7 Ways a Private Placement Both Complements and Differs from a Bank Loan

22.11.17

 

Utilising both bank debt and private placements can help a business achieve its strategic goals while simultaneously minimising funding risk.

Accessing capital under a traditional bank credit arrangement and through a private placement relationship are not mutually exclusive events. Properly executed, companies can do both, establishing access to a broader palate of stable capital in support of their long-term corporate objectives.
 

Here are 7 ways a private placement complements and differs from a bank loan:

1. Short-Term vs. Long-Term Orientation - Bank loan commitments tend to be shorter term (typically 3-5 years), whereas private placements offer longer maturities (typically 3-12+ years). Because of this, a private placement is often well-suited for financing the long-term goals of a business, such as growth by way of an acquisition or to finance a new plant and equipment assets. Alternatively, the short-term nature of bank loans makes them more suited for fluctuations in working capital. The long-term nature of private placements allows companies more time to realise a return on their investment as well as minimises the refinancing risk that comes with shorter-term debt maturities.

 

"The breadth and investment appetite of the private
placement market can often equal or exceed that
of the syndicated bank market
."

 

 2. Broadens Capital Pool - The introduction of private placement financing to existing bank debt expands the pool of capital available to companies; they would have multiple types of capital to draw from depending on the need at hand. The breadth and investment appetite of the private placement market can often equal or exceed that of the syndicated bank market.

3. Diversifies Capital Structure - The combination of bank loans and private placement financing diversifies a company’s capital base, better preparing them for any changes to interest rates and other issues that could arise by taking on only one type of debt. Private placement lenders are often able to consider financing arrangements that extend beyond senior debt to include junior capital and equity.

 4. Minimises Fees - While banks rely on ancillary services and fee generation to enhance investment return, private placement lenders rely solely on the yield they receive from their loans. As a result, the private placement provider’s interest in lending is not dependent upon ‘expectations’ for future fee income, better aligning issuer and lender interests over the life of the lending relationship.

 

"Reduced dependence on a single market for capital can be an important consideration for companies should bank regulators become more stringent, or during times of heightened public market volatility."

 

5. Regulatory and Market Independence - The private placement market along with the insurance companies and pension plans that participate in the market are not subject to governance by the regulations that impact bank lending practices. Similarly, the private placement market is often seen as a more stable market than the public debt markets, and is ‘open for business’ at times when the broader public debt market is ‘closed’. Reduced dependence on a single market for capital can be an important consideration for companies should bank regulators become more stringent, or during times of heightened public market volatility.

 6. Contrasting Capitalisation - Private placement providers are capitalised differently than banks. The capital they have to deploy is traditionally more stable than the capital the bank market relies upon. Reason being that insurance companies and pension plans are not materially exposed to short-term liquidity risk. This was most acutely demonstrated during the 2008-2009 financial crisis, as many private placement lenders continued to provide capital, while many banks limited their lending availability to preserve corporate liquidity.

7. Structural Parity - When combining bank debt with a private placement, transactions are often completed on a ‘pari-passu’ basis. In this manner, both the bank lenders and private placement lenders work together to maximise the company’s access to low cost capital, while ensuring that neither lender group is disadvantaged by structure nor their rights as a senior lender. For transactions involving collateral, the private placement structure is typically negotiated and documented with an intercreditor agreement that governs how collateral proceeds are shared equitably between lenders in the event of a liquidation. If a bank loan is unsecured, private placement notes will most likely also be unsecured, and an intercreditor document is typically not required. 
 
Ensuring that private placement debt is ‘pari-passu’ with all other senior debt obligations, including bank loans, is the most efficient and cost-effective way to issue debt in the private placement market. This approach also improves the ability to work with lenders on any post transactions modifications and amendments that may be needed over the life of the financing.

 

Now that you know the ‘7 Ways’, here is a little background on how this works:

Savvy managers who understand the pros and cons of the bank market and private placement market can use both funding sources tactically to optimise their capital structure as well as enhance their liquidity risk management.
 
