Debt Financing from LOI to Close: An Expert's Guide

Speaker A: You're listening to Deal by deal, a, uh, McGuire woods podcast. Deal by Deal invites you to conversations with experienced independent sponsors and other private equity professionals. Join Meguiar Woods Partners, Greg Havre and Jeff Brooker as they explore middle market private equity M and A to provide you with timely insights and relevant takeaways.

Speaker B: Hello.

Speaker C: Welcome to Deal by Deal, a podcast for independent sponsors and other private equity investors in the middle market. My name is Greg Havre. I'm an M and a partner at McGuire Woods. I sit in the Chicago office and I'm excited to be joined today by Parm Atwell at, ah, Configure Partners. Parm and I are going to dive deep into the current dynamics in the debt finance markets for middle market transactions and his viewpoints on how to find the right debt finance solution for your transaction. Really excited to have an expert here in debt advisory like Parm from Configure for the audience's reference. I'm an M and a lawyer, so I work on acquisitions. I am not an expert in debt finance. We have lots of fantastic partners here at McGuire woods who get in the trenches with Farm and with his clients as far as negotiating the detailed credit arrangements, et cetera. And so if you are a listener who's not an expert in these nuanced debt finance matters, no fear, because we're going to be asking some 1.0 questions and we're also going to be benefiting from Parm's 2.0 nuanced knowledge here. And so we're going to balance the basics with some deep dives. So very excited to cover the landscape here. Before we do that, Parm, why don't you, uh, take a minute to talk about yourself and your practice at Configure?

Speaker D: Yeah, I'd be happy to. First of all, thank you for having me, Greg. Really, uh, excited about the opportunity to speak to your audience. So Configure Partners is a credit oriented investment bank. We have roughly about 40 professionals based in Atlanta with offices in New York and Chicago as well. And our core business, while we do other things, is providing outsourced debt capital advisory. Just to give you a general sense of scale. We're typically doing about 40 to 50 transactions a year.

Speaker B: Great. And what's a typical size of one of your transactions?

Speaker D: So we tend to go, uh, start at about 5 million in EBITDA and do companies larger than 100 million in EBITDA. So that makes the debt quantum typically between 25 and 600, which is a very broad range. I'd say that probably the Sweet spot though is more kind of a 75 to $150 million raise.

Speaker B: Great, that's fantastic. So an idea here, Parm. I think it might be helpful for our listeners if we structured this podcast as uh, sort of a start to finish practical guide from your perspective about how you think about raising debt capital and finding the right debt capital for a deal. So let's start this hypothetical with a, you know, an independent sponsor or a private equity fund gets a deal under LOI with the founder of uh, a manufacturing company. You know, the purchase price is 100 million. So a nice meaty transaction, they sign the LOI, they have 90 days of exclusivity and they want to start thinking about what is going to be the right capital structure for this transaction. You know, how and when do you get involved with that investor and what are your initial thoughts as you approach a transaction?

Speaker D: Yeah, well, I appreciate that example earlier is always better. That's going to be the answer to a lot of these questions. When we talk about hypotheticals, we position ourselves as a, uh, relationship focused advisor. We want to be that focus partner. We want to know what you guys are spending your time on ahead of, even when a deal is under loi. So that's the way that we can kind of start having those conversations about what is the sponsor's priorities and how can we make the capital stack, um, address those priorities. So you mentioned a capital intensive business, a manufacturer. There's going to be some considerations in coming up with an optimal capital structure there. Among those being kind of the cash flows, how much capex is going to be needed for that business, the cost of growth and uh, whether or not we're going to need to kind of lend on the assets. So that's a lot I threw back at you. But each one of those kind of factors as well as a number of others is going to dictate kind of the timing and pace of the transaction. Got it.

Speaker B: No, and you raised an interesting point about building a relationship with a sponsor before a transaction is in hand. You know, as you are thinking about an opportunity, you know, you're thinking about the target company. I mean, how much does the sponsors profile come into the equation?

