A life cycle approach to private equity financing: What sponsors and lenders need to know

Establish lender relationships early (and have a plan)

Lender relationships are crucial to the success of any financing structure and become even more critical over time. Before entering into a transaction, parties should consider the following:

• The deal life cycle extends beyond closing. Financing terms are not static, and most borrowers will need to re-engage lenders to address evolving business needs. A collaborative, solutions-oriented approach at origination can promote more constructive discussions later.
• Private credit is a relationship-driven market. Lenders often place significant value on repeat business and may offer more flexibility around economics or terms when a strong sponsor relationship exists.
• Early engagement in stressed situations is critical. Companies that approach lenders proactively, including before liquidity becomes constrained, are better positioned to preserve adaptability, maintain available options, and pursue a consensual solution.
• Preparation fosters credibility. Engagement is most effective when paired with a clear plan, including a defined ask, and alignment among key stakeholders and advisors.

Embrace versatility in deal structures and capital solutions

Structuring decisions at origination should account for both current needs and future uncertainty. To ensure that they do:

• Focus on durability, not just optimization. Overleveraging a business can constrain flexibility, particularly in downside scenarios. Financing structures for portfolio companies should reflect existing leverage and realistic cash flow expectations while capital solutions should be determined on a case-by-case basis.
• Ask what could go wrong. Evaluating potential stress points at the outset of a capital structure can help avoid constraints if performance weakens.
• Maintain your flexibility post-closing. A measured approach at closing, combined with the ability to amend terms as performance evolves, can be more effective than over-engineering a structure upfront.
• Don’t forget about broader capital solutions. Private credit markets are increasingly appealing to borrowers because of their ability to adapt terms and offer solutions beyond traditional senior debt, including hybrid capital and other capital solutions, such as:
  • Mezzanine facilities
  • Preferred equity
  • Holdco payment-in-kind facilities
  • First-in-last-out structures
• Make sure refinancings are purpose driven. Leverage headroom should not be the sole factor when a refinancing is being considered. Refinancings are often most effective for portfolio companies when they are tied to an objective, such as extending runway to achieve a set goal or taking advantage of more favorable credit terms under improved market conditions.

Take lender considerations into account when underwriting a deal

Both lenders and sponsors are placing increased emphasis on execution capability and downside resilience. Lenders tend to focus on sectors where they have the most experience, which can influence underwriting decisions. Notably:

• Focus on underwriting factors. Core underwriting factors remain consistent, including deal structure and pricing, sector dynamics and investment outlook, and scalability and growth potential.
• Be attentive to execution risks. When it comes to execution risk, the strength of the sponsor and management team – and their ability to deliver on the business plan – is a top consideration.
• Plan and be transparent. Lenders will want clarity on liquidity, free cash flow, covenant cushion, sponsor equity support, and add-on acquisition strategy.

Identify the root cause of stressed and distressed situations

Challenges may arise from excess leverage, operational underperformance, management issues, regulatory disruption, or broader macroeconomic headwinds. When performance declines, early action and accurate diagnosis are critical to preserving value:

• Distinguish between liquidity and operational issues. The best response may range from a targeted capital infusion to broader operational changes, asset sales, or a full restructuring.
• Know that out-of-court solutions are preferred. Lenders and borrowers generally prefer out-of-court solutions to avoid the costs, delays, and uncertainty that surround a Chapter 11 bankruptcy filing.
• Note that these solutions have limits, however. Holdouts, exchange mechanics, and legacy liabilities such as lease, environmental, or mass tort exposure can still make a Chapter 11 filing the more effective tool in extreme situations.

Acknowledge lender priorities in downside scenarios

As situations become more challenging, lender focus tends to shift. When performance deteriorates, lenders typically look for increased transparency, sponsor support, improved visibility, and greater control. Lenders may also seek:

• New money and capital support, such as additional liquidity, enhanced collateral, or other forms of credit support, such as sponsor guarantees or capital-call agreements.
• Enhanced governance, which may include appointing a chief restructuring officer or similar independent fiduciary and obtaining outside financial advisor oversight.

Lenders will also turn their attention to documentary rights, collateral protection, and potential enforcement actions.

Conclusion

Both private equity sponsors and lenders are increasingly required to take a life cycle approach to financing that integrates origination strategy with restructuring preparedness.

Strong lender relationships, flexible capital structures, disciplined underwriting, and early engagement in stressed situations are key to navigating the current landscape. While each situation is different, a proactive and well-informed strategy can expand available options, facilitate constructive stakeholder engagement, and help preserve value across a range of market conditions.