A debt-led approach to UK private equity investing
westbrooke dynamic opportunities UK fund plc
digital information memorandum
Additional potential upside through equity warrants / co-investment
A diversified portfolio of 5 – 10 investments across the UK
Including a target cash yield of 4% p.a.
Contractual revenue streams with the protections of debt
3 – 5 year target duration on each underlying instrument, with proceeds returned to investors on exit
Target investor IRR of 12%+ in GBP (net of all fees and costs)
Returns linked to interest rates, providing an inflation hedge
Since the establishment of our presence in the UK in 2017, Westbrooke Alternative Asset Management UK (“WAAM UK” or “Westbrooke”) has built a meaningful track record investing in a variety of debt instruments in the UK lower-middle market (“LMM”) segment. To date, the business has successfully deployed over £250m across 110+ transactions, spanning across senior secured debt, mezzanine finance and preferred equity instruments in both real estate and corporate credit. Westbrooke shareholders and management have invested more than 20% of this capital alongside clients to date.
The LMM offers an attractive opportunity for a hybrid capital solution due to multiple structural factors:
- the accelerated retreat of banks from the LMM space since the global financial crisis due to increasing regulatory costs;
- the ending of Covid-19 lending schemes, leading to structural changes and an increasing opportunity to provide capital to the LMM segment;
- post-Covid-19 concerns regarding general market outlook going forward, an uncertainty that hybrid capital can capitalise on;
- a nascent alternative lending market which remains hamstrung by tight investment mandates; and
- an increasing desire on the part of incumbent equity investors to partner with flexible funding providers who can assist them in enhancing equity returns.
The combination of the above factors has created a unique gap which WAAM UK has increasingly capitalised on.
WAAM UK's hybrid capital platform
Since the beginning of 2021, WAAM UK has offered investors the opportunity to participate in deal-by-deal syndications in our hybrid capital platform.
Providing bespoke financing solutions to a range of UK companies alongside best of breed partners, WAAM UK’s hybrid capital platform offers investors the ability to participate in a combination of senior debt, mezzanine debt and preferred equity financing transactions alongside Westbrooke shareholders and management.
By providing flexible funding solutions to a variety of sponsors in the LMM space, WAAM UK is able to structure tailored funding packages for clients. These are primarily debt finance (senior, junior and mezzanine) led solutions, but through the favourable negotiating position of being a key funder, we are able to participate in the businesses’ inherent upside by negotiating an equity co-investment. This can take the form of preferred equity, equity warrants, direct equity co-investments or a combination of these instruments.
UK headquartered – Targeting businesses with operations and headquarters within the UK
Established, performing businesses – Backing businesses with compelling financial metrics
Best of breed partners – Backing like-minded partners in the form of private equity, management teams and entrepreneurs
Sector agnostic – With a focus on borrower and sponsor fundamentals
Investing across the capital structure – Able to invest in debt and equity, to minimise risks while maximising returns
the launch of the inaugural WDO UK fund
In this context, WAAM UK is pleased to launch the inaugural 2022 / 2023 vintage of Westbrooke Dynamic Opportunities UK Fund Plc (“WDO UK” or the “Fund), which aims to provide investors with a unique blend of debt-like risk protection (including an interest coupon, security, enforcement rights and a defined exit term) with the potential for equity-like returns. This is achieved by blending the above instruments, providing investors with a portfolio of capital preservation focused yielding debt investments, with the ability to achieve outperformance through the equity positions taken.
To date, WAAM UK has deployed £35m across five transactions within the hybrid capital strategy. With an average 4-year investment horizon, the current portfolio targets an overall weighted average annual return of 12.0% + per annum in GBP (net of all fees and costs). This return is comprised of a weighted average annual debt yield of 10.0% per annum (of which 4.0% is cash paid and 6.0% is rolled up) and the remaining return being earned through the equity participations taken.*
*Please note that these historic transactions will not be included in the WDO UK Fund and that past performance is not necessarily an indication of future returns.
The WDO UK Fund represents the next phase in the evolution of Westbrooke’s UK hybrid capital strategy and will serve as the vehicle to house hybrid capital transactions going forward. The Fund has been established on the following basis:
- The Fund will raise capital on an annual, vintage basis. The current 2022 / 2023 vintage targets to raise a maximum amount of £50m, at which point it will be closed for new investments
- It is envisaged that the 2022 / 2023 vintage will target to establish a portfolio of between 5 – 10 transactions, with no single investment comprising more than 20% of the Fund NAV
- The Fund targets to generate a net annual IRR of 12%+ in GBP (after all fees and costs), comprising of:
- Yield on debt positions taken:
- Cash yield of 4% per annum;
- Payment in kind (“PIK”) yield of 6% per annum; and
- Upside on equity positions taken:
- 2%+ per annum
- The Fund will enjoy a first right to all investments concluded in the WAAM UK hybrid capital platform. No investors will be provided with the opportunity to co-invest alongside WAAM UK outside of the Fund unless the Fund has reached applicable exposure limitations, at which point Fund investors who have invested £1m and above will be provided with an exclusive first right to co-invest in these deals outside of the Fund
Once the 2022 / 2023 vintage has completed its investment mandate, the Fund will launch a second vintage by way of a separate capital raise in a new share class. Through this mechanism, investors are provided with the opportunity to vintage their allocations to the Fund on an annual basis.
timing and next steps
We believe that the timing for the launch of the Fund is opportune, for both investors and borrowers.
Many investors are currently seeking secured, higher yielding investment opportunities which have the ability to outperform, in the context of the current economic landscape, which is characterized by volatile and declining public markets, high inflation and rising interest rates. The WDO UK Fund provides such an opportunity.
For borrowers, the current UK market dynamics have created a strong demand for flexible funding solutions in the UK LMM. This has allowed WAAM UK to build a strong origination pipeline into which the Fund will be invested going forward.
