Mid-market debt shortage yields opportunity

A dearth of available credit for lower mid-market businesses has attracted new debt vehicles, but fundraising remains difficult even for managers with strong track records.

In the smaller end of the US mid-market, a continued shortage of available debt has put a premium on groups that can lend to lower mid-market businesses.

With financial institutions no longer lending at levels close to the amount in the years leading up to the financial crisis, debt providers represent an even more crucial lifeline for smaller businesses, which has attracted new entrants to the lending market.

“There’s a lot of interest in our asset class right now, and that’s due to credit contraction, especially in the lower end of the middle market,” said Richard Wheelahan, director at CapitalSouth Partners, which provides private equity and mezzanine capital to lower mid-market companies.

Wheelahan was speaking on a panel at Mayer Brown’s credit symposium in New York on Tuesday.

“If you can deliver a 10 percent dividend to your limited partners per year, whether you’re a business development company or you’re distributing earnings to private LPs, there’s a lot of interest if you’ve got any sort of track record,” Wheelahan said. “So there are people piling into our [investment] class.”

One such group is TPG, which began raising a business development company targeting between $750 million and $1 billion to lend to mid-market companies in 2011. The vehicle, called TPG Specialty Lending, makes direct investments in senior secured and mezzanine loans, as well as equity of US mid-market companies. The vehicle targets companies with annual earnings before interest, income taxes, depreciation and amortisation of $10 million to $250 million.

Still, successfully transitioning into debt investing is no mean feat for private equity firms that previously haven’t raised debt funds.

“A lot of people talk about [new] debt funds, but I haven’t seen as much growth and I haven’t seen them be as successful as you might think,” Matt Posthuma, a partner at Mayer Brown told Private Equity International.

While the demand for returns from credit strategies is strong, fundraising remains difficult, even for established groups.

“There are managers who are pretty good who are having a hard time with their follow-on fundraises right now,” Wheelahan said, adding that the difficult fundraising environment is tied to “the resiliency of the [US] consumer.”

“Unemployment hasn’t done much in the way of improvement in the last 18 months,” he said. “As long as it doesn’t get any worse, we’ve sort of become accustomed to this very slow progression of unemployment and addition of jobs.”