Speaker D: Um, I'd say it oftentimes depends. There's a lot of folks who even bark at themselves as generalists out there who have direct experience in a sector or subsector, either at their current firm or a previous firm. It's nice to have that kind of connection to the asset or the industry. It works well with that kind of narrative that these guys are the right ones to own this business. These are the ones that know the levers to pull and when to pull them. And uh, it definitely works well with kind of strategy kind of going forward as they pull through that sponsor thesis.

Speaker B: Got it. Yeah. No, that, that makes a lot of sense. I mean not as critical as the equity capital partners are gonna be thinking about the profile of the sponsor, but still an important piece. What's your process for sort of asking key questions about the target company so that you can approach the market? And uh, what's kind of the timing of that?

Speaker D: We get involved oftentimes pre loi, but maybe more typically at loi or shortly thereafter that signing. So while we wanna get our arms around everything, all as soon as possible, I think the initial discussion is always going to be surrounded, uh, centering around the historical financials, just kind of understanding what's driving that financial story. We want to get our hands on audits, if available. We want to get our hands on any internal materials, be it board decks or anything else they've had about uh, around kind of the process, if there was one, just to get our arms around what the profile of the business is. Because we're constantly thinking about calendar, we're thinking about preparing materials, we're thinking about potential lenders and, and, and those profiles associated with them. So it's, it's important for us to get that information as soon as possible so that we can drive a process that typically will work in that 75 to 90 day, uh, time frame.

Speaker B: Got it. And so disclaimer here. I'm an M and a deal lawyer. I'm not a debt finance specialist. So feel free to not only answer my 1.0 questions, but you know, if you want to dive into the 2.0 and the real granularity on any of these, don't let my lack of knowledge on these deep topics, you know, hold you back. So with that being said, you know, I'm interested in how do you strategize with your clients about how to approach the market? You know, what, what are kind of current trends out there? Target, talk us through that process.

Speaker D: Everybody has their own priorities that they're bringing to the table. And that typically comes from their experience with previous transactions, potentially with scar tissue things, things of that nature. So it's important in initial conversations to kind of understand those priorities because there are a lot of options out there in terms of partners, in terms of structure to finance a, uh, transaction. So when I say priorities, it could be something where it's just like, listen, they say to us that I don't need last dollar of leverage here. I just want to find that relationship partner who ultimately is going to give me the flexibility to go operate and is not going to be concerned about footfalls and I'm just going to be able to go run the business and kind of, um, pull through my pieces how I need. So that would be telling to me in a lot of ways because that means not needing to go out and get last dollar of leverage kind of changes that profile. If you're just looking for a relationship focused guy, somebody who's going to offer a lot of flexibility and you're not price sensitive, I'm already in my head thinking about who your partners are. So another way they could kind of frame that would be like, listen, this is going to be an M M and a heavy platform. We are a buy and build strategy here. So I'm going to need to go find that lender who's going to have the capacity to grow with me and is going to offer me the flexibility, huh. To use leverage to go pursue that strategy. Well then I'm thinking about a different guy. In another case, it could be just, I want the cheapest debt out there. And now I'm thinking about a different profile. So priorities really drive this a lot. And I wouldn't be a good partner or advisor to my clients if I wasn't hearing them on that. I don't want to go bring them guys that aren't going to be a great fit for what they're looking for.

Speaker B: That makes a lot of sense. I would maybe ask you to paint in broad strokes here, but when you think about private credit being a big new piece of this market versus traditional banks and sort of other flavors in between, I mean, again, sort of painting in broad strokes, where do you see private credit being a good match? Where do you see like traditional bank lenders being a good match, et cetera?