Investors now have the opportunity to subscribe for an allocation to the inaugural WDO UK Fund, alongside Westbrooke group, its shareholders, and related entities who have committed to hold a minimum of £5m in the WDO UK Fund. The Fund is targeting a maximum capital raise of £100m and a first close at the end of August 2022.
view our launch webinar now
2022/2023 vintage | information memorandum
1. an overview of westbrooke
westbrooke alternative asset management
Founded in 2004 and with offices in the UK, USA and South Africa, Westbrooke Alternative Asset Management invests, manages and advises capital in multiple geographies on behalf of its shareholders and investors in private debt, hybrid capital, real estate, private equity and venture capital.
Westbrooke Alternative Asset Management was established as a multi-asset, multi-strategy manager of alternative investment funds and products structured to preserve and compound our clients’ wealth to cement their future prosperity.
Our team is comprised of experienced entrepreneurs and investment professionals who apply a broad range of experience and skills to deliver investment opportunities which offer a simple investable outcome – predictable, sustainable, risk managed long term returns for investors in an increasingly complex environment.
We have a heritage as a shareholder and operator of assets, investing our own capital to develop and grow our businesses and assets. We believe our operational experience and expertise gives us and our investors a competitive advantage.
We are wholly committed to financial alignment. We invest materially alongside our clients and partners in all our funds and investments.
westbrooke alternative asset management UK
WAAM UK has been active in the UK LMM since its establishment in 2017, having successfully deployed over £250m across 110+ debt-led transactions. The team have invested across multiple sectors, asset classes and capital structures and hold a leading reputation within the UK market.
the WAAM UK investment team
James is the Head of Westbrooke UK’s Hybrid Capital business. With over 20 years’ experience in the UK M&A market, he was most recently Head of Growth and Acquisition Finance at Investec. James is a Fellow of the Institute of Chartered Accountants and holds an MA(Hons) from the University of Edinburgh.
Kieran is an Investment Associate at Westbrooke UK. Prior to joining the team, he spent 3 years at Investec where he specialised in growth and acquisition Finance. Kieran holds an MSc in International Business from the Grenoble Graduate School of Business, as well as an MCom in Management from Stellenbosch University, and is a CFA Charterholder.
Richard is based in London and is the Managing Director of Westbrooke UK and a member of Westbrooke Alternative Asset Management’s Executive Team. Richard led Westbrooke’s Section 12J product offering and was previously a consultant in the Structured and Acquisition Finance Team at Investec. Richard holds a BBusSci (Hons) in Finance, Economics and Strategy from the University of Cape Town.
Before joining Westbrooke UK as an Investment Associate, James founded and ran a software company. Prior to that, he spent 5 years at RMB in South Africa, focusing on a range of real estate and principal investment transactions. James holds a BBusSci from the University of Cape Town and is a CFA Charterholder.
Antimo is an Analyst in the Westbrooke UK investment team. Antimo trained and qualified as an attorney at Werksmans Attorneys in South Africa, gaining experience in mergers and acquisitions and international tax. Antimo holds BCom and LLB degrees from the University of the Witwatersrand and an LLM from the London School of Economics and Political Science.
Rob is a Principal in Westbrooke Alternative Asset Management UK’s private equity business. Rob has extensive investment banking and private equity experience having previously worked at Macquarie Capital, Investec Bank and RMB Corvest. While at RMB Corvest (a leading South African private equity firm) he was involved in a number of acquisitions, including Excellerate, Adcorp Support Services, Prime Light and Inscape. His successful exits include Trudon and Plush Leathercare.
Harry is an Analyst in the Westbrooke UK investment team. Prior to joining the team, Harry worked as an analyst for a family office in London which was focused on early-stage venture capital. Prior to that, he was part of the founding team of a retail technology company. Harry holds a BA in Economics from University College London.
the investment advisory committee
Martin is the Executive Chairman and co-founder of the Westbrooke Group and is also Chairman and Non-Executive Director of Westbrooke’s subsidiaries and associates. Prior to founding the Westbrooke Group in 2004, Martin co-founded and led a number of businesses.
Chris joined Capricorn Capital Partners in 2007. He was appointed as an Executive Director in 2013 and has over 18 years’ experience in investment management. Prior to joining Capricorn, Chris was a senior investment manager at the Industrial Development Corporation where he was responsible for sourcing and structuring transactions, managing due diligence teams and providing strategic support to the various investments.
Rob is a Non-Executive Director on the Westbrooke Group Board. Rob founded Capricorn Capital Partners with two other partners and is currently the CEO. He sits on the Board of Hollard Holdings and Anchor Group and is also the Chairman of the Hollard Investment Committee and Chairman of the Remuneration Committee.
Avron is seasoned financier and banking professional with over 25 years of banking experience. In 2002, Avron established Investec Bank Plc’s Growth and Acquisition finance business and served as the CEO of the Investec Specialist Private Bank.
Paul is a co-founder of ASK, and shares responsibility for credit, due diligence and investor relations. He has been involved in the banking sector for over 40 years, (the last 25 years exclusively in property finance) and as such has a deep and established network. In 1995, Paul established Investec Bank plc’s European property finance business. Under his management the division’s assets grew to over £3.5 billion, generating peak annual profits of circa £100m.
Simon is the CEO and Executive Director at Newpark REIT Ltd. Simon is also the co-founder of RMB Westport, a real-estate development fund that is focused on property development in Sub-Saharan Africa. Prior to RMB Westport, Simon worked at Rand Merchant Bank Limited for 12 years, where he gained experience in the structured finance, private equity and global markets businesses before establishing himself in the investment banking division where he headed the real estate investment banking business for seven years.
the wider westbrooke team
Dino is Westbrooke Alternative Asset Management’s Head of Product Development and Distribution and is a member of Westbrooke Alternative Asset Management’s Executive Team. He is also the Chairman of the 12J Association of South Africa and has previous experience in Corporate Finance Investment Banking at Investec and Deloitte in both South Africa and the USA. A CA(SA), Dino also holds an MCom in Finance and a BAccSci (Hons) from the University of the Witwatersrand.
