Key Considerations for Borrowers
The private credit market in Australia has experienced significant growth and is becoming an increasingly important part of the financial landscape. Private credit now accounts for approximately 11% of business lending in Australia, according to recent Reserve Bank of Australia data. However, this market share is still considerably lower than in the United States and Europe, suggesting there is room for further expansion.
The fundamental tailwinds driving growth in the sector are well documented, these being, stricter regulatory capital requirements on banks resulting in reduced appetite in certain sectors, flexibility in structuring and speed of execution, and increased demand from investors given the higher yields versus public market transactions.
However, as private credit becomes a more widely accepted source of capital, we see daily articles expounding on what investors should look for in a private credit fund manager. What we rarely see is any commentary on what potential borrowers should be on the lookout for when selecting a private credit provider as a capital partner. Below are some of the key considerations when borrowing from a private credit provider.
The Full Cost of Borrowing: More Than Just Interest Rates
While the interest rate is often the first consideration for businesses, it is important to look at the full cost of borrowing. Private credit typically applies higher interest rates than traditional bank loans, with this premium reflecting the flexibility and access to capital it provides, especially when banks won’t lend.
The “all-in” cost of borrowing includes more than just the interest rate. It’s essential to factor in origination fees, line fees, ongoing fees, and potential prepayment penalties. Borrowers should also be clear on whether the interest rate is fixed or floating, and if floating, which index it is tied to (e.g., BBSW, LIBOR). Another consideration is whether the loan includes any step-up or payment-in-kind (PIK) interest features, which can affect the overall costs.
Finally, compare the loan’s cost not only to traditional bank loans but also to your cost of equity. In some cases, private credit can offer a more competitive cost of capital when compared to giving up equity in your business.
Loan Structure and Flexibility: Tailoring to Your Needs
One of the primary benefits of private credit is the flexibility in loan structuring. Unlike rigid bank loans, private credit providers are often able to customise loan terms based on your business’s specific needs. This could include flexible repayment schedules, such as interest-only periods, bullet repayments, or a combination of amortization and lump-sum payments.
Understanding the loan’s duration is equally important. Short-term loans might offer lower rates but could require refinancing sooner than expected, which might introduce uncertainty into your long-term planning. Some private credit managers may also offer accordion features, allowing borrowers to increase the loan size as their business grows, which can be particularly useful for companies anticipating expansion.
It’s also critical to assess whether the loan includes any equity kickers or warrants that may dilute your ownership. These features can add complexity to your financing arrangement, so ensure you understand all the potential implications.
Speed and Certainty of Execution: A Competitive Edge
In today’s fast-paced business environment, speed and certainty of execution are often just as important as cost. Many businesses turn to private credit because of the speed with which these managers can lend capital compared to traditional banks. Private credit providers often have more streamlined decision-making processes, which can lead to faster deal closures, a critical advantage if your business needs immediate access to capital.
Certainty of funding is another key advantage. Private credit providers are often able to offer capital when banks cannot, especially for businesses with complex financial needs. However, not all providers are created equal in this regard. Before selecting a partner, assess their track record of delivering on commitments. Look for a partner with a history of successful exits and reliable capital deployment, particularly in your sector.
Collateral and Security: What’s on the Line?
Private credit loans often require significant collateral, and understanding what assets will be used to secure the loan is crucial. Private credit managers typically seek security in the form of property, equipment, receivables, or inventory. The loan-to-value (LTV) ratio a provider demands will dictate how much collateral is required relative to the loan amount, which can affect your business’s operational flexibility.
It’s important to evaluate how the level of security might impact your business in both the short and long term. Some lenders may be more aggressive in their demands for collateral, which could restrict your ability to raise future funding or use those assets for other purposes.
Industry Expertise and Long-Term Partnership
Selecting a provider with industry-specific experience can offer significant advantages. Lenders who understand your sector are better positioned to offer terms and advice that align with your business model and growth trajectory. Providers with experience in your industry may also have a higher tolerance for certain risks, enabling them to structure deals that a generalist lender might shy away from.
Equally important is their approach to the borrower relationship. Some take a hands-on, partnership-driven approach, offering not just capital but strategic advice and guidance. Others may be more passive, focusing strictly on the financial aspects of the deal. Consider which approach aligns better with your business’s needs and management style.
Fund Track Record and Expertise: The Foundation for a Strong Partnership
When selecting a private credit provider, the fund’s track record, structure, and the expertise of its investment team are key indicators of its ability to support your business in both good times and bad. A proven history of successful investments reflects their reliability, particularly when it comes to navigating complex or challenging deals.
Equally important is the structure of the fund itself. Closed-end funds may require borrowers to refinance sooner due to predefined exit strategies, creating potential pressure to meet short-term deadlines. By contrast, open-ended funds, offer greater flexibility and long-term stability, allowing businesses to focus on growth without the constraints of imminent exits.
The experience and approach of the investment team can significantly impact how well a private credit provider aligns with your needs. A team with deep industry knowledge not only structures a deal effectively but also provides valuable strategic insights that can help your business manage risk and capitalise on opportunities.
When selecting a private credit provider, it is also important to consider the character of the people behind the private credit fund. Just as lenders assess borrowers based on the three C’s of credit (character, credit, and capacity) borrowers should also evaluate the character of the people they are dealing with. What is their reputation in the market? Have they been transparent and direct during negotiations? It is essential to ask yourself whether these are people you can trust, especially when circumstances become challenging. Will they continue to operate with integrity when things get tough? The answers to these questions can significantly impact the long-term success of your partnership.
Conclusion: Finding the Right Fit
By thoroughly evaluating these factors, you can make a more informed decision about which private credit provider aligns best with your borrowing needs and business objectives.
GCI targets transactions ranging from $5 million to $50 million in the mid-market across three core financing capabilities: Asset Backed Finance (physical or financial assets), Real Estate, and Strategic Capital (leveraging assets or cash flow).
If you would like to discuss with the GCI team our approach to partnering with businesses as a strategic capital partner, please get in touch.
To read more about how we have helped a variety of businesses transform over the years, visit www.gcifunds.com/case-studies/
Authored by Henry Stewart (Managing Director) and Gary Looi (Investment Director)