Colbeck Capital’s View: The Case for Unsponsored Middle- Market Lending in Today’s Market
Middle-market firms commonly experience a financing gap as they can often find their capital needs too small for the attention of large banks, yet too substantial or complex for community banks. More recently, banks of all sizes have pulled back from middle-market corporate lending due to regulatory obstacles and perceived risks.
This retreat, along with market volatility, has ignited the growth of unsponsored middle-market lending opportunities. Unsponsored middle-market lending – when loans are made to companies not backed by private equity – presents a particularly appealing opportunity for private credit managers who can fill the void left by banks.
In our view, there are three significant benefits to participating in unsponsored middle-market lending:
Sponsorship approach: Unlike loans to sponsored companies, loans to unsponsored companies typically require participation from the lender as though they are the sponsor. That means the lender is rigorously performing due diligence, adding value for the borrower, and guiding the company through its transformational journey in the credit lifecycle, just like a sponsor would. This hands-on approach not only enhances the lender's influence but also fosters a deeper relationship between the lender and the company, paving the way for the company’s robust growth and development overtime. Furthermore, this deeper relationship fosters greater communications transparency, quicker decision making, and a more partner- centric approach that helps reduce risk for both the lender and the borrower.
Less competition: When compared to sponsor-backed lending, which we view as a highly saturated market, unsponsored lending is much less crowded, given many institutional lenders are unable or unwilling to lend to unsponsored companies. The relative dearth of competition in turn can lead to better risk-adjusted returns for private credit managers.
Increased diversification: Many sponsor-backed lenders focus on lending to companies based on industry, transaction type or credit metrics. We believe this type of lending leads to a more concentrated portfolio given that private equity firms focus on only a subset of businesses. On the other hand, unsponsored lenders can be more industry agnostic, allowing them to lend to a variety of different companies, across industries, with more flexible transaction types and credit metrics which minimizes concentration risk. This can be particularly important in times of economic uncertainty when certain industries or borrowers may be more vulnerable to default.
While some private credit managers may view unsponsored lending as a challenge, we see it as an opportunity. As both the lender, and in many ways the sponsor, we dedicate significant effort to understanding the unique risks of each of our investments as if we are the owners.
We do more than just provide funds; we assist companies with operational improvements, market expansion, and regulations navigation. This approach strengthens our relationships with borrowers, increases the potential for repeat investments, and creates an opportunity to yield greater results all the while being a trusted partner of the business.