Emma is a Manager of Operations and Finance at Westbrooke UK. Prior to that, Emma spent 4 years at JTC Fund Solutions as a Fund Accounting Supervisor. Emma holds a BBusSci and BCom (Hons) in Taxation from the University of Cape Town and is currently studying towards her MCom in International Taxation.
Olivia is a Finance and Operations Analyst at Westbrooke UK. Prior to this, she worked as an Operations Consultant at Allan Gray. Olivia obtained her BCom Honours in Investment Management at the University of Pretoria and is studying towards her Chartered Financial Analyst qualification.
Laura is an Operations Executive at Westbrooke Alternative Asset Management. Laura is a qualified CA(SA) and completed her articles at Deloitte in London. She also holds a Postgraduate Diploma in Financial Planning. Laura has spent the vast majority of her career to date in the wealth and financial planning industry with a specific focus on operations and project execution.
Claire is the Financial Manager for Westbrooke Alternative Asset Management. She is a qualified CA(SA) and completed her articles at Deloitte, where she also spent time as a manager in the Accounting and Financial Advisory division. Claire was the financial manager at Vumatel in its start-up phase, and thereafter gained experience in the private equity space, at an Africa-focussed fund of funds with an offshore investor base.
2. the market opportunity in the UK lower-mid-market
This section outlines the addressable market for lower-mid-market (“LMM”) investments in the UK. It explains why the supply of lending capital is decreasing and why demand from private equity (“PE”) and entrepreneurs is stable and how this creates a gap in the market. It then assesses the key economic trends that result in uncertainty and outlines why a combination of debt and equity (referred to in this document as hybrid capital) is an appropriate solution in the current climate.
an overview of the UK private capital markets landscape
Lending to the LMM is a c.£30bn-£50bn a year market*, with inherent diversity and attractive risk-return dynamics. It consists primarily of privately held business that have c.£2m – £10m of earnings before interest, taxation, depreciation and amortization (“EBITDA”).
* Source: British Business Bank & Westbrooke Analysis
The broader UK private capital markets are segregated by several distinct features, including:
- the size of the underlying borrower (large-cap, mid-market and SME);
- the underlying asset class (i.e. real estate or corporate); and
- the type of capital provided (equity vs debt).
Focusing specifically on the size of the underlying borrower – the large-cap market is dominated by the ‘mega-funds’ which provide syndicated facilities into the hundreds of millions of pounds to the largest companies in the UK and Europe. These funds are backed exclusively by institutional investors.
At the opposite end of the spectrum is the algorithmic SME finance market, where small enterprises require ‘micro-loans’ ranging from a few thousand pounds and above. These loans are typically unsecured and higher risk, with the leading player, Funding Circle, quoting an estimated lifetime weighted average default rate across cohorts of 20.5% (FY 2020)*.
* Source: https://corporate.fundingcircle.com/media/press-releases/full-year-2020-results/
The LMM offers an attractive risk profile and a multi-billion pound lending opportunity.
The LMM comprises an estimated 35,000* established businesses, that are diversified across regions and sectors.
* Source: FAME
As well as being diversified, the underlying businesses also offer an attractive risk profile. Historic default rates for LMM businesses, are substantially lower than SMEs.
Source: British Business Bank
Assuming a conservative recovery rate of 50%, the expected loss for LMM loans is between 25bps and 10bps across the entire market.
The WDO UK Fund aims to further reduce this loss, by implementing the capital preservation strategy which is covered later in this document.
Competition exists to serve the LMM, but lenders have structural challenges that cause a dislocation in supply
Capital markets within the LMM, are dislocated because expectations regarding the availability of capital often do not meet reality. The current market is complicated by multiple independent stakeholders that do not collaborate effectively; this leaves a dearth of adequate capital provision that in turn causes dislocation. The illustrative chart below shows how capital to LMM businesses is typically provided, distinguishing between what is expected, the actual provision and Westbrooke’s view of the optimal solution. We explain the market dynamics below.
* Source: Westbrooke research
Business owners expect to be able to tranche capital effectively, using a combination of equity, preferred equity, mezzanine and senior lending. Realistically, the LMM tranches differently, with equity and senior lending from banks being the largest providers of capital. However, in many cases banks offer insufficient leverage for equity providers meaning borrowers increasingly require alternative solutions. Westbrooke’s hybrid capital solution is consciously focused to overlap with the space where highly conservative lending (i.e. banks) ends and intermediate capital starts.
Banks were already decreasing their LMM lending stock before the onset of Covid-19 due to the increasing burden of regulatory requirements.
Banks are the largest suppliers of capital to the LMM but have been retreating for a number of reasons. A tightening of credit policies following the global financial crisis (“GFC”) saw banks becoming increasingly risk averse when participating in the LMM – appetite often sits at 2x EBITDA or 50% LTV for non-mortgage real estate lending, creating a gap in the market for alternative lenders.
The implementation of the regulatory risk management framework under Basel III further hastened the retreat of banks from the LMM. Basel III, amongst other requirements, required banks to increase risk weighted capital for unrated loans (which most LMM businesses are), in turn making this a capital intensive and therefore less profitable area for them.
The high degree of regulation means that banks incur similar absolute transaction costs for £50m loans as they do for £10m loans, leading to a preference to allocate to larger transactions.
Banks’ complex systems and operational issues have made them less competitive and less business friendly in the LMM.
Siloed internal lending functions and bureaucratic processes create long lead times than borrowers cannot afford to wait on.
High staff turnover rate at banks further creates a lack of personal relationships with borrowers.
