Strategic Non-Control Capital: An Attractive, Growing Asset Class

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Introduction

The Covid-19 pandemic has accelerated demand for capital solutions that help businesses achieve their corporate objectives and align themselves with a strategic equity partner, without relinquishing control. We believe providing flexible capital and strategic partnership without taking control represents a unique and growing opportunity in private and public markets.

 

Demand for Non-Control Capital Is On the Rise

A significant funding shift is underway. Businesses are increasingly seeking capital by pursuing partnerships with sophisticated investors through non-control equity and equity-linked solutions. This form of funding requires no change of ownership, allowing companies to retain control of their businesses while avoiding additional strains on their balance sheets. Owners and management teams are seeking capital to grow their companies, surface value in strategic operating segments and/or stabilize operations, while not leveraging or exiting their business. The non-control capital being sought can be offensive in nature, with businesses seeking financing to help spur growth, or it can be more defensive, with businesses seeking stabilization or rescue capital. 

We believe this trend represents a significant opportunity for investors to provide capital at scale to a growing set of high-quality businesses. We have found that a considerable capital void exists for businesses that are seeking flexible and creative capital solutions while also not wanting to cede ownership of their business through a buyout or risk financial stress by adding debt. Traditional capital markets may not match the scale or customization required in these cases. Companies seeking this form of capital want to maintain control and gain a strategic partner who is aligned with their goals, without taking on restrictions of additional leverage. We believe this opportunity in providing non-controlling strategic capital stakes is large and growing.

Demand for Non-Control Capital Comes in Various Forms

Strong companies are looking for strategic capital to help them take advantage of the dislocation in their markets, while weaker earnings and uncertainty are necessitating others to strengthen their balance sheets. Revenue and earnings per share for S&P 500 companies came in far lower in 2020 than a year earlier, marking a significant deviation from strong growth trends over the 10 years since the Global Financial Crisis (GFC).

While earnings continue to grow, leverage levels remain elevated, requiring companies to decide how to continue funding their strategic objectives (see Figure 1). One well-established option is to sell equity via controlling stakes or meaningful minority stakes. Another is to continue taking on inexpensive debt—which runs the risk of constraining a company’s balance sheet.

Figure 1: The Lockdown's Impact on Revenues and Earnings in 2020 Created Liquidity Pressures That We Believe Will Persist

Figure 1 Projected Covid-19 Impact on Revenue and Earnings per Share
Figure1 Russell 2000 Net Debt to EBITDA
Source: Bloomberg

A compelling alternative, however, is to sell hybrid securities—which offer investors some downside protection while allowing companies to achieve their valuation aspirations and also gain a partner aligned with their strategic vision, as outlined below:

Strategic Vision - Strategic Non-Control Capital
Value-Add Partnership Is an Enduring Opportunity

The demand for non-controlling capital today is coming from companies that have growth opportunities and require capital to pursue them, as well as from companies that have been negatively impacted from Covid-19 lockdowns and are no longer able to access capital markets efficiently. 

We see corporate demand for this type of capital continuing and growing from here, with capital markets generally struggling to keep pace (see Figure 2).

Figure 2: Businesses in Every Economic Environment Need Flexible Capital From a Strategic Partner

Figure 2 Businesses in Every Economic Environment Need Flexible Capital From a Strategic Partner
Strategic-Non-Control-Bridge
Deep Dive: The Opportunity in Taking Minority Stakes 

We see a particularly compelling opportunity in providing flexible capital to predominantly healthy companies seeking bespoke financing solutions—without requiring the businesses to cede ownership. This opportunity involves delivering attractive, large-scale capital solutions to high-quality companies needing fresh equity for growth or help in upcoming development obligations due to a lack of capital markets access. 

These firms either cannot access the public markets efficiently, or they choose not to. Instead of overleveraging themselves, they seek a strategic partner who can assume an active role in solving their complex capital needs. They can do so with non-control equity and equity-linked solutions that involve taking a minority stake and less aggressive equity upside in exchange for more protections, such as preference securities and credit-like downside protection. By shaping the financing solution and adding value to the business, the strategic partner should help drive returns for the entire equity ownership.

Similarly, we see the need for this type of capital with companies that must recapitalize because they are strained and overleveraged (see Figure 3).

Figure 3: We See Opportunity Across Multiple Industries and Market Segments

Figure 3 We See Opportunity Across Multiple Industries and Market Segments.png

We differentiate non-control equity from typical private equity and private debt investments (see Figure 4).

Figure 4: Providing Non-Control Capital Is Different Than Traditional Private Equity or Private Credit

Figure 4 Providing Non-Control Capital is Different than Traditional Private Equity or Private Credit

We differentiate non-control equity from typical private equity and private debt investments (see Figure 4).

Non-control equity, and equity-linked investments, can provide investors with private-equity-like returns, but with added downside protections characteristic of private credit investments. These protections arise from the structured nature of the investment, with its priority preference in the capital stack, as well as its potential governance and liquidity rights. Governance rights can include board representation and consent/veto rights, and frequently also include financial covenants or step-in rights that allow investors to maintain influence through control-like enhancements in an otherwise non-control investment. There also can be significant downside protection from a value standpoint, given that these investments tend to have lower buy-in multiples than a common equity investment.

Influencing the Outcomes for Companies—and Investors

Non-control equity does not mean no influence. Rather, the opportunity is in securing preferential positions in a company’s capital structure and structuring transactions with bespoke features that bring significant influence, allowing the strategic partner to potentially boost the value of the company with limited economic downside to investors. 

These types of deals can be pooled together in funds that aim to provide attractive internal rates of return for investors, given the lack of a control premium and the value-add offered by capital providers in the form of strategic and operational expertise. Importantly, we do not see non-control equity as a replacement for income opportunities in a portfolio. Rather, we believe it should be considered as part of the private equity, opportunistic or general alternatives portion of a portfolio. We view it as a way to diversify within alternative investment allocations.

Disclosures 

This commentary and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This commentary discusses broad market, industry or sector trends, or other general economic or market conditions and is being provided on a confidential basis. It is not intended to provide an overview of the terms applicable to any products sponsored by Brookfield Asset Management Inc. and its affiliates (together, "Brookfield"). 

This commentary contains information and views as of the date indicated and such information and views are subject to change without notice. Certain of the information provided herein has been prepared based on Brookfield's internal research and certain information is based on various assumptions made by Brookfield, any of which may prove to be incorrect. Brookfield may have not verified (and disclaims any obligation to verify) the accuracy or completeness of any information included herein including information that has been provided by third parties and you cannot rely on Brookfield as having verified such information. The information provided herein reflects Brookfield's perspectives and beliefs. 

Investors should consult with their advisors prior to making an investment in any fund or program, including a Brookfield-sponsored fund or program.