Speaker D: Yeah, it's kind of an interesting time. Without going too much kind of back into the history, the proliferation of private credit kind of came over the last call it five plus years. And in a lot of ways it filled the void that was kind of created by banks in the broadly syndicated market. So private credit is as significant part of financing these deals as it's ever been before. So with that being said, banks and broadly syndicated are making a comeback. Let me talk a little bit about banks first. On the bank side of things, there's definitely an appetite to be active in this world, but they Want to do it kind of on their own terms. And by that I mean they want it to be in conjunction with bank products which they value. So deposits, accounts, all types of bank products, ancillaries. And they want to be in a good structure and not necessarily in kind of a yield piece, meaning they want to keep their risk profile modest. So um, being kind of pro deal but not necessarily wanting to go and take on a lot of risk has forced creativity. So with the banks they're doing first out last outs for example, so they find they're working together with a partner, oftentimes arranged by us, where there's a last out partner who is more of a yield investor who is taking on substantially more risk. So that's a way for a bank to be active in this market. ABLS definitely another place. And historically a uh, bank product as well. So that priority revolvers. The point is, is that they're getting creative to be active in sponsor finance which is an attractive place to play even for banks. So private credit works well with banks not necessarily always directly competing because their product is different. At the end of the day they're offering typically a uh, more flexible a product which is going to go deeper in the capital structure and more expensive. So private credit's really competing more with each other than it is necessarily banks who tend to work in collaboration with private credit or mezzanine financing.

Speaker B: Yeah, and how do you see the interaction between the two private credit and banks as the portfolio hold period goes on? I mean uh, is it the case that most borrowers are seeking to refi out the private credit and replace it with more cost efficient bank but maybe more risk averse bank product or how does that evolve over time?

Speaker D: It's a great question because honestly you'll see it going kind of going in both directions. I'd say right now though we're seeing more bank to private credit refinancing. So you have obviously we just worked through kind of a um, interest rate rising environment which put pressure on a lot of capital structures. So a lot of those that had originally been housed by banks, they were looking to kind of move those along off of their balance sheet. So it was a pretty natural progression for banks to kind of to not retain those assets and have those assets kind of move over to private credit and other dynamics like you kind of alluded to. You are going to see situations where you needed a uh, riskier, more expensive kind of capital structure right out of the blocks where as the business kind of grew and the sponsor thesis kind of Pulled through. Ultimately they had more options on the table and they would do a private credit to bank refinance in order to kind of lower their cost of capital. So it does go in both directions and it really just depends on kind of the, the journey that that portfolio company has gone off.

Speaker B: Yeah. And I guess another nuance is as you think about the independent sponsor market, the private credit partners can bring many times to the table an equity component as well. Whether that's, you know, an equity kicker or even like the full slug of equity for a transaction. How do your clients think about as uh, pro or a con?

Speaker D: Well, more options is definitely going to be a pro. So when you get into the independent sponsor world, there's actually quite a few players. You have kind of that the bank market that we talked about and banks, not across the board but in certain cases are playing in kind of that deal size. You've got the SBIC market which has grown considerably. You've got Mets players down in that market, private credit as well. And then you've got the one stops that you alluded to. So at the end of the day there are going to be pros and cons with each type of lender there, each type of investor on the one stop side of things, it tends to move that direction, and I'm speaking a little bit in generalities that it tends to move in that direction if your equity is encircled early in the process or if there's a reason why you're going to struggle with kind of a typical equity raise. So if time is of the essence, Tom, and the profile isn't going to necessarily bring a lot of investors around the table, a, uh, one stop is a terrific solution. But it's not, that's not always plan

Speaker B: A. Yeah, I mean, and that kind of brings up another topic as far as just the challenge of getting a deal, you know, financed from both a debt and an equity perspective. You know, Parm, what would you tell the people who are maybe thinking about, well, should I just go out on my own and try to call the banks I know to get this thing financed and the lenders I know versus using a configure sort of what are the value adds?

