Private credit firms are stepping up to provide staple financing to help facilitate private equity deals amid a sluggish M&A market, encroaching on an area dominated by banks.

After record levels of private equity activity in 2021, buyout activity fell down to earth two years ago as credit markets locked up and companies struggled under high inflation and geopolitical risk – limiting financial sponsors’ ability to secure committed financing they rely on to complete deals. Annual buyout activity by deal value in North America fell by more than 50% to USD 220bn last year from USD 516bn in 2021, according to Dealogic data.

Staple financing – debt arranged by a seller’s advisors prior to the launch of a sale and available to all potential bidders – is now becoming more common to help facilitate transactions, said Augusto Sasso, global head of capital markets at Moelis. Private credit firms, eager to put dry powder to work, are often the lenders.

Staples have long been the domain of large investment banks able to shoulder balance sheet risk and eager to collect fees advising a seller and financing a buyer on a single transaction. Banks in recent years though have become more conservative on the terms they offer financial sponsors for committed financing.

PE buyers are asking for more leverage than banks are willing to provide, Sasso said. To stay relevant, some banks are allowing private credit firms to provide junior capital as part of the staple, bumping up the overall leverage.

“If somebody doesn’t come up with the rest of the credit in the credit stack to make the deal work, the deal might never happen,” Sasso said. “So, everyone is incentivized to be creative.”

Private credit firms are eager to step in and show a financing package ahead of time as there are fewer opportunities to provide debt for a buyout, said Carolyn Hastings, a partner in Bain Capital Credit’s private credit group. Private credit firms such as Golub Capital and Crescent Direct Lending have advertised their willingness to provide staple financing for private equity firms on their websites.

“[Private lenders] are highly focused on defending their portfolio, and maintaining their incumbencies,” Hastings said. “If one of your borrowers has performed well… staple financing is a great way to prevent that deal from churning out of your portfolio.”

In a recent deal where Bain provided staple financing, the sponsor and M&A banker agreed not to have the bidders reach out to other lenders until the very end of the process because the initial financing package was priced competitively, Hastings said. After a cursory check with the market, Bain ultimately won the mandate and expanded its exposure to the borrower by taking out one of its prior co-lenders, she said.

The phenomenon can be seen downmarket as well in the core and lower middle market, said Matt Plooster, co-founder and CEO of investment bank Bridgepoint. Regional banks are not as active as they have been in prior years and private credit has an opportunity to step in.

Bridgepoint completed a deal around six months ago where the incumbent bank lender “went out and found a [mezzanine] shop” to put together a staple, Plooster said. The bank needed the private credit partner to provide a competitive staple package and maintain the relationship with its existing borrower, he said.

Adding staple financing to a deal shows prospective buyers that there are financing options available in the market and what the going rate is, Sasso said. The buyers can later decide if they want to stick with this initial financing package or find their own debt package. With so few M&A deals closing these days, all parties are incentivized to understand what the financing market can support, he said.

It helps the private equity seller and banker confirm that there is a lender willing to provide, for example, 5x EBITDA leverage, Hastings said. Getting that leverage and pricing read allows sellers to estimate what their asset will price at on the market. For potential buyers, staple financing allows them to prioritize due diligence as they can always shop the staple term sheet to other lenders toward the end of the process, she said.