I recently had the occasion to think about and articulate how to approach private debt transactions. When you’ve done something for a long time it becomes second nature. So when I sat down to deconstruct how I go about evaluating a transaction, it became an interesting exercise.
This will be the first of a series of articles that will present a simple and efficient way to think about how to approach a transaction. While written from the perspective of the investor/lender, this series will have application for any type of investor, as well as for those seeking to raise capital.
When you think about making a private debt investment, or really any type of private investment, it calls for the assessment of a number of aspects of the transaction. Having a systematic approach will help you touch on the critical aspects of the company.
The approach I will describe has three essential pillars. Sitting on top of the pillars is the investment decision (if you decide to proceed) of commitment size and required IRR. For most investors the size of the investment is tied to the required IRR. I’d submit that there is an inverse relationship between the size of the investment and the IRR; i.e. the higher the required IRR the lower the investment commitment. Of course there are those that like swinging for the fences. For those investors, there might be a closer, or positive, correlation to the required IRR and the size of the investment.
Each of the three pillars described below has several components to it. Listing and describing these pillars and their respective components is straight forward. It’s the analysis and evaluation of each pillar and its components where the rubber meets the road. It’s what you do with your evaluation that’s important.
The three pillars that this series will discuss are:
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Capital Structure;
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Ownership;
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Company.
Below is a simple list of the various components for each of these pillars. Subsequent articles in this series will expand the various components listed here.
Capital Structure When thinking about the Capital Structure of a company, consider its leverage (debt to cash flow), both senior and total leverage; loan-to-value; liquidity; intercreditor relationships; and bankruptcy considerations.
Ownership Aspects of a company’s ownership to consider include who owns the company; who controls the board; the management team and the breadth of the management team; track record; relationships; strength, reputation and integrity of the ownership/management; and access to additional capital.
Company This is where the majority of due diligence is spent on a transaction. the components of this pillar are quite broad. They include the company profile (franchise business value or diversified business value); strategic risks; execution risks; and industry dynamics.
Capital structure, ownership and company, the three essential pillars for evaluating a transaction. It’s interesting that while I never explicitly spelled out these aspects when working on a transaction, I invariably would touch on most of these topics when working through a transaction.
The next part in this series will look at Capital Structure and some of the aspects of each of the components identified above.