Middle-market companies will often rely exclusively on traditional bank debt financing to fund capital needs that exceed internally generated cash flow. They tend to find their need for debt capital expands meaningfully, either as a result of natural growth, capital investment, business acquisitions, or because of a company’s need to alter its ownership or capital structure. In instances such as these, companies will often pursue a private placement debt financing as a means of diversifying and complementing their existing bank lending arrangement.  
 
A private placement is a common term used to describe the private sale, or ‘placement’, of corporate debt or equity securities by a company, or ‘issuer’, to a limited number of investors. 
 
Private placements are typically event driven; they are often issued when opportunities arise such as debt refinancing, expansion, acquisitions, stock buyback/recapitalisation and transitioning to an Employee Stock Ownership Plan (ESOP).

 

"A private placement issuance allows institutional investors to lend directly to companies in a similar fashion as banks."

 

Private placement investments are generally completed directly by large private investment firms, such as insurance companies, pension plans or other large institutional investors. A private placement issuance allows institutional investors to lend directly to companies in a similar fashion as banks. Like banks, institutional investors who purchase private placements do so with a ‘buy-and-hold’ approach to lending, and thus are not beholden to the normal public information disclosures and rating requirements associated with public securities offerings.

In addition to working directly with a private placement firm, businesses can also access the private placement market through an intermediary or agent (most often an investment bank) to the extent that the issuer desires to place its debt with several different institutions. 

 

Let’s look at a side-by-side comparison of bank loans and private placements:

The combination of private placement financing and bank debt can play an important role in a company's business strategy, providing the capital needed to operate on both a day-to-day basis as well as funding initiatives that support growth for years to come.

It’s not easy for companies to find a capital provider that can tailor terms and structures to meet their specific financing needs. With more than 75 years of history in structuring and investing in the private market, Pricoa Capital Group can implement a customised private placement that best suits your liquidity objectives, and provides financial support that coordinates with your bank facility rather than competes with it.

 

Private Placement Example

Hypertherm: Private placement and bank debt financing working together

Many say a business is only as good as its employees. Hypertherm, an advanced metal cutting company, was so proud of the role its 1,300+ Associates played in its success, that in 2001, it created an employee stock ownership plan (ESOP) to hold a minority stake in the company’s stock.

When succession planning twelve years later, Hypertherm’s founder and majority owner decided to transition the company to a 100% ESOP ownership. Hypertherm’s ESOP and financial consultant, Verit Advisors, was brought in to help secure the necessary financing, and thus introduced the company to Pricoa Capital Group.

After assessing Hypertherm’s needs and financial profile, Pricoa Capital Group structured a financing package that included a senior secured term loan as well as a shelf facility, under which Hypertherm could issue additional debt as needed. It was important to Hypertherm that Pricoa Capital Group also design an amortisation structure for the deal that fit the company’s cash-flow profile and existing debt-maturity schedule.

One of the main challenges the company faced while transitioning was finding the right combination of senior debt and subordinated seller notes that would allow for the full buyout of the founder’s majority stake, and also avoid over-levering the company to the point of financial risk or limiting their ability to grow in the future. Another challenge was structuring the debt as to not subordinate the claims of the Hypertherm Associates, while retaining an investment grade credit rating and associated pricing.

Pricoa Capital Group’s financing package was augmented by shorter-tenor financing from the company’s bank, which provided a senior secured revolver and an additional term loan. A strong working relationship between the lenders allowed for a constructive negotiation with an outcome satisfactory to all parties involved, most importantly Hypertherm.

To finance a 100% ESOP conversion that would support its long-term strategy, Hypertherm chose Pricoa Capital Group for its expertise in ESOP transactions, the flexible structuring of its financing package, and because of the relationship-focussed approach that met Hypertherm’s financing needs.

 

Interested? We would be happy to discuss how a private placement could work for you.

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1An investor is considered “accredited” if they meet minimum financial net worth qualifications as well as other requirements set by the federal government; They are considered to be more experienced and are the only investors allowed to purchase private placements. Being accredited should imply that the investor has the knowledge required to make prudent investment decisions but also that they can afford to take a loss should something go wrong.

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