Source: BoE Statistics
UK lending growth
Bank lending increased substantially during Covid, driven by government support/guarantees, but is now declining due to a focus on portfolio management, offering an opportunity for non-bank lenders.
Supply of bank lending to SMEs increased during the Covid-19 pandemic, with the support of the government backed lending schemes including the Bounce Back Loan Scheme (“BBLS”), the Coronavirus Business Interruption Loan Scheme (“CBILS”) and the Coronavirus Large Business Interruption Loan Scheme (“CLBILS”). Businesses had to prove that they were negatively impacted by Covid-19 and the loans could generally not be used for M&A. The government paid all borrower interest and arrangement fees in the first year which facilitated >£75bn of additional lending.
The government forced banks to focus on the riskiest SME segment by providing BBLS loans of up to £50k. More than £45bn was lent to an approximate 1.5m SMEs through BBLS. This caused banks to allocate additional resources to these loans away from larger tickets in the LMM.
In October 2020, the National Audit Office outlined that 60% of BBLS loans were unlikely to be repaid. Banks are responsible for remediating these loans, which requires additional resource and again moves their focus away from deployment in the LMM to portfolio management. The BBLS scheme was closed to new applicants in March 2021.
Just over 100k of CBILS loans (up to £5m) were provided, totalling £26bn. Only 753 CLBILS loans (from £5m-£200m) were provided, totalling £5.56bn. In the British Business Bank’s latest reporting, less than 750 CBILS loans (0.5% of total value lent), and only 4 CLBILS loans have defaulted (0.2% of total value lent).
The CBILS and CLBILS schemes have also since expired, which offers opportunities for non-bank lenders to refinance the best loans in this segment.
The combination of bank’s withdrawal, their inherent inefficiencies and focus on existing portfolio management drive borrowers to new forms of faster, leaner financing solutions such as hybrid capital.
Alternative lenders have increased market share in the LMM as banks have withdrawn, but internal restrictions and low volumes mean they are unable to fully solve the dislocation
80% of mergers and acquisition (“M&A”) transactions in the LMM are now funded by alternative lenders, who have gained market share as banks have retreated from the market post Covid-19.
Alternative lenders operating in the LMM offer loans of £1m-£15m at up to c.3x EBITDA or 75% of LTV, filling some of the gap left post many of the banks’ withdrawal from the space. These lenders compete directly with banks for senior loans, taking security in the form of a first ranking fixed and floating debenture
In exchange for multiple benefits, such as faster lending, better structuring and higher gearing levels, these alternative lenders generally price up for the privilege, at c.8% – 10% gross lending rates.
Alternative lenders are funded in one of two ways, namely through high-net-worth (HNW) investors or through institutional capital, both of which have limitations:
- Alternative lenders with HNW investor backing are competitive, both on leverage (which can exceed 3x EBITDA) and on structuring which often contains a large bullet component (up to 100%). However, because of the source of capital, loans rarely exceed £10m and the total corporate lending books rarely exceed £100m. As such, these lenders are generally competitive but due to size limitations only cover a limited proportion of the market.
- Alternative lenders funded through structured institutional capital are usually focused on lending greater volumes than those funded by HNWs, with the ultimate goal being to build a loan book of c.£250m in 2 to 3 years and then securitise this on the public markets. No lender targeting the LMM in the UK has yet been able to successfully securitise, though they have built books. Leverage offered by these lenders is typically in the range of 3x EBITDA. In addition, these lenders are subject to further requirements, based around tight sector concentration, regional concentration, and obligor limits (total loan to ultimate borrower). Additionally, the investor structuring often requires individual underwriting authorisation from the lender, an external ratings agency and the SPV investors (equity, mezzanine & senior investors). These additional requirements lead institutionally funded alternative lenders to be less competitive and slower in extending credit. Currently, these lenders also cover a small proportion of the market and will remain constrained due to the restrictions placed on them by their funding base.
The relatively small scale of alternative lenders provides a further opportunity for a hybrid capital solution.
Mezzanine lending and preferred equity are useful solutions but only account for a small niche because of their inherent complexity.
Mezzanine lending comprises loans that sit behind a senior lender (be it a bank or an alternative lender) taking second ranking security. They offer additional leverage to a potential borrower and because of their ranking, they obtain a risk premium. They are often flexible on structuring, mainly offering a 100% bullet over a 4-year or 5-year term and usually include a small warrant.
Preferred equity comprises minority equity positions that have certain debt-like characteristics (such as a first claim to dividends or repayment before equity) but which remain subordinated to senior debt providers. As LMM businesses rarely pay substantial dividends (they prefer to retain cash in the business for growth or to repay senior debt), preferred equity’s returns are dependent on growth, with some downside protections. Preferred equity typically sits just below ordinary equity.
Both mezzanine lending and preferred equity are inherently complicated structures that require sophisticated investors to underwrite and manage them. Most individuals with this sophistication choose to focus on larger tickets than the LMM and as such there is limited provision of mezzanine lending and preferred equity in the LMM.
In this context, whilst mezzanine lending and preferred equity are potentially attractive solutions, there are a limited number of providers who focus on the UK LMM segment, offering an opportunity for Westbrooke to become a key player in this space.
Supply for LMM equity funding mainly comes from private equity, who require lending solutions in order to make their business models work.
PE firms generally purchase businesses directly from entrepreneurs or other PE firms. While not lenders, their investments fill some of the financing gap for the LMM.
As PE firms are focused on equity investing at higher returns, their funding alone is insufficient in order to address the full funding shortage faced by the LMM. They require cheaper debt solutions in order to enhance equity returns to suitable levels for their investors.
Annual deal volumes for mid-market private equity houses have risen from £32bn in 2017 to £46.8bn in 2021. Investment remained above 2017 levels in 2020 despite Covid-19 and grew substantially in 2021, following the reopening of the economy*.
