Hi everyone:
I’ve been thinking about this question, and would love to get your perspective - how do the priorities in private equity versus credit investment processes differ? I’d love to know what each side think the other side might be missing, and how to form an integrated view!
Here’s what I came up with:
PE - key priorities in investment thought process: Margin, growth, exit
Credit - key priorities in investment thought process: Stability of cash flow, term/structure
Would love to hear your views!
Can't talk about the PE side, but currently a distressed / deep value investor.
I would say that the investing approaches are somewhat similar to an extent, although depends on the PE firm and their investing style (some target growth while others are value driven). We look for business with low capex needs, stability in cash flows, and cheap valuation.
We try to find situations where there is a temporary dislocation in the market price of the debt due to some circumstance, either forced selling, temporary accounting issues, heavy temporary investment spending, etc. We stay away from turnaround situations as they are too risky.
I would say one thing that is different versus PE is that distressed investors focus a ton on the legal side of things. We focus on credit agreements/indentures heavily and figure out how we can get screwed by management/sponsor or in a bankruptcy process. A lot of game theory involved.
Thank you so much!
Private equity funds will focus on both potential upside as well as downside, whereas private credit funds will primarily focus on just the downside. Basically it reflects the risk/reward profile of the 2 asset classes - PE will care about upside as their returns are primarily driven by equity value, whereas the returns on private credit will be capped at their margin/coupon so they care less about upside and are more concerned about how things can go wrong. That's not to say PE don't care about downside - they definitely do given they have the most to lose if things go south(they are at the bottom of the recovery waterfall). On top of my head, I'd say some key area topics in terms of potential upside vs downside diligence are:
Potential Upside diligence: - Outlook for add-on acq. opportunities -- this is key because it's usually quicker to scale up businesses via acquisitions than via organic growth. You'll see a lot of sponsors do this strategy of "acquire Company XYZ as an acquisition platform, do a bunch of add-ons, sell for similar exit multiple, then profit" - Potential procurement to supplier contracts, esp as the business grows in scale - Potential buyer landscape, esp strategics (in light of exit in year 5-7) - Various potential cost cutting measures - ProperManagement team to drive sponsor business plan
Potential downside diligence: - Revenue visibility - Customer stickiness - Net Working Capital needs - Capex (Maintenance vs Growth) - Cash Flow generation - Fixed cost vs. variable cost - Op leases vs. capital leases - Cyclicality of industry - Competitive positioning - Addressable market - Barriers to entry - Covenants - Historical Performance - LTV
I could list a ton more, but a lot of it becomes sector specific so I'll just leave it at the above. Full disclosure - I'm a credit guy so I'm more familiar on the credit analysis side of things but I'm sure other PE guys on this board can chip in on what addt'l aspects they focus on as an equity investor
Hope this helps
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