Private Credit an Emerging Opportunity for Latam Companies

Continuing our series of articles on unconventional financing alternatives for companies in Latin America, we would like to discuss private credit (also referred to as direct lending, subordinated debt, mezzanine, among others). Private credit has emerged as a dynamic alternative to traditional bank lending. While both alternatives serve the purpose of financing businesses, private credit distinguishes itself through its unique characteristics and flexibility for borrowers.

Private credit refers to debt financing provided by non-banking financial institutions, such as private equity firms, hedge funds and specialized lending platforms. These lenders extend credit to borrowers, ranging from small and medium-sized enterprises (SMEs) to large corporations. Unlike traditional bank lending, private credit is typically not subject to the same stringent regulations, allowing for greater flexibility in its terms and structure.

In environments where banks tighten their lending standards due to uncertainty and increased general economic risk, private credit funds step in as an alternative to cover the demand for credit by companies. Institutional investors provide most of the resources for the funds focused on this alternative.

The private credit option is widely available and common for companies in the United States and, more recently, this alternative is available to Latin American businesses.

According to an article by Goldman Sachs (October 2022): “Much of the growth in demand for private credit solutions, however, has been driven by the unique value proposition that private lenders can offer borrowers. Private lenders are becoming preferred financing partners due to their sophistication, flexibility, certainty of execution, and the critical support they can offer to borrowers in challenging environments, as evidenced most recently through the COVID-19 pandemic. Some strategies also focus on assets or structures too complex for typical traditional lenders to underwrite, relying on complex approaches to properly evaluate and manage risks.”

Some of the main differences with traditional bank credit include:

• Less Stringent Requirements: Bank loans often involve a rigorous screening process, requiring extensive documentation, high credit scores, and collateral. Private credit, on the other hand, may be more lenient with requirements, making it accessible to a broader range of borrowers who might not meet traditional bank standards.

• Customization and Flexibility: Private credit offers borrowers a more tailored approach to their financing needs. Lenders have the flexibility to craft unique loan structures and terms that suit the specific requirements of the borrower, enabling a more personalized borrowing experience versus one size-fits-all loans typically offered by commercial banks.

• Speed of Execution: Banks typically have complex decision-making processes, leading to longer approval times. Private credit providers are known for their agility and faster decision-making, allowing borrowers to access funds more quickly, which can be crucial for time-sensitive opportunities.

• Cash Flow and/or Asset-Based Lending: While banks may focus heavily on a borrower's creditworthiness, private credit lenders often emphasize cash flow and/or asset-based lending. This means they may be more willing to provide financing based on a sound business plan (unsecured) and the value of tangible assets, rather than solely relying on credit history.

Private credit generally has a higher cost than traditional bank loans. However, when companies do not have the capacity for traditional bank indebtedness or have collateral limitations to apply for these credits, private credit is a viable and flexible option compared to obtaining new equity from third-party investors. Since the equity alternative can be more expensive and complex (shareholder agreement, company valuation negotiation, exit and liquidity clauses, participation in the board of directors and corporate decisions, among others), private credit could be a good option and provide a lower cost of capital than equity.

Private credit providers target a wide range of borrowers, with funds specializing on lower- or higher risk borrowers, including companies that might have difficulty obtaining loans from traditional banks. This includes businesses with unconventional financial situations and financial stress. Private credit allows borrowers to negotiate more flexible repayment terms and covenants compared to standard bank loans. This can provide borrowers with greater operational freedom and strategic maneuverability.

Private credit lenders often have a higher risk tolerance, leading to innovative financing solutions that may not be available through traditional banks. This can be beneficial for borrowers with complex financing needs.

Private credit has emerged as a compelling alternative to traditional bank lending, offering diverse borrowing opportunities, flexibility, and customized solutions. For borrowers who may not fit the traditional banking mold or seek innovative financing structures, private credit represents an appealing and accessible option to meet their financial requirements. However, borrowers should carefully evaluate the terms and costs of private credit to ensure it aligns with their long-term financial objectives. With the support of experienced and specialized advisers, this alternative may be convenient for some companies in the region.