Trends in PE financing — covenants are getting easier again
The financing of private equity transactions is becoming increasingly progressive. With interest rates extremely low, we are currently seeing leverage well in excess of 50%. In some cases, even 70% and above are achieved. The debt capacity of companies has increased sharply as a result of low interest rates — which has made banks more willing to lend a lot of debt capital if the assets are good. Covenants are also becoming increasingly ‘lighter’. Competition on the banking side seems to have increased considerably.
Whether company valuations are too high in individual cases certainly depends on the asset in question. However, as a result of high leverage and low interest rates, prices in the German market have picked up considerably. This, combined with the fact that few primaries and good assets are available, has once again driven prices up considerably. The danger for private equity investors to buy too expensively has definitely increased significantly. In the meantime, this market trend is also taking hold in other European countries, such as the U.K., whose economies have picked up again with a time lag and are now following suit. As a result, dropout rates are increasing sharply there as well. In France and Italy, the situation has been comparable with Germany for some time.
In fact, there are already many market participants who speak of a financing bubble. However, this does not only affect the banking side, but certainly also the equity side in private equity transactions. There is currently a considerable amount of liquidity in both the European and German markets. Also, many additional private equity funds have formed as part of spin-offs. Competitive pressure has therefore increased considerably. As long as companies generate stable earnings due to the good economic environment, this should not be a problem. However, a flattening of the economy and thus of the earnings situation of highly indebted companies could quickly lead to substantial defaults. In this respect, the situation is quite comparable with that before Lehman. Investors fear the so-called “Winner’s Curse”.
About Norton Rose Fulbright LLP
At our offices in Frankfurt, Hamburg and Munich, we advise national and international companies, credit institutions and private equity houses as well as medium-sized businesses in all relevant legal areas. We support clients from all over the world in their business activities in Germany and in Europe. With 150 lawyers in Germany, we combine the firm’s international strength with in-depth knowledge of the local legal market and assist our clients in domestic as well as cross-border transactions, projects and contentious disputes.
About Holger Scheer
Holger Scheer is a partner in the Corporate department in Frankfurt. He specializes in private equity and venture capital transactions as well as strategic and institutional joint ventures. In national and international transactions, Holger Scheer primarily advises Anglo-American strategic and institutional investors. His experience goes back to more than 130 transactions especially in leveraged buy-outs, venture and growth financings, joint ventures and restructurings in a variety of industries. His clients are large private equity firms, venture funds, investment banks and companies from various industrial sectors. There is particular sector expertise in technology companies, e‑commerce and digital entertainment.