Unlocking Liquidity to Enhance Private Equity Portfolio Returns: The Non-Bank Lending Advantage

Kyle Wilson

Last Modified : Apr 18, 2024

Fact-checked by: Bruce Sayer

During the past two years, spiking interest rate hikes curbed the private equity (PE) market’s 2021 and early 2022 record high-performance levels. And with this comes a noticeable decrease in dealmaking. As a result, the value of aging unexcited companies hit a record high of $3.2 trillion by the end of 2023. Over 40% of all global buyout companies have been held for at least four years – unsold assets are piling up, limiting PE firm’s access to capital. Unlocking liquidity to support strategic investments in portfolio company efficiencies that enhance profit margins and improve exit strategies is essential.

During periods of low exits, PE firms often lean more heavily on business financing to support various aspects of their operations. Unfortunately, in contrast to this emerging push for additional funding, banks and conventional lenders continue to restrict credit to most small and middle-market enterprises. As the traditional lending market remains tight, an alternate source of business financing is needed.

This article explores the advantages of non-bank lending to unlock liquidity, an essential step to support portfolio company efficiencies and improve valuations to help drive returns.

The challenge – unlocking liquidity

For over a decade, the private equity industry has heavily depended on increasing portfolio company multiples and revenue growth to drive returns. However, rising interest rates have restrained these familiar growth drivers, making this approach no longer viable. As assets accumulate, PE firms are experiencing capital constraints limiting their ability to finance acquisitions, growth initiatives, and operational improvements within their portfolio companies. And given the current economic forecasts, passively waiting for conditions to improve is not a feasible strategy.

Instead, PE firms must concentrate on operational efficiencies to improve profit margins and  enhance exit strategies. Sellers must fund strategic initiatives to boost EBITDA and demonstrate to the next owner that there’s money left on the table. This effort begins with accessing additional funds to invest in portfolio efficiencies.

However, in this environment of tight credit within the traditional lending market, unlocking liquidity will remain challenging unless alternate financing solutions, such as non-bank lending, are employed.

The non-bank lending solution

Non-bank lending presents liquidity advantages for private equity firms with companies in their portfolio that need access to more working capital. Significant advantages include greater flexibility in terms of loan structures, faster decision-making processes, and access to capital that might not be available through traditional banking channels. Additionally, non-bank lenders typically provide tailored financing solutions that better suit companies’ specific needs and growth strategies, enabling PE professionals to execute strategic initiatives with agility and efficiency.

Maximizing opportunities with non-bank lending

Securing the right financing is crucial to maximizing liquidity. Non-bank financing is an effective strategy to optimize business investments, support growth, manage distressed assets, and enhance the financial health of the businesses within your portfolio. Customized terms allow portfolio companies to strategically navigate mergers and acquisitions, debt refinancing, capital investments, and recapitalizations.

• Financing up to $50 million
• Repayment schedules can be aligned with the business’s ability to pay.
• Minimal loan covenants increase autonomous control of how funds are used.
• Expanding credit limits increases access to working capital as the business grows.
• High asset evaluations and advance rates maximize asset leverage while optimizing ownership structure and minimizing equity dilution.

Leading non-bank lenders have extensive experience in multiple industries. Their expertise provides valued insights and guidance to help enhance portfolio management capabilities and deliver the best possible outcomes. Understanding how to leverage the strategic advantages of non-bank lending and knowing the options available can unlock valuable opportunities for PE firms.

Non-bank lending options

Leading non-bank lenders offer a range of flexible financing options, including the following:

• Asset-Based Lending: Provides a line of credit based on the value of your business assets, including accounts receivable, inventory, equipment, and sometimes even real estate. Available credit is typically a percentage of the appraised value of the secured assets, offering maximum liquidity with fewer rules.
• Invoice Factoring: A financial transaction in which a business sells its accounts receivable (invoices) to a third party (a factor) at a discount in exchange for immediate cash. Invoice factoring offers industry-specific solutions such as Freight Factoring and Staffing Factoring.
• Inventory Financing: Extending a line of credit or short-term loan secured by the company’s inventory.
• Equipment Refinancing: Offering a line of credit or short-term loan secured by the company’s existing, typically unencumbered, equipment.
• Asset-Based Lines of Credit: Providing revolving lines of credit secured by a combination of assets such as receivables, inventory, and equipment.

Choosing a lender

The decision to engage in non-bank lending to improve liquidity is a significant first step towards capitalizing on opportunities to enhance returns. The next critical decision is to choose a lender best suited to meet your financing needs.

The first and most important goal in selecting a financial partner is to choose a lender dedicated to helping your PE firm grow and be profitable.

Make an informed decision by considering essential lender qualities, including the following:

• Experience and industry knowledge: Lender experience is crucial as it ensures access to expertise, personalized guidance, and tailored financial solutions that can help navigate challenges and optimize financing options effectively.
• Tailored solutions: Ensure the lender offers financing solutions tailored to your business needs and inquire about their ability to customize solutions to your specific requirements.
• Customer support: Evaluate the quality and availability of customer support, including their responsiveness to inquiries and concerns.
• Transparency: Assess the lenders’ transparency regarding fees, interest rates, and terms by requesting a clear breakdown of all associated costs.

Along with offering industry insights to help you assess your growth opportunities, your lenders’ experience, flexible solutions, and cooperation can give your firm a competitive advantage by maximizing access to credit.

Conclusion

The private equity market faces challenges as two years of interest rate hikes have resulted in decreased dealmaking and a record-high value of aging unexcited companies. This has led to limited access to capital for PE firms, necessitating the unlocking of liquidity to support strategic investments in portfolio company efficiencies. However, traditional lenders continue to restrict credit, prompting a need for alternate financing solutions like non-bank lending.

Non-bank lending offers advantages such as flexible loan structures, faster decision-making, and tailored financing solutions. These include financing up to $50 million, aligned repayment schedules, minimal loan covenants, and expanded credit limits. Leading non-bank lenders provide expertise across various industries and offer creative options, such as asset-based lending, invoice factoring, inventory financing, and equipment refinancing.

Choosing the right lender is crucial – consider factors such as experience, tailored solutions, customer support, and transparency. By leveraging non-bank lending, PE firms can optimize liquidity to help support operational efficiencies, increase profits, and enhance exit strategies, ultimately driving better portfolio returns.

Key Takeaways

• The value of aging unexcited companies hit a record high of $3.2 trillion by the end of 2023. The pressing issue of low exit volumes has exacerbated liquidity challenges.
• Passively waiting for conditions to improve is not a feasible strategy – PE firms need to increase margins and enhance exit strategies to improve returns.
• Non-bank lending empowers PE firms to optimize liquidity to help support operational efficiencies, increase profits, and enhance exit strategies, ultimately driving better portfolio returns.

Kyle Wilson

SVP, Sales Director of Business Development for eCapital’s Commercial Finance Division

Kyle Wilson, CPA, CMA is the Senior Vice President, Sales Director of Business Development for the Commercial Finance Division at eCapital. Kyle is responsible for leading business development efforts throughout North America, supporting eCapital’s mission to empower companies by accelerating their access to capital. Kyle ensures the company’s highly skilled team of business development professionals are well-positioned to support market needs.

Kyle has more than 13 years of expertise in commercial financing. Kyle joined eCapital from Hitachi Capital Canada, where he held the position of Director, Business Development. Prior to that, he held business development management positions at Bibby Financial Services (now eCapital), i-Cubed Industry Innovators, BDC and Bank of Montreal. He is instrumental in supporting clients and partners financing requirements while driving our continued growth in the commercial lending space.