Institutional investors are combing through the private credit market searching both for higher returns and experienced managers to deliver those returns. The key to understanding why some firms are targeting higher yield investments is to also appreciate the kind of credit risks those managers are taking to achieve those yields.
In this special series, we’ll review various major categories of business characteristics and how veteran underwriters analyze where companies fall on the risk spectrum. We hope to help investors better understand the implications of stretching for yield.
Management experience – This is the most critical element of corporate risk. It’s a serious misunderstanding of the role of private equity to think that sponsors manage portfolio companies. As one managing partner told us, “That’s what we hire management teams to do. We spend more time getting the right people in place than any other issue.” Having the wrong C-suite members can destroy enterprise value faster than any exogenous factor.
It’s also key to any successful growth strategy. Management needs to understand how to steer companies through product extensions, expansions into different markets, and respond to unexpected competitive challenges. Sponsors often turn to executives with whom they’ve enjoyed past portfolio company successes to run new investments.
Integration risk –