Source: KPMG mid market lending report
Purchase multiples remain high (>10x EV/EBITDA), though they have fallen since 2017 as PE buyers have shifted from purchasing high growth technology businesses to focusing more on traditional growth sectors such as business services and healthcare. Lowering multiples and high levels of dry powder are causing increased demand from PE buyers.
Source: KPMG mid-market lending report / Preqin
The gap between the average PE valuation multiple (of 10x) and the 2x-3x multiple that can typically be achieved from senior lenders, leaves a gap which provides the opportunity for hybrid capital in conjunction with other forms of capital.
While a funding gap clearly exists in the LMM, the economic condition in the UK is uncertain. From our investor perspective, the desirability of the hybrid capital solution, which offers a unique asymmetry between risk and return, has rarely been higher.
The lingering impact of Covid-19 and the implications of the Ukraine crisis are continuing to impact key UK macro indicators, with GDP growth forecasts suggesting a challenging period ahead.
In the UK, input costs have risen at their fastest rate in over a decade, driven by the war in Ukraine and Brexit. With no slow down expected in the next 12 months and many businesses looking to pass these costs on to consumers, inflation is a key concern for lenders that needs to be underwritten when assessing any potential borrower. The ability to manage the cost base, both in raw materials and in wage costs, and in pricing power, are key considerations.
This has continued to fuel inflation, with UK inflation having reached its highest level in 40 years in May 2022.
*Source: ICAEW – Note: data not recorded for Q3 2020 due to Covid-19.
Sustained inflation has triggered successive increases in base rates across the developed world, following the previous cuts in rates to all-time lows in response to Covid-19. The Bank of England has now increased rates to 1.25% in June 2022, the highest level in 10 years. Further rate hikes are imminent with the consensus being that rates may hit 3.0% within the year.
In this context, it is essential that loans written by the WDO UK fund are variable rate in nature. This can be achieved by pricing with reference to either SONIA or the Bank of England Base Rate. Such pricing can also provided enhance protection to lenders.
The fear of rising inflation has resulted in tempered expectations regarding UK economic growth post-Covid-19. GDP growth expectations for FY22 are now well below the initially expected 4.0%, with FY23 closer to c.1.0% and broad consensus that a recession is now imminent.
Within this uncertain backdrop, it is important to focus on the highest quality businesses that offer superior risk-adjusted returns by providing a solutions driven approach but also protected capital structures to mitigate risk in these environments.
In addition, it is highly likely that both banks and alternative lenders will focus on protecting and managing their existing portfolios going forward, rather than focusing on new business. This is likely to lead to a further reduction in competition, offering greater opportunity for Westbrooke to improve terms and pricing.
In this context, it becomes clear that a hybrid capital funding solution offers a potential solution to the complexities in obtaining funding faced by businesses operating in the LMM.
Hybrid capital works by providing the borrower with a package of debt and protected equity (often by way of a warrant, liquidation preference, etc.)
In the UK LMM context, ticket sizes range between £1m and £20m.
Hybrid capital is appealing as it provides the borrower with a blended offering, allowing them to deal with a single counterparty which plays across the capital stack. This can add additional flexibility, improved process efficiency and additional leverage when compared to what a traditional lender is typically able to offer.
This offering is appealing to a wide variety of partners:
- Entrepreneurs can use hybrid capital to finance growth, while minimising dilution;
- PE can use hybrid capital to complement their offering, obtaining reasonable leverage while sharing their equity upside with hybrid capital;
- Banks and alternative lenders can work alongside hybrid capital, to increase their ability to serve clients within their lending parameters.
The funding gap created by the mix of a lack of a ready supply of capital, set against the backdrop of increasing demand for capital, presents a unique opportunity within the UK lower-mid-market, especially for market participants who are correctly positioned to support growing business with flexible capital. It is this market dynamic that the WDO UK Fund seeks to capitalise on.
3. the westbrooke hybrid capital platform
As highlighted in the market overview section above, a funding gap exists in the UK LMM segment. The WDO UK Fund seeks to capitalise on this by providing the market with a flexible, solution-driven approach to providing capital.
The WDO UK Fund has been established by WAAM UK to take advantage of the dislocation in the LMM and to provide investors with the opportunity to invest alongside Westbrooke and related parties in hybrid capital transactions in the LMM.
WDO provides investors with the ability to access a diversified pool of opportunities which target an equity-style return whilst utilising debt-like characteristics to mitigate capital loss, creating a debt-like risk profile.
Utilising our existing UK origination network of reputable and experienced specialist loan originators, family offices, private debt and equity funds and investors (“Originating Partners”), WDO UK focuses on providing investors with unique access to transactions which demonstrate a distinct asymmetric risk return profile:
- WDO sources, structures and executes on transactions (the “Transactions”) across the capital spectrum, ranging from high-yielding secured loans, to mezzanine finance, preferred equity and equity to businesses in the LMM segment
- The Transactions typically take the form of a hybrid capital instrument, which derive income and capital growth from two components being:
- an interest-bearing coupon, and;
- a variable performance-based instrument (i.e. warrant, option, equity).
- In addition, the Transactions will benefit from having security, monitoring and financial covenants, demonstrable route to exit/liquidity and significant equity cushions.
The thesis is centered around the Westbrooke risk philosophy and approach underpinned by four key pillars:
Principled risk structuring – WDO adheres to a consistently applied set of principles & risk philosophy, focusing on capital preservation, sensible leverage, probabilistic investment upside and full alignment with our partners. Our experienced investment team follow these principles, focusing their time on conducting thorough analysis to understand the risks and opportunities contained within the best LMM assets.
Partnership ethos – we have aligned with best of breed partners in private equity, banking, advisory and the entrepreneurial community. This network has provided a continual flow of quality opportunities in the LMM since inception.
