Private equity houses that offer debt and traditional equity could face something of a conundrum during an economic downturn. If a business is struggling against macroeconomic headwinds, does the lender call in its debt or prioritise the equity value?

From left: Mark Jeffries, author and communications consultant; Lisa Rejler, acting communication director/IR & CSR director at Rejlers; Paulo Eapen, senior managing director at GSO Capital Partners

The issue was addressed by Paulo Eapen, senior managing director for Blackstone’s GSO Capital Partners unit, speaking at the EY World Entrepreneur of the Year conference in Monaco on 14 June. Eapen argued a combination of equity and debt gives private equity firms a stronger incentive to bolster a business in the face of adversity.

“It’s not necessarily a conflict, it’s more of an alignment, which ultimately is better for the business,” Eapen said.

“If we are sitting in the equity and the debt, we’re not going to cut off our nose to spite our face. We’re not going to accelerate the debt portion just to have it destroy our equity value, if we can see this is a result of just the business cycle.”

“The benefit of this patient … capital is that it can look through a long term,” Eapen added. GSO’s funds operate over a typical 10 to 12-year period.

“A lot of businesses we do fund are industrial, cyclical businesses [that are] capital-intensive, asset-heavy, that could face the cycle. They come to us because our capital doesn’t look like that [of a] traditional lender; it has much more bandwidth to weather the amplitude of a business cycle, and if we’re in the equity, again we’re incentivised to make sure that that equity value continues to remain, and also grow.”

The strategy is gaining traction. Apollo Global Management is seeking $3 billion for a Hybrid Value Fund that will focus on focus on “capital solutions”, or senior and subordinated loans that often will have equity upside via warrants or participation rights; non-control investments in financially stressed or distressed businesses and structured equity, either control or non-control positions that would fund myriad transaction types, including growth capital and deleveraging deals.