Speaker D: And this is one where we have a premium product. It's one of those things where we bring to the table quite a few things, but not necessarily everybody is going to go and say I need to go have that because you can go and do it yourself. So in our case what we say is that, listen, certainty of execution we bring to the Table optimized terms. Through using competitive tension, we bring to the table a true lift. So that ultimately you're saving hundreds of hours of time not only on your sponsor's deal team, but also on the management side of things. We drive the process, we make sure timelines are met very much cradle to grave pre loi work all the way through credit documentation and funds flow. So it's a terrific product. A lot of sponsors love it because it is a very natural outsource. But it is one where sponsors have their own relationships. They've been doing this for a long time and they have the ability to go run this themselves. The difference is that there's been quite a bit of a proliferation in private credit. And just because you knew that for the 20 guys to call seven years ago doesn't mean that you necessarily know the 20 guys to call now. And it's an important part to have a deep Rolodex. And speaking of which, we actively are talking to three to 400 private vendors, um, on a monthly basis, if not, if not more frequent than that.

Speaker B: Yeah, you raise a good point on bandwidth. Right. And I think that it will differ for each sponsor and each transaction. But many times you just have to pick which areas you're going to be able to lean heavily into and which areas you're going to have to look to trusted advisors. Because between dealing with sellers on the M and A side, maybe you've got rep and warranty insurance, maybe you're having very detailed negotiations with a family office on the equity side. You know, many times you need to pick your poison, it seems.

Speaker D: Yeah, that's right. And quite honestly a lot of the sponsors profile is relatively lean shops. You can't insource absolutely everything. There was a time when you tried to do a lot of your financial diligence yourself and I'm old enough to see sponsors who did that. And then it became very commonplace that uh, all financial diligence was outsourced to a third party and the quality of earnings, uh, industry kind of grew and proliferated. So this is one where we kind of view some similarities with that. And this is ultimately not going to be necessarily using a debt advisor, isn't necessarily going to be for every shop. But, but right now, the way that we kind of view this, it's gaining more and more traction within the sponsor community and demand is outstripping supply.

Speaker B: That's great. Tell us if you could get your crystal ball out now and just sort of, as you look at the current market landscape, what rates are doing at the moment. Together with the rise of private credit, there's also been a couple notable bankruptcies. But just given the whole milieu of what's going on right now, I mean, what's the next 12 months going to look like? Uh, and maybe more concretely, what are you telling your clients out there as far as the current landscape for debt finance?

Speaker D: Got it. Okay. That's a lot to unpack. If I don't hit every one of those, please hold me honest and we can circle back.

Speaker B: Yeah, no, it was, I think it might have been a seven parter. So uh, good luck.

Speaker D: So let's start with the, with the interest rate side of things. I will give it a shot, although I don't have a crystal ball either. But I think the expectation is that we're going to have some um, steady cutting through 2026. We're not going back to a zero world. That era of ultra cheap money is over. But generally speaking, the macro environment is going to push us into a rate cutting kind of cycle. So economic growth projections generally are being revised downwards. Jobs data, uh, isn't great. Manufacturing output is suppressed. So those kind of drivers should put us down. That, that being said, interest rates are going to help and be part of the story. But also kind of helping is that with the proliferation of private credit, there's significant dry powder in the industry that's sitting on the sidelines. So ultimately that dry powder is driving competition which is lowering rates. We're seeing for, let's say a uh, vanilla LBO rates pushing into the sub 500 spread territory, more so than we have in recent memory. So two dynamics kind of pushing rates down from that perspective. But then you bring up the bankruptcies that have gotten a lot of headlines recently. So on that side of things, that's going to have an impact on lenders and credit committees and internal discussions. But we're not necessarily seeing a pullback in credit appetite. What we're seeing is that okay, this might make spreads go a little wider. So while the dynamic is still going down, it might slow kind of that progression. Lenders would be asking more questions, they might be more patient, but the capital is still sitting on the sidelines and it still does need to be put to work. So think more diligence, more selectivity, maybe some structural enhancements, but not necessarily changing the need to deploy capital, even with some headline bankruptcies.

Speaker B: Got it. In a similar vein, as far as what's market, are you seeing any unique deal structures, whether it's, you know, pick toggles Things of this nature to address, you know, whether it's the concerns we just mentioned around bankruptcy, but more broadly, you know, what are some discrete trends you're seeing in the market, if any, as far as structuring these deals?

