June 03, 2024 | Read Online

HYH Interview - Anon Private Credit VP

Discussing Private Credit Financing and how to grow in your Private Credit Career

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Welcome Back!

I have an exciting interview for you guys.

I hopped on the phone with a Private Credit VP to talk about the mechanics of different types of private credit financings, as well as career advice for Associate level professionals trying to get promoted to VP.

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Let's get into the full interview piece below.

Note, for ease of reading I transcribed and condensed down our phone conversation into easy to follow notes.

Question 1: Let's Talk about Different Types of Private Credit Financing that you've focused on:

Fund financing traditionally uses subscription lines backed by capital calls, typically leveraged at 1:1. Lenders provide funds to a borrowing base, with an advance rate of 60-75%. If the dealer is not performing well, this poses a risk. Lending based on the Net Asset Value (NAV) is also common. General Partners (GPs) have huge portfolios they are looking to leverage, and these NAV Loan deals are typically done at a low Loan to Value (LTV) between 10%-30%, which is significantly lower than traditional private credit financing. This makes it cheaper to lend at the private equity (PE) level than at the corporate level. This offers potential exit liquidity for Limited Partners (LPs) and can inject capital into portfolio companies. Crestline is a major player in this space and so far, the market has shown good performance with limited workout situations. 17 Capital, which was sold to Oaktree, is also active in this area.

In terms of the private credit space in general, the largest firms are increasingly dominating. They're seeking new niches to explore, so entering fund financing aligns with the challenges sponsors face with fund maturities, providing a solution outside of secondary markets.

Opportunistic private credit can be a very hybrid mix of debt and equity. This could include being a recurring revenue lender, offering a mix of cash and payment-in-kind (PIK) interest, and including penny warrants and/or liquidation preference. Returns for older funds have been above 25%, while opportunistic targets range from 16%-18%, which is the middle of junior debt and equity return goals. This approach includes debtor-in-possession (DIP) financing depending on the right returns. Overall this offering can be very flexible and is particularly relevant in the current economic climate as coverage ratios in particular have been significantly hurt lately.

Asset-backed lending is growing, with firms like KKR, Ares, and Apollo getting involved, and seeing returns of 15%-20% when utilizing their own origination platforms in sectors like consumer and auto loans. Credit risk trades are also prevalent, with transactions like KKR buying RV loans from BMO, where BMO then becomes the senior lender, facilitating significant capital release. KKR can probably make a 18%-20% return through this capital release. Blackstone can probably make north of 15% on buying the receivables of Barclays credit cards. This type of financing is not intended as a loan-to-own strategy but aims to work in alignment with both sponsors and borrowers.

DIP financing is a component of special situations for some funds, especially when it can secure high fees and protections for backstop fees. Situations have arisen where the transition from cash interest to 100% PIK was necessary when a borrower was non-compliant with covenants. If PIK continues and the equity value becomes minimal, an out-of-court restructuring may be initiated, where, for example, 60% of the balance becomes newco debt and the remainder is converted to preferred equity with a liquidation preference.

The primary goal in private credit is to mitigate restructuring with actions like converting cash interest to PIK. Restructuring is a last resort, and out-of-court restructuring is generally less costly and preferred to an in-court filing.

In the area of recurring-revenue loans, companies with high retention rates and low churn, particularly in late-stage SaaS businesses, are targeted by private credit shops like Golub, for example. These companies, with enterprise values ranging from $200 million to $10 billion, have low attachment points in financing—typically 2.5x to 3x revenue multiples—allowing lenders to feel well-protected even if the enterprise value-to-revenue multiple falls to 5x-7x. Securitizing these businesses presents a substantial market opportunity, and firms have seen positive results given the low recurring revenue attachment points.

Question 2: How does one advance from Associate to VP?

Advancing from Associate (ASO) to Vice President (VP) involves transitioning from a supportive role to a leadership position. As an associate, you are responsible for execution and act more like a co-pilot, whereas the underwriting and presentation of deals are handled at the VP or Director level, who provide guidance and instruction. Although associates and analysts are primarily focused on execution and less on voicing opinions, senior associates begin to offer their views and decision-making insights, though not definitively. Your voice starts mattering, but you don't have 100% decision responsibility or the final word. As a VP, you become the focal point of the deal. To make this transition, you must demonstrate the ability to lead a deal from its inception to conclusion, manage relationships with borrowers, articulate and defend ideas effectively, and coordinate the entire process. This includes leading term sheet drafting, negotiating, performing in-depth due diligence, and managing communications with various parties including the investment committee and leadership. A VP must also establish the right structural safeguards to protect principal capital and take accountability for every step of the deal. This involves being able to explain why you want to draft docs in a certain way and being able to communicate effectively to lawyers.

