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.