throughout 2021. As Karina Davydov, Managing Director at Gemino Healthcare Finance, states, “Usually the deals that we could not close are either because of credit quality or overall health of the company.” The following sectors are certainly experiencing their own challenges in 2021Partnering with other debt providers can improve collaboration and cultivate both new and existing business relationships. As Nick Payne, Director at Siena Lending Group,  states, he tends to work with other debt providers in two ways: “…working together on the same deal and being collaborative in referring each other to deals that aren’t quite a fit for us or for them.” Consider implementing this strategy in your own network to strengthen business connections – by paying attention to the needs of other deal professionals, you are planning for long-term relationships in the middle market.

Another way to partner with other debt providers is to follow the model that Karina Davydov discusses: “We actually work quite well with other debt providers because we’re asset based. We typically don’t compete with traditional banks, but partner really well with investment banks, larger healthcare lenders, or real-estate-only providers.” Each industry is unique in its own way, but traditional banks and other asset-based lenders came up frequently in Lou’s discussions with the Opus Connect community. Sami Altaher, Executive Director at FGI Finance, notes that “We are an asset-based lender, our role is to provide the revolver; many of the transactions we work with tend to have need for a revolving line of credit.” Margaret Ceconi, Senior Managing Director at Encina Capital Partners, similarly mentioned revolving lines of credit: “Typically, we do joint participation and revolving lines of credit. We do work a lot with other lenders.”

In inquiring what percentage of business comes from other lenders, the diverse interviewees for this article gave a wide range of responses. Estimated figures were all over the place, ranging from 5% to 80%, with the majority hovering around 30% to 40%. Essentially, the data here reflects the various industries that these debt providers are doing deals in, proving that each deal and company has a unique set of circumstances when it comes to receiving business from other lenders. This is good news, however, and encourages deal professionals to approach each deal with a fresh perspective and the possibility of working with other lenders to complete deals.

On the flip side of the above, many debt providers will partner with equity providers to fill the gap. Bob Colgan, Senior Vice President at Blacksail Capital Partners, described his approach: “We tend to work with equity providers in that we’ll look at the asset stack, provide a number that we can provide the debt on, and then they back fill for the equity around that, and we partner with them to some degree to provide as much liquidity as we can on the  assets and let them do the equity from there.” Other responses noted the frequency of partnering with equity providers, whether they are private equity lenders or traditional and independent sponsors. A handful of respondents quantified their working relationship as working with equity providers about 50% of the time, indicating their overall importance to middle market M&A. Steve Healey, Managing Director, Utica Equipment Finance, asserts that “we think we’re a good fit for independent sponsors. We can bring a lot of value as independent sponsors are generally  looking for a fair amount of capital- senior debt, sub debt and equity – to raise. We’re very eager to do a lot of work with independent sponsors. It’s a big area of opportunity for us.”

A few more responses to this question are worth highlighting – do they apply to your deal pipeline?

• “We support financial sponsors on mostly leveraged buyouts for auction processes that they’re involved in. We’ll come in for acquisitions, add-on opportunities for sponsors that are trying to expand bank facility or perhaps refinance it with more favorable terms after the platform company has grown.” –Alex Rigos, Associate at LBC Credit Partners.
• “We are comfortable providing leverage in a leverage buyout scenario for the target business to be the lending credit for the target business and draw down against the assets of the company for the buyout. We also work with a number of private equity firms for recapitalizations of current portfolio companies.” –Graham Bachman Director at Context Business Lending.
• “We have 19 originations professionals located in 12 offices across North America that allow us to directly originate in both the private equity space and also the non-sponsor space, where we focus on entrepreneurial companies, family companies, and public companies. –Stuart Aronson, Chief Executive Officer & Group Head at Whitehorse Capital.

Finally, we asked what our deal professionals expect the rest of 2021 to look like – is the outlook good? Rich Davis, Senior Investment Manager at Aberdeen Standard Investments, leads the way by noting that “I think 2021 is going to be an interesting year. I think there’s going be a little bit of hangover of a lot of credit that may be challenged, some of which may come back faster than others and so it will be interesting to see what happens. A lot of the government programs and a lot of things help provide liquidity for companies through a certain bit of time but there seems to be a fair bit of “tired” lenders in the portfolio, a lot of which who are looking to get out this year. I think we’re also going to see aggressive sponsors that are trying to make acquisitions in 2021 and so a lot of them are going to have portfolios that don’t have a lot of dry powder so we think we will see a continued use of NAV lending to help fund more acquisitions.”

Overall, the Opus Connect community is approaching the market with what appears to be cautious optimism. They view the deal market as more active, with businesses having more confidence and presenting deal professionals with a lot of opportunities for closing deals. The general sentiment seemed to be that there are “not as many distressed deals as we think” and that the uncertainty in the market will lead to rebuilding and a back-to-basics attitude that will create slow upward growth.

As global vaccine distribution ramps up and the United States rollout continues at a robust pace, consumers will get back out and start spending again. This is good for traditional and non-bank lenders as deal professionals, having weathered 2020, look to the variety of debt and equity providers that are still present in a recently challenged market. Predictions for the second half of 2021 reflect the reality of those obstacles while looking ahead to a hopeful future.

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