Question 3: How do you learn to communicate with your MD/Director?

Effective communication with Managing Directors (MDs) or Directors can be fostered by first handling communications with external parties. Having some parts of the deal where you are the focal point provides training for managing and communicating more comprehensive responsibilities, like doing the full deal. It's all about the ability to manage expectations. If you set a deadline, hit it. If something is out of your control, you need to communicate what happened. Set realistic deadlines and meet them. You need to manage expectations on all sides of the deal; this is a key thing in order to go to the next role. If you say you'll send the term sheet by next week, then you need to do this by next week. Don't create frustrations on other parties. If you can execute faster then you can even outcompete someone even if pricing is tighter, just because you're a faster party to work with.

Question 4: How do you move from an individual contributor to a project manager?

(As a VP) don't step in and do someone's job just because you think you can do it. Let Associates do the Associate work. When giving the associates work, think "this is good enough, they're learning" and create that ability to delegate and coach that person. That's really important. You were there before - put yourself in their shoes and understand their needs and their role. When you delegate you can focus on the whole picture as opposed to specific strategic items. Delegating and asking "what's the task I should delegate vs what I should do?" is an important way to allocate time, this is crucial for efficient time management.

Question 5: How do you manage junior people?

Managing junior staff involves including them in processes from which they can learn and grow. When I was a junior, I was often excluded from some communications; therefore, it is important to CC junior resources on emails or involve them in calls. They can learn from conversations even if they're not talking. They'll be talking one day. This inclusion not only helps motivate them but also prepares them for future roles. It's vital to provide them with meaningful tasks and make them feel part of the team. Give them more than a repetitive task, let them know they're a part of something.

Question 6: How do you start to bring in deal flow and pivot to managing relationships/managing sponsors?

Developing deal flow and managing relationships is more of an art than a science.

The sponsor side is very tricky, some shops will do a bad deal to keep deal flow going, but i don't agree with that approach. One way to mitigate that is to take a bad deal to IC. Even if they kill it in IC and it's a pass at least it will show the Sponsor they tried at least.

It's important to have a relationship with management, whether it's a CFO or Controller or VP of Finance, it doesn't have to be just the CFO. That Controller or VP may get promoted in the company, or move into a different job. Creating different layers of relationships as things people and people change is an important way to build contacts.

Maintaining strong connections with bankers who can remember your diligence on deals can lead to more opportunities. We always try to do the work on deals with bankers we have good relationships with, we know eventually they'll bring us a good deal. They may remember us on competitive deals because you were the guy always trying to figure out something even on the bad deals. Showing interest even in long shots is a great way of developing relationships.

Question 7: What is the right balance between current deal flow and portfolio management?

Portfolio management is typically more of an associate-level responsibility, while VPs focus more on deal flow. Someone senior sits on the board from a PM level though. It's important to look to the future and figure out time management between managing the portfolio and working on a new deal. Random stops happen along the way, so you have to be ready for that. If it's a live deal you can always ask for help when conflicts come up. Overall, manage time wisely and manage expectations.

Question 8: How do you handle going into IC or early reads?

Entering IC meetings or presenting early reads is more of an art than a science. Focus on the major risk factors early in the evaluation process to determine if a deal is viable. Spending excessive time on the initial stages without addressing significant risks can be inefficient. If there is a high risk that could terminate the deal, address it first. Why spend 10 days on a deal if there's, for example, significant industry risk? Try to focus on what could kill the deal first, talk to someone with insight early on to flush out. Look at the key factors that could make the deal a no-go, if you get initial comfort THEN go take a deep dive. But if it's binary risk, then kill the deal immediately. There's always exceptions though (maybe it's a relationship deal).

Ending Thoughts:

Whatever role you're in - you need to prove you can do the next job in order to get the next job. Practice part of the next job, if they see you can execute and manage a relationship then that's a good start. If they show me they're not ready, then the VP can still take the task on and give them more time. But from my perspective, I try to give Associates more next level opportunities. If you can show what you can do then that's your opportunity to go get promoted. Always be proactive, always ask to help people. If you don't have the ability yet, always think about how you can improve and gain the ability you're lacking. Learn from senior ppl and scale into doing that yourself. You have to have a form of self learning - self reflect and if you can try to find some coaching internally. Some shops may not have that coaching, which is why I wanted to talk to the newsletter audience and help.

That's all for this edition. I really appreciate that closing remark about providing coaching. I think this will really help the people who don't have internal coaching and provides a lot of transparency in a relatively bespoke industry.

If there's any other types of investment professionals that you can want to see me interview, let me know!

Until next time!

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