Speaker D: Yeah, it's um, it's a little tricky because the second we get into more exotic features, they're very kind of fact specific. So are we seeing what you mentioned, pick toggles? We certainly are. We're seeing it as you kind of go and cross maybe that 30, 40 million dollar EBITDA threshold. It still hasn't come all the way down into the lower middle market just yet. We're seeing the use of pick though as a solution, particularly in buy and build strategies. And that's why private credit, that's one of the reasons why private credit is so attractive because they have the ability to take pick, whereas you go, you go see a bank that is less likely, probably closer to impossible. So there are going to always be back specific kind of structural nuances to these transactions. But hard to say that we're seeing anything that's created a trend at this point because uh, we're seeing little things here and there. One thing I will highlight though is that we are seeing more and more interest in preferred or structured equity, particularly in these situations where interest rates have created over leverage situations on platforms. So coming in and bringing in a non cash tranche in order to alleviate that stress on the capital structure is becoming more and more attractive and we don't think that is going to change anytime soon. Quite honestly, even with interest rates coming down, there are still some capital structures that need to be fixed.

Speaker B: And ah, uh, are you seeing that from new investors coming in with a slug, uh, of preferred equity? Are you seeing, you know, existing lenders maybe using that as a tool to get more capital into the business?

Speaker D: You're going to probably see both. But the example I was using was more new investors where just this business is not broken, it just doesn't have a good capital structure in place right now. So I'm going to come in, I still view it to be, and I'm speaking as a new investor, I still view this business and this model to be a winner even though it's struggling right now. So I'm going to bet middle innings on a winner.

Speaker B: Yeah, yeah, no, that's great. So one of our last topics here, talk to me a little bit about what are some unique considerations for independent sponsors as opposed to your average private equity fund as you think about debt capital and just deal by deal Considerations generally. I know we talked about the bandwidth factor, which is important. Uh, any other nuances?

Speaker D: While there is more depth in our Rolodex than at any other time, for the types of lenders and investors who are focused on the independent sponsor channel, it's still, there's always going to be some issues out there. You're not going to really be able to push leverage as hard because you do have this dynamic. You're going to pass the hat whenever there's a need for equity. So it's not really true traditional sponsor finance in that the capital is always there to support the business, but you are finding deals at value multiples and you are bringing a skill set to the table that makes it more attractive than a founder owned business in some cases. So you've got that balance going on at any given time.

Speaker B: Parm, uh, could you explain real quick the distinction there as far as a fund financing a portfolio company, but then having some additional tools within the fund to provide more liquidity if it's needed?

Speaker D: Yes, sure. So typically this is one of the more attractive reasons why lenders like to focus on sponsor finance transactions. On the one hand it's a recurring, like you build a relationship there, it's recurring deal flow. But on the other hand, if things are not going as everyone expects, then ultimately the sponsor has the ability to support the business with equity. And that could take the form of okay, repaying the debt to right size the capital structure, providing liquidity or making an acquisition that would be deleveraging and either create scale or reduce concentration, things like that. That's why folks like kind of uh, investing in sponsor backed platforms. So independent sponsors are a little bit different from that perspective because they don't necessarily have the deep pockets, but they do bring a lot of things to the table in the sense that they're typically buying businesses because they know the industry, they've worked on something previously in their career that makes them the right person to own that. They have operational shops that can help them scale this business that the founder didn't necessarily have. So they are bringing a lot to the table. It's just they're not necessarily bringing the deep pockets and the ability to, to kind of raise capital kind of middle innings. So that's why there's a balance. And some lenders are going to look at that and say, all right, well for an independent sponsor deal, even though I'm interested in this business, in this sector, I might not look at it like a sponsored transaction. So I'm going to be a Bit more conservative on how much leverage I'm going to be able to put on this one. But it's still not necessarily a founder owned business. It's somewhere kind of hovering in between and everybody's kind of crafting their own strike zone according. So I think they're viewed generally attractive, which is why there's more folks kind of moving into this market. But you gain another level of attraction when you're circling the equity capital earlier in that process. That typically gets the lenders kind of leaning into the process a little bit more. Otherwise they're kind of hanging around the hoop a bit. And that comes from the fact that they're just waiting to see whether or not the equity comes together first, otherwise there's nothing there for them.