Solutions driven – by embracing an investment’s inherent operational, structural and market complexity, we are able to deliver tailored and differentiated solutions for our partners. This improves Westbrooke’s screening process and conversion rates to be substantially above market levels.
Robust investment approach – our risk philosophy focuses on capital preservation first, designed to minimise risk. Our investment process (outlined in more detail below) ensures that risks are identified quickly for any sector/situation and that our internal operations are efficient which results in high quality Transactions being processed quickly.
Proactive monitoring and recovery – the investment team monitors each transaction regularly, to ensure performance and identify early warning signals. We typically hold observer/board positions on transactions providing additional visibility. Westbrooke’s strong relationships and continual communication with our sponsors, portfolio companies and advisors assist in mitigating risk and pre-empting situations.
The sections below outline how we approach and implement each of these pillars, in more detail.
principled risk structuring that protects investor capital and provides investor upside
The Westbrooke risk philosophy can be distilled into the key principles outlined in the table below. These principles form the basis for risk assessment across each Transaction and enables a consistent approach irrespective of the nuances a Transaction may present. They represent a culmination of skills obtained from a deeply experienced investment and advisory team, many of whom have 20+ years UK investing experience.
WDO UK uses these principles as a means to approach complex event driven Transactions (often where the structuring opportunity is not always apparent), driving enhanced investor returns through the ability to assess and price risk accordingly.
These principles have resulted in us being able to successfully build the investment performance which is further outlined in the Westbrooke’s hybrid capital track record section of this document.
partnership ethos which builds long-standing relationships
Westbrooke partners with intermediaries, sponsors (in the form of private equity houses), banks, management teams and/or entrepreneurs to solve a partner’s problems and build a working relationship based on trust.
By aligning WDO UK with partners with shared values and who are focused on a partnership-first approach to investing, Westbrooke mitigates risk and efficiently sources new opportunities.
solutions driven approach which offers differentiation and investor upside
The WDO UK Fund serves the market as a solutions driven funding partner, built on a reputation for deliverability, creativity, and flexibility in its approach to complex financing situations and needs. Partners look to WDO UK for solutions of up to £20m to fund established growing UK companies whose EBITDA’s typically fall in the range of £2m – £10m.
By providing a hybrid solution that combines a debt-type instrument together with a minority equity position, Westbrooke’s WDO UK Fund provides the flexibility that partners look for. The combination is tailored to the partner’s needs and allows WDO UK to approach each financing request with an open mindset to deliver a holistic funding solution across the capital structure, rather than the traditional single loan product approach normally adopted within the market. This tailored approach has allowed Westbrooke to achieve a success rate from issuing terms through to funding, which is substantially above the market rate of <5%.
WDO UK provides Borrowers with a simplified, differentiated and efficient capital raising process in a challenging and unstructured capital environment, while delivering investors with a superior and differentiated investment opportunity providing compelling risk and return dynamics.
robust investment approach that focuses on capital protection
Transactions are assessed through a rigorous screening process comprised of 4 distinct phases designed to thoroughly test and scrutinise investment propositions. This allows WDO UK to assess the nuanced complexity of each transaction to find opportunity and deliver outsized returns relative to the underlying risks:
proactive monitoring and recovery that further ensures capital protection
Investee businesses are monitored regularly to ensure that they are performing and have adequate capital to service current and future obligations. Management provides trading information to the investment team on a monthly basis.
The WAAM UK team typically also takes a board seat, or board observer seat, on every transaction within the WDO UK strategy. This regular contact deepens the relationships with management while providing strategic insight on how the Transaction is performing.
All performance information is tracked against forecasts and budgets, with formal investment reports compiled on a semi-annual basis.
early warning signals (EWS)
EWS help the WAAM UK team to identify where a Transaction is underperforming and may default. WAAM UK is vigilant in tracking this information, focusing on mitigating potential risk before it happens. Westbrooke uses the following information to identify EWS:
All non-performing transactions require additional information. In these instances, the management team of an investee company is required to meet with us to discuss the situation. Further information, such as a new business plan or rationale for sub-performance, may be requested.
WAAM UK assesses each case and decides where a plan can be implemented to improve the performance, if amendments / waivers to the facilities are required or if an impairment charge should be implemented.
defaults and recovery
Westbrooke manages each default to protect capital invested. The first goal is to minimise any loss that may be incurred. While the documentation and ranking provides security to the position, and to our investors, the strong relationships with equity partners and the reputation of WAAM UK creates a reputational risk for equity partners involved with defaults. This provides a strong negotiating position for Westbrooke which incentives equity co-investors to remediate any defaulted position. Typically defaults include, but are not limited to:
- Lack of repayment
- Lack of financial disclosure that is not remediated
- Fraud or misrepresentation
If a default occurs, we follow the process below:
1. Our investment team uses our principled risk structuring approach to outline the potential scenarios available to us. The immediate focus is to ensure that capital is preserved, and that the WDO UK investment value is maintained. In the majority of scenarios, remediation will be completed quickly, with the business or the sponsor(s) paying their obligations to WDO UK on request from WAAM UK.
2. In more complex cases, the investment team may work with third-party lawyers and advisors to assess the business and understand further viable solutions which may include restructuring, re-capitalisation, administration or a business sale. In addition, the investment team would build related forecasts in order to recommend the best solutions to the investment committee, who would then approve the proposed solution. Solutions would be tested against the probable expected recovery, time to recover and the cost of the recovery. Once a solution is validated, the investment team then make a request to the defaulted business that they confirm it will be implemented. In the event that it is confirmed, then a detailed plan will be requested from the management and weekly monitoring will be conducted. In the event that request is rejected, or unable to be honoured, we then move to the following procedure.
