We are committed to the lower mid-market.

We launched our direct lending platform in 2010 owing to the tremendous opportunity we saw backing companies generating EBITDA between €3m to €25m+ as traditional banks stepped back from these growing businesses in the wake of the GFC. It was an area we already had experience in, having supported a number of businesses in the space in the years prior. Working with entrepreneurial management and trusted financial sponsors we crafted bespoke structures for their deals, willing to back the high potential others had shied away from.

Where others said ‘why?’, we said ‘why not?’

Our exclusive focus on the lower mid-market from a single team with a strategy of holding to maturity helped to differentiate us from a growing number of private debt funds that entered the market in the post-GFC years. This led to our long-term partnership approach, supporting businesses in growth rather than on a purely transactional basis. This franchise approach helped us to develop strong trust-based relationships with management teams and sponsors alike.

The risk-adjusted returns are very attractive too for those with established sourcing channels and the ability to invest the time required in this high-volume end of the market. Investec has generated high single-digit unlevered returns with average leverage less than 3.5x across our 12 year track record, pointing to a clear illiquidity premium as well as highlighting our reputation among not just sponsors but the advisory community as lenders that do things a bit differently. With no distraction from larger (and typically more intermediary-led) segments, we have remained committed to our investment strategy, backing growth businesses with clear downside protections.

Reputation matters, especially in a large and growing market.

Private debt now represents the third largest private capital asset class globally, and Europe’s piece of it accounts for over a quarter of global AuM¹. This growth – set to continue at CAGR of 17% through 2026² – illustrates the attractiveness of the segment, and it also reminds us we need to continue to stand out by virtue of our knowledge, expertise and our focus on capital preservation.

Our current portfolio of over 130 growth businesses has given us a significant borrower base for future deployment, with 60% of investments in our first fund supported with repeat funding. These deep and valued borrower partners typically value service over price as they often look to bolt-on acquisitions, and that supports a strong pipeline of high-quality lending opportunities. This matters now more than ever as sponsors extend hold periods.

Lower mid-market companies are typically more insulated to capital markets than their larger counterparts.

This is a boon for our forward-looking pipeline. There are lots of businesses seeking capital too – over 80% of the market volume comes from transactions with an EV of less than €100m³. That this high-growth market is underserved by the larger debt capital market and direct lending competitors with large funds creates attractive competitive dynamics for differentiated lenders like Investec.

Our current portfolio of over 130 growth businesses has given us a significant borrower base for future deployment, with 60% of investments in our first fund supported with repeat funding.

While the private debt market is growing, the lower mid-market remains underpenetrated. 

We know this because we have invested over €8bn across 200 unique investments since 2010, and remain as committed as ever: many financiers, whether equity sponsors or lenders, have moved upstream, sometimes following the teams they’ve backed previously, sometimes focused on AuM and fee growth.

While larger investments might be easier to deploy and entail a lower acquisition cost, we feel the intermediation at that end of the market can erode the benefits of private debt investing – namely reduced spread, higher leverage and less attractive terms. In our sweet spot, lower competition combined with ongoing high deal volumes support our focus of underwriting the highest quality borrowers at the optimal risk-return profile. This puts us in a strong position to provide tailored solutions rather than be price takers. 

Growing businesses lend themselves to an evolving credit underwriting profile. 

We believe that senior lending and unitranche co-exist, and this allows our portfolio construction to move from senior to unitranche as the business grows and our knowledge of the business deepens. What this means in action is that we often re-underwrite a credit multiple times across the investment period as they grow. It means the legwork we put in on day one to understand the business when it is at its riskiest pays dividends – sometimes literally. This “credit picking” means we can retain business and grow as the business grows, yet with less additional legwork and substantially less risk. It allows us to achieve similar IRRs over the investment term to more mandate-constrained peers, who typically solve for yield first. This is a great competitive advantage for us in this market. 

We don’t just invest across cycles, we preserve across them, too. 

Risk is a given when funding to growing businesses in the lower mid-market, but we mitigate this by our dedication to this market segment and by prioritising capital preservation. By nature, these borrowers are not one-size-fits-all and therefore we avoid “market terms”, preferring more crafted finance solutions that optimise the strategic growth plans of the borrower and the downside controls of our investment. We do this via a disciplined focus on conservative portfolio leverage and high single-digit unlevered returns, highlighting our ability to harness alpha and an illiquidity premium in the investment class. This is mutually beneficial, as our portfolio is robust and in a strong position to grasp the opportunities of today’s backdrop.

What next? 

The lower mid-market continues to provide tremendous opportunities for those willing to understand the dynamics of ambitious and fast-growing businesses. We remain fully focused on continuing to address these opportunities and to be a leader in this exciting market segment.

References

¹ Deloitte Alternative Lender Deal Tracker Report, Autumn 2021.
² Deloitte Alternative Lender Deal Tracker Report, Spring 2022.
³ Centre for Management Buyout Research (“CMBOR”) Data. 2020.