The Appeal of Flexible Capital Solutions

Companies always need capital. But depending on their needs and the economic environment, they are increasingly seeking new types of solutions.
Flexible capital solutions span the middle ground between debt and equity and can be customized to meet a company’s specific needs.
For investors, these opportunities combine the essential elements of both debt and equity in a hybrid, tailored investment structure with a focus on strong downside mitigation, along with upside potential tied to equity performance.

Introduction

Markets and economies move up and down. But no matter where they are in the cycle, companies will always need capital—whether it’s to spur growth, shore up their defenses or access liquidity to support their corporate initiatives (see Figure 1).

Since the global financial crisis, it has been more difficult for companies to access traditional forms of capital. And while the private markets increasingly have filled the void, flexible capital solutions have emerged as a strong alternative for companies with specific needs.

Flexible capital is a global, all-weather solution that sits between private credit and private equity. The key is customization: A company teams up with a strategic partner who provides alternative sources of capital to help execute its vision.

For investors, it combines the essential elements of both debt and equity in a hybrid, tailored investment structure with a focus on strong downside protection, along with upside potential tied to equity performance.

Figure 1: Flexible Solutions Across Economic Cycles

Traditional Capital Sources Are Falling Short

Since late 2021, the cost of issuing both equity and debt have increased. This has led to a significant decrease in capital issuances.

In the U.S., for example, financial conditions have tightened dramatically following the Federal Reserve’s determined effort to curb elevated inflation. The more tentative mood in credit markets can be seen in both high-yield corporate bond issuances and leveraged loan issuances. Combined, they have slid to the lowest level since the financial crisis (see Figure 2). Meanwhile, the increased cost of capital has translated directly into lower equity valuations, and by extension, a weaker IPO market.¹

Figure 3: Private Debt Capital Has Grown to the Size of the Institutional Loan Market

AUM by region (bil. $)

Source: Preqin and BofA Global Research

Finding a Middle Ground Between Debt and Equity

Structured capital solutions span the middle ground between debt and equity (see Figure 4). And because they are customized through a negotiation process, each structured capital solution is unique.

Finding a Middle Ground Between Debt and Equity

Structured capital solutions span the middle ground between debt and equity (see Figure 3). And because they are customized through a negotiation process, each structured capital solution is unique.

Figure 4: Solutions Along the Debt-to-Equity Spectrum

The Opportunity Set Is Wide

Today, structured capital solutions are essentially another capital source for both public and private companies to choose from. But importantly, they are more flexible than other options. They can:

Maximize flexibility within a capital structure—and stabilize or repair a company’s balance sheet
Provide growth capital to support a large strategic acquisition or a roll-up type acquisition strategy, or to provide development capital
Supply access to capital, especially where “blunt” instruments, like high yield bonds, leveraged loans or equity issuance, might not be the best option
Limit the cost of capital and dilution for public companies that want to grow or acquire other businesses, but don’t want to take on more debt or issue more common equity
Allow a company to gain a strategic partner—who can assist with operations, acquisitions, capital markets, etc.—while still maintaining control

As a result, structured capital solutions appeal to a wide variety of companies. These can include private, founder- or management-owned businesses that want to maintain control and upside, private-equity-backed companies where the sponsor is looking for access to incremental capital, and more.

Today, we see opportunities to provide flexible capital in several industries. Take the global healthcare services sector, which at $8 trillion is roughly equivalent to 33% of U.S. GDP. For higher growth, higher quality healthcare businesses, valuations can be in the mid- to high-teens—around 16x EV/EBITDA, for example. Many private equity sponsors like to put a good amount of leverage on businesses, but they will probably only get six turns of leverage from the banks (i.e., 6x debt/EBITDA). Thus, while a sponsor might view this flexible and strategic capital as relatively expensive, it also knows that high-quality healthcare businesses tend to grow and accrete value at a rate that would exceed this cost of this capital. In addition to the strategic value this capital partner might bring, the sponsor creates accretive leverage.

Aviation is another sector that could benefit from flexible capital. This sector, where private equity has historically been involved, should grow at a GDP-plus type rate. However, as a result of challenges caused by the pandemic, flight activity has been delayed, and world daily flights are still not back to 2019 levels (see Figure 5). With some players in the aviation space facing significant debt maturities in the next few years, flexible capital could be an option to fill a funding gap.

Providing Meaningful Capital—With Protective Features

Flexible capital offers an attractive solution for companies and investors alike—and expands the universe of solutions across private debt and private equity.

More than ever, companies are looking for meaningful capital and partnership, without having to take on more debt or dilute their equity ownership. As corporate boards and management teams become more sophisticated and comfortable with assessing possible financing options, more are seeking out new types of solutions.

For investors, flexible and strategic capital solutions cover an attractive middle ground between debt and equity. Since part or all of the return is contractual, these investments can include downside protection with more upside exposure than traditional debt. And since these transactions are often highly negotiated, the inclusion of other protective features—like board seats or consent rights—only enhances the appeal of the asset class. Capital providers can assist in influencing a company’s overall strategy without taking full control—and help drive great outcomes.

Providing Meaningful Capital—With Protective Features

Flexible capital offers an attractive solution for companies and investors alike—and expands the universe of solutions across private credit and private equity.

Companies today are looking for meaningful capital and partnership, without having to take on more debt or dilute their equity ownership. As corporate boards and management teams become more sophisticated and comfortable with assessing possible financing options, more are seeking out new types of solutions.

For the investor, flexible and strategic capital solutions cover an attractive middle ground between debt and equity. Since part or all of the return is contractual, these investments can include downside protection with more upside exposure than traditional debt. And since these transactions are often highly negotiated, the inclusion of other protective features—like board seats or consent rights—only enhances the appeal of the asset class to investors. Capital providers can assist in influencing a company’s overall strategy without taking full control—and help drive great outcomes.

^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. 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.}

^Endnotes:

^{1. Goldman Sachs, “2023 U.S. Equity Outlook: Paradise Lost,” November 21, 2022.

2. BofA Global Research, “The present and future of Private Debt,” October 24, 2022.

3. Bernstein Research, “Commercial Aircraft: Airline traffic recovery…,” November 29, 2022.}

Brookfield

The Appeal of Flexible Capital Solutions

Key Takeaways:

Introduction

Markets and economies move up and down. But no matter where they are in the cycle, companies will always need capital—whether it’s to spur growth, shore up their defenses or access liquidity to support their corporate initiatives (see Figure 1).

Figure 1: Flexible Solutions Across Economic Cycles

Traditional Capital Sources Are Falling Short

Since late 2021, the cost of issuing both equity and debt have increased. This has led to a significant decrease in capital issuances.

More Companies Are Turning to Alternative Solutions

One alternative is the private credit, or private debt, market. Accounting for $1.2 trillion of capital globally, the private debt market now matches the sizes of the leveraged loan and high yield markets (see Figure 3).

Figure 3: Private Debt Capital Has Grown to the Size of the Institutional Loan Market

Finding a Middle Ground Between Debt and Equity

Structured capital solutions span the middle ground between debt and equity (see Figure 4). And because they are customized through a negotiation process, each structured capital solution is unique.

Finding a Middle Ground Between Debt and Equity

Figure 4: Solutions Along the Debt-to-Equity Spectrum

The Opportunity Set Is Wide

Today, structured capital solutions are essentially another capital source for both public and private companies to choose from. But importantly, they are more flexible than other options. They can:

Providing Meaningful Capital—With Protective Features

Flexible capital offers an attractive solution for companies and investors alike—and expands the universe of solutions across private debt and private equity.

Providing Meaningful Capital—With Protective Features

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