Speaker B: Yeah, that's a really interesting point. So you're coordinating with the sponsors to make sure you're communicating where you're at on the equity raise, who that partner is going to be and then passing that along to the debt finance. And that makes a meaningful difference.

Speaker D: It sounds like it does, uh, like you don't have to have to kind of tip uh, all the hands early in the process, but it's good to give those kind of periodic updates where it's just like, listen, we have this much circled, we have that much circle. Here's the profile of the guys who are coming around the table. It changes the dynamic of um, the debt raise and it keeps everybody on calendar. So it's an important side of that. And that's why when we think about independent sponsor transactions, we're thinking about who we want to back in this. Because we want every engagement that we take on to have best execution. So in order to get the equity around that table, best execution is going to look like a certain profile. And sometimes that profile is an independent sponsor who's done this six or seven times. And it's just kind of okay, I need to focus on this business. I don't have the bandwidth to uh, worry about the capital raise. That's a guy that's pretty straightforward to back because not only does he have his own LP relationships to start, but he has a track record. And in a lot of cases you don't have an independent sponsor with a track record. Sometimes you have that guy who's incredibly bright and incredibly well connected and has all the chops, but his resume doesn't necessarily have six independent sponsor platforms on it. So that could be a difficult capital raise or challenging capital.

Speaker B: And as you mentioned, it probably impacts when you're going to market with Respect to the lenders to build the competitive tension. I imagine the competitive attention increases when you've got committed equity capital. Before we wrap Harm and I really appreciate your time today. This has been really great to get a download on the current debt capital markets, any other sort of words of wisdom or predictions or anything for our independent sponsor and other private equity investors.

Speaker D: At the end of the day, it feels like the market has normalized a bit. This was a challenging market in the first half of the year. We kind of work on both sides of it. So part of our business is new LBOs, part of our business is dividend recaps, part of our business is refinancing. So we can be busy in any market. But we are tracking how M and A is slowly ticking up in the middle market. So volumes may be down kind of year over year, but they are picking up. And so I think that's a nice dynamic for everyone out there. We feel like maybe the broader macro condition hasn't impacted the independent sponsor market as much. You don't have the considerations of, um, that sponsors with committed funds necessarily have if an independent sponsor is pursuing a single deal. So we think that the market looks pretty good for them. Like I said, this is the deepest time, deepest Rolodex on both the debt and the equity side that we've seen in this market. And we feel like value multiples are still pretty common in the independent sponsor market. Quite honestly, you have sponsors with committed funds more and more interested in this world and partnering up with independent sponsors than at any time as well. So there's a lot of value in that side of the market, which is why everybody's circling it, us included. I think it's an exciting time to be an independent sponsor. We love working with independent sponsors. We're proud to put those tombstones up alongside everything else we're doing and, uh, hope that this will be a growing part of what we do going forward.

Speaker B: That's great, Parm. Thanks again for your time. And if our listeners want to learn more about you and about Configure, where can they find you?

Speaker D: Well, a great starting point, we do a quarterly private credit quarterly webinar every call it. It's probably about six weeks after each quarter end. It's a great way not only to get kind of all of our insights on the credit markets, but it's a great way to kind of interact with some of our senior folks. So I think that's a perfect first stop. Otherwise, feel free to reach out to me directly. My contact information is on the Configure website. I'd love to meet more folks in the Independent Sponsor community so thank you

Speaker A: thank you for joining us on this episode of Deal by Deal a M Meguiar Woods Podcast. To learn more about today's discussion and our commitment to the Independent Sponsor community, please visit our website@mecguirewoods.com we look forward to hearing from you. This podcast was recorded and is being made available by Meguiar woods for informational purposes only. By accessing this podcast you acknowledge that, uh, Meguiar woods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information or opinions expressed during this podcast series are solely those of the individual individuals involved and do not necessarily reflect those of McGuire Woods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.