3. Legal advisors would be engaged to enforce the solution on the defaulted business. They prepare the required documentation and share this with the defaulted business and its investors. This route may require additional involvement of a third-party who specialises in restructuring and/or the specific sector. All additional costs will be incurred with the overarching goal to resolve the issue with the best financial outcome for investors. The costs are ultimately borne by the defaulted business.
4. westbrooke’s hybrid capital track record
Westbrooke has been actively investing in the UK LLM market since the establishment of our UK business in 2017. Since then, we have invested in excess of £250m across 110+ private transactions in and around the UK. These transactions have been offered to investors primarily though our Westbrooke Yield Plus secured private debt platform, which currently manages in excess of £100 million of third-party and shareholder capital. Westbrooke shareholders and management have invested more than 20% of this capital alongside clients to date.
Driven by the structural shifts in the market as outlined in the market overview section above, Westbrooke began investing in hybrid capital transactions in early 2021. We have provided total funding packages of £58m across five transactions in debt, preferred equity and equity in the building products, special education needs schools, electrical components, hotel and pub sectors.
The existing portfolio of transactions targets an overall weighted average annual return of 12.0%+ per annum (net of all fees and costs). This is comprised of a weighted average debt yield of 10.0% per annum (of which 4.0% is cash paid) plus the upside anticipated through the applicable equity participations in the investee businesses,.
The table below summarises the key features of the five transactions
a narrative summary of each transaction is presented below
Westbrooke structured a £5.0m preferred equity investment to support Innervation Capital Partners’ establishment of the Melrose Education Group, a UK special education needs school group. Melrose Education was established as a ‘buy-and-build’ strategy to consolidate and expand smaller, UK special education needs schools, a highly fragmented and operationally complex sector with high barriers-to-entry.
Melrose Education presents the opportunity to create a pan-UK group of special education needs schools at exit and achieve multiple arbitrage due to scale.
Westbrooke investors were invited to invest in a £5.0m preferred equity note, which targets a 15.3% net IRR under the base case, comprising a 9.0% annual PIK yield and the remainder being generated by way of a 30% equity stake in the business.
To date, Melrose Education has exceeded expectations in terms of its ability to execute the buy-and-build strategy, and in July 2022 completed its fifth acquisition, bringing consolidated pro forma run rate group EBITDA to £3.6m. In this context, we believe the cover implied in our preferred equity position to have improved and that our equity stake now carries a material level of value.
Westbrooke lead arranged a total £19.5m investment via a £15.5m senior debt facility and £4.0m preferred equity facility to support H2 Equity Partners’ management buyout of Folkestone Fixings Ltd (trading as “FFX”). Based in Kent, UK, FFX is a fast-growing, cash-generative, market-leading e-commerce distributor of power tools to a well-diversified B2B customer base in the UK. FFX benefits from an attractive, growing market segment driven by a shift from offline to online, further accelerated by Covid-19.
The Transaction valued FFX at £35.3m (6.8x Dec-20 last twelve months EBITDA of c.£5.2m), with FFX presenting the opportunity to deliver a ‘polished asset’ on exit and achieve multiple arbitrage due to the long-term attractions of the end market.
Westbrooke investors were invited to subscribe for a £7.6m hybrid capital note, comprising £3.5m of senior debt and £4.1m of preferred equity, the combination of which targets a 12.5% – 17.5% net IRR. This IRR is comprised of a target 10.0% annual yield (4.75% of which is cash yield and 5.25% is PIK), with the remaining return to be derived through 7.99% equity stake in the business.
Since inception, FFX has traded slightly behind budget, driven primarily by Covid-19 lockdowns and the related supply chain issues arising from both Covid-19 and the Ukraine crisis. Our debt position in the business remains well covered, with all interest obligations having been serviced to date. We are yet to see a material level of equity value built up in our equity stake, although this may change as the market continues to open up into the future.
Westbrooke provided a £7.4m senior debt facility to support the acquisition of a portfolio of 99 leasehold pub assets in Wales alongside the partners of Cerberus Capital Management (“Cerberus”) and Song Capital (“Song”) (collectively, the “Consortium”), experienced sponsors with an over 12-year track record in pub ownership and operations in the UK.
The transaction was structured in two stages, with the Consortium initially acquiring the pub portfolio for £75.7m and simultaneously selling the freehold to an investment buyer for £60.0m in return for a 150-year lease over the pub portfolio. The remainder of the cost, being £15.7, forms the pub portfolio purchase price which is what the Westbrooke debt facility part-funded.
In order to monetise the value inherent in the leasehold interest, the Portfolio was let to Marston’s PLC on a 15-year triple net lease, paying £5.2m per annum. Marston’s is a listed, c.£420m market cap* pub operator which focuses on pubs outside of urban areas across the UK.
*As at July 2022
Of the debt package, the Westbrooke Yield Plus senior secured debt fund provided the first £4.0m as an “A-Note”. Westbrooke investors and management invested in a £3.8m “B-Note” (£3.4m debt and £0.4m of co-invest equity and deal costs), which ranks behind the A-Note and targets to generate a net 9.0% – 11.0% return under the base case, comprising an 8.0% annual cash yield, with the remaining 2.0% – 3.0% annual return being generated by way of a 3.5% equity stake in the business.
The Project Sky transaction has been implemented in line with the investment strategy to date.
Westbrooke provided £10.5m of funding to support H2 Equity Partners’ (“H2”) acquisition of Acal BFi (“Acal”), one of Europe’s leading value-add distributors of electrical components, serving over 6,000 original equipment manufacturers across several geographies and multiple end markets, with a key focus on the transport, industrial, energy and medical markets, all of which are supported by strong secular growth trends.
The facility comprised £10.0m of second-ranking mezzanine funding (£2.5m of which was provided by the Westbrooke Yield Plus secured private debt fund as an “A-Note”) plus a £0.5m pro-rata equity investment alongside £15.8m of additional equity being invested by H2 and management.
