Those high costs aren't deterring private equity firms, and experts say demand is at an all-time high. While some of the biggest lenders — such as Carlyle Group — say these debts are relatively safe, others are already starting to take precautions by adding covenants that enable seizure of other underlying fund assets, highlighting worries about possible losses. Some are warning of perils when a firm faces claims from more than one type of loan simultaneously.
"If the value of the fund drops, for example, you're looking at a margin call situation," said Jason Meklinsky, chief revenue and strategy officer at Socium Fund Services, a New Jersey-based firm that helps administer PE portfolios. "It would be like a volcano meets a tornado."
For an industry long used to easy money, the rush for such loans marks a reversal in fortune. Buyout firms have been battling rising interest rates and economic uncertainty, forcing takeover volumes to almost halve this year. Cash on hand at PEs is near the lowest since at least 2008, according to data from PitchBook.
That's spurring these high-cost loans, which use collateral rarely heard of before.
One of these types of financings is the relatively new manco loan, for which appetite is soaring. Taken by the management company or the entity that oversees the PE investments, this debt uses cash flows such as fee streams and equity returns as collateral.
The manco loan proceeds are used to meet various needs: seeding new strategies, succession planning and even funding an individual partner's equity stake in the PE fund.
Another comes in the form of the more widely known net-asset-value, or NAV, financing that's backed by a pool of portfolio companies. This is typically used by PE firms to help them return money to investors.
Lenders such as Carlyle, Oaktree Capital Management-backed 17Capital and Hark Capital say they are doing more business than ever.
"We're now getting in-bound calls," said Rafael Castro, partner and co-founder at Hark Capital, an NAV lender. "Ten years ago we were the ones that were doing all the dialing."
About 83% of lenders reported an increase in the number of NAV transaction opportunities over the last year. Average number of deals rose to 22 in 2022, from 16 the previous year, according to a report by Rede Partners. Augustin Duhamel, a managing partner at 17Capital, said his firm's average lending in 2022 was over $250 million, reaching as much as $500 million. The volume of NAV financing is set to swell sevenfold to about $700 billion by the end of the decade, according to estimates from his firm.
Manco loans are a more recent phenomenon, with no data available showing the outstanding amount. 17Capital said deal sizes are getting larger, while Carlyle said it saw a range of $50 million to $350 million.
"The investor universe is unbelievably unaware of the underlying leverage throughout this entire ecosystem," said New York-based Dan Zwirn, founder and chief executive officer of Arena Investors, an institutional manager overseeing more than $3.5 billion in assets. "That hasn't hit the PE investors yet, but it's becoming more clear for real estate investors," he said, referring to the recent delinquencies in the commercial property sector.
