Debt and Hybrid-Debt Options in the Current Market

As sentiment in the growth financing market has reset this year there is one consistent topic on the agenda with our clients. Debt and hybrid-debt options with low equity dilution have always been an attractive funding source when business valuations come under downwards pressure. However in this cycle, the retrenchment of equity providers has coincided with a coming of age for venture and growth lending in the UK as the available pool of this type of funding continues to deepen.

HMT has advised on two transactions in as many months for high-growth businesses (Chorus and Cirrus), securing debt structures to support continued organic growth strategies and for acquisitions, avoiding the need for costly equity raises or premature business sales. As the appetite to fund long periods of cash-burn dissipated towards the end of last year, the readjustment of 2023 business plans to bring profitability sooner has played into the hands of venture and growth lending appetite. Often used interchangeably as comprehensive terms, this type of financing steps outsides traditional bank lending policies and advances funding to fast-scaling firms that are often suppressing their profitability through a period of growth investment.

We have seen more variety in terms and structures emerging from this part of the market as the number of new credit funds targeting it has increased. Negotiations typically centre around financial covenants, amortisation profiles and the all-in economics for the lender. Interestingly a number of these funds continue to offer fixed interest rate loans in low double-digits resulting in a narrowing differential in the debt service costs versus the base rate + margin pricing from bank lenders.

Whereas in the past these loans may have been used to bridge to another equity round, the principle use of funds now is to bridge to self-sufficiency. Funds that provide time to execute the transition to profitability through more conservative growth plan prevents a costly equity “down-round” or a premature exit sale of the business.

The prospect of turning the tables in a subdued valuation environment and making acquisitions is also at play. Whilst lenders are more cautious, where identified targets are logical additions and the team has the bandwidth and experience to integrate them, appetite does exist to fund purchases with sensible deal economics.

Often a secondary consideration in the buoyant fundraising market of the last few years, the evolving debt market is providing more optionality for business owners than before. Engaging an advisor with a holistic approach and a live experience of the options is key to ensuring you make the right long term decisions for the business and shareholders through the market disruption this year.

Article written by Jack Longden – Director at HMT LLP


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