Senior Debt vs. Private Equity
In the past 30-40 years, the private equity market has grown significantly. Although the essence of private equity, that of pooling resources together to buy controlling interests in privately run businesses, has been around for centuries, the modern private equity firms really originated in the 1970’s and 1980’s. Not until after the RJR Nabisco buyout in 1988 did private equity firms really become in vogue.
Small private equity firms are now in strong supply and a critical component of the small business market in the United States and internationally. Many small privately held companies, Celtic included, have used private equity funds to help grow their businesses at one point or another.
So how does private equity fit with senior debt? Actually, if used properly, quite well, as they are not mutually exclusive and can be somewhat co-dependent. The proper use of private equity is to leverage the company (with senior debt among other vehicles) so as to provide the best possible return to the investors. Senior debt, on the other hand, is most comfortable when partnered with an equity backer that has some depth in case trouble arises.
In the small deal market that Celtic operates within (loan sizes under $5,000,000), we have seen a growing presence of private equity firms involved with our borrowers and prospects over the past 10-15 years. Even in the 90’s, we rarely saw private equity in our sized transactions. Today, we see them in 15%-20% of the deals we review.
Small private equity firms have sprouted up all over the country and there is no lack of appetite for placing their funds in small businesses across the country. Private equity can often bring a level of sophistication and financial expertise to small businesses who are lacking in both areas. This can often propel the business in their growth plans as they now have the financial expertise and capital to achieve their plans.
Businesses should be wary of taking on too much equity in place of a mix of equity and senior debt, so as to avoid further dilution of their equity and create more strain to achieve the desired rates of return. It may look attractive at first blush to avoid the cost of the senior debt, but the increased equity will end up costing the business much more in the long run.
Working together, senior debt and private equity can achieve great success in helping to turn a small business into a mid-size to large business and in letting the company founders realize the vision that drove them to create the business in the first place.
Celtic always welcomes the opportunity to work with a private equity backed small business, as it is a sign the business has proper access to capital, financial acuity and is serious about achieving its vision for success.