Structured flexible capital: Beyond traditional debt and equity

Macroeconomic headwinds have impacted capital inflows globally and in India as well. Access to traditional sources of capital has tightened, inflation has largely been near the higher end of the Reserve Bank of India’s (RBI’s) target range and interest rates have been raised by 250 basis points, in line with global trends. Rising interest rates have created cash flow pressure for companies with a focus on debt repayment, and increased borrowing costs.
 

The BSE 100 is at an all-time high due to increased fund flows into the Indian equity market. Inflows to Indian equity mutual funds jumped 31 per cent sequentially to $2.5 billion in March 2023 buoyed by strong retail participation. However, public market premiums in valuations don’t necessarily translate into similar valuations in private equity and strategic sales. For business owners, the valuation mismatch between private and public markets has been a challenge. Founders are unable to get public market-like valuations in private equity or through strategic sales.
 

This has created a catch-22 situation for many companies and founders looking to raise capital. High-yield debt markets have limited depth in India and founders don’t want to be seen taking on expensive debt, which is perceived as a sign of stress. Founders are often looking for capital with certain debt-like features but are keen to ensure this is not classified as debt for accounting or rating purposes.  
 

Founders may also be reluctant to dilute equity at the current valuation, which may not reflect future growth that investors are unable to value today or the valuation may be suppressed by temporary headwinds facing the sector. Many times, founders seek equity-like capital, with the access and reputation that a strong partner brings, but without losing control of their business, which they have built over years or generations.
 

Opportunity for structured capital solutions
 

Increasingly, founders are turning to flexible structured capital for their capital requirements as they realise the unique benefits this can deliver. Flexible capital is a global, all-weather strategy that sits between private credit and private equity. The key is customisation: A company teams up with a strategic partner who provides a bespoke capital solution to help execute its vision.

It combines elements of both debt and equity in a hybrid, tailored investment structure with a focus on strong downside protection, and upside potential tied to equity performance. Globally, it is a well-established strategy, which is on its way to becoming a major segment within alternative assets in India.
 

Structured flexible capital solutions are constructed to give you the best of both worlds. Private credit funds can provide capital at scale. However, it is typically a more standardised product where companies are less likely to gain strategically from the relationship beyond capital access. On the other hand, founders can get a traditional private equity partner, which may involve giving up substantial control of their business and strategy. With a structured, flexible solution, a founder can access an experienced global private equity firm, which addresses concerns around valuation or dilution but also ensures the firm works as a strategic partner, helping the business to organise and grow. It’s a compelling proposition where the founder maintains control and keeps the majority of the upside created from the value added with the private equity partner.
 

One size does not fit all

We are in a world where consumer experience is increasingly customised — from the advertisements we see linked to our previous purchases to the movie recommendations on Netflix. Flexible capital extends this to the world of finance. Each structured capital solution is unique and tailored to the specific situation.
 

This all-weather strategy works across business and market cycles with opportunities that span:

• Growth funding: Provide growth capital to support a large strategic acquisition or a roll-up type of acquisition strategy, or to provide development capital.
• Special situations: When a company has experienced a failed sale process due to a value mismatch arising from market dislocation.
• Liquidity solutions: Provide capital requirement for a potential buyback by promoters or provide an exit to private equity partners.
• Short-term stabilisation: Infusion of capital to solve a short-term cash flow mismatch or to stabilise operations.

There are several good examples of sectors and situations that suit this strategy. Airline services coming out of the pandemic saw a complete dislocation but had a clear path to recovery. Another good example is the logistics sector, which has seen high variability in margins over the last two years. While all participants agree that the sector will see normalisation of margins, it is challenging to complete an equity raise due to differing points of view on the extent of the changes coming up.
 

Given the flexibility afforded by the strategy and the ability to offer solutions across the capital stack, investors can customise the offering to include debt and equity-like features. Examples of these solutions may include redeemable preferred shares plus warrants; convertible preferred shares, which convert to a higher or lower stake in the company based on performance; 

or even optionally convertible debentures with upside features.
 

All of this flexibility sometimes leads to the founders asking for a simple and direct answer to what structure we can offer early in the discussions and at what combination of debt and equity. My response is usually my favourite analogy of a doctor: It depends on the symptoms! There is no one right medicine for all situations.

Dev Santani is managing director, Brookfield Special Investments — India, Middle East and Asia Pacific