The transaction provided investors with the opportunity to fund a well-established and successful business presenting strong downside mitigants, with a conservative investment strategy and multiple paths to exit underpinning the equity co-invest.
Westbrooke investors were invited to commit to a £8.0m stapled note, comprising £7.5m of the mezzanine funding (through a secured, second charge “B-Note”) and £0.5m of pro-rata equity investment. The investment targets an 11.0% – 12.5% overall net IRR, comprising an 11.0% annual yield (5.0% cash paid and 6.0% PIK), with the remainder being generated through a 2.8% equity participation in the business.
The transaction was concluded towards the end of 2021 and Acal has continued to trade ahead of expectations since making the investment.
Westbrooke provided a €6.45m secured preferred equity note to support the acquisition of the leasehold interest in a newly constructed 340-key aparthotel in Dublin, Ireland. The transaction was concluded alongside Song Capital, a trusted and experienced operational real estate sponsor with whom Westbrooke has transacted in the past.
The transaction was structured in two stages, with Song Capital initially acquiring a full interest in the hotel for €93.2m, and simultaneously selling the freehold interest to an investment buyer for €71.7m in return for a 99-year lease over the property. The remainder of the hotel cost, being €21.5m, forms the purchase price of the leasehold asset which the secured preferred equity note part-funded.
In order to monetise the value inherent in the leasehold interest, the hotel property was then let to StayCity on an inflation-linked 25-year triple net lease paying €4.46m p.a. StayCity is an established UK and Ireland focused apart hotel operator backed by the Irish Sovereign Wealth Fund, with 23 sites across Europe and the UK.
The secured preferred equity note offered to investors is forecast to earn a total 21.5% net IRR in the base case scenario, with 11.5% thereof being contractually payable via a PIK note (and ranking ahead of Song’s equity) and the remaining 10.0% being a share in the equity participation from any proceeds on sale of the leasehold asset.
The Project Sky transaction has been implemented in line with the investment strategy to date. Initial indications suggest that the leasehold interest might be capable of being sold at a premium earlier than initially anticipated.
5. portfolio construction and expected returns
The WDO UK Fund targets to invest between £5m and £20m in hybrid capital opportunities in the LMM.
The WDO UK Fund invests in consistently cash-generative, primarily UK headquartered businesses. The investment parameters of the WDO UK Fund are further detailed in the table below:
The WDO UK Fund typically invests in transactions which can broadly be segmented into the following five categories:
The aforementioned transaction categories are outlined in more detail below:
Type I – high-yield only
- Structured as a senior / junior secured loan facility with a high-yielding contractual coupon
- The majority of the coupon is typically cash paid, and partially accrued
- No equity participation is taken
- Targets a total base gross IRR of between 10% – 12% per annum
Type II – unirate
- Structured as a senior ‘stretch’ secured loan facility consisting of a contractual coupon with small equity participation
- The majority of the coupon is cash paid and partly accrued
- A small proportion of the return is generated via equity
- Targets a base gross IRR of between 10% – 15% per annum
Type III – mezzanine I
- Structured as junior secured loan facility consisting of a contractual coupon with small equity participation
- The coupon is evenly split between cash paid and accrued
- A moderate proportion of the return is generated via equity participation
- Targets a base gross IRR of between 12%-15% per annum
Type IV – mezzanine II
- Structured as a junior secured loan facility consisting of a contractual coupon with higher equity participation
- The coupon is partly cash paid with the remainder accrued
- A high proportion of the return is generated via equity participation
- Targets a base gross IRR of between 15% – 17% per annum
Type V – preferred equity
- Structured as a preferred equity investment with a contractual accrued coupon and significant equity participation
- The coupon is fully accrued and not paid through the term
- The majority return is generated via equity participation
- Targets a base Gross IRR of 20% – 25% per annum
Debt: debt facilities charge coupons which are priced dependent on the risk and ranking that WDO UK takes in the capital stack. WDO UK ensures that the gross coupon is priced above 8% + UK Base rate, unless the equity participation justifies a lower margin. The coupon may comprise a cash paid and accrued interest component, dependent on the facility type. Cash payment provides a periodic/annual return to WDO UK and may be between 50% and 80% of the overall coupon, although this is highly transaction specific.
Equity: WDO UK generally takes equity in the form of warrant or option instruments, and on occasion will invest directly in equity. The size of the stake depends on the investment team’s projected enterprise value of the business, the business fundamentals and the competitive dynamics.
WDO targets a net investor return of 12%+(IRR). For illustrative purposes only, we have modelled an illustrative portfolio under the following scenarios:
- The base case profiles no multiple expansion with a c.6% EBITDA growth for the portfolio. This results in a net c.12.0% IRR and a 1.67x money-on-money return for investors.
- The upside case assumes higher EBITDA growth of c.10-15% and a multiple expansion on exit of one turn. This results in a net c.14.0% IRR and 1.85x money-on-money for investors.
- The downside case assumes that the portfolio businesses EBITDA flatlines and that multiples contract. This all but eliminates equity upside for the fund, but it is worth noting that the debt return is not impaired. In the downside case investors still achieve a net c.10.0% IRR and 1.54x money-on-money.
6. fund term sheet
7. fund structure
Fund investors will invest into a Jersey domiciled closed-ended expert fund prior to the Fund’s financial close.
The Fund’s assets will be invested into Westbrooke Private Capital S.à.r.l (the “Investment Vehicle”) via a subscription for loan notes. The Fund will invest predominately via its own bankruptcy remote compartment of the Investment Vehicle (“Compartment 28”) although WDO UK may invest in other compartments of the Investment Vehicle at the discretion of the Directors.
The Fund may not be the sole investor in the Investment Vehicle, although it will be the sole investor in a Compartment. The Investment Vehicle may create additional compartments and third-party investors may invest directly into these compartments of the Investment Vehicle alongside the Fund.
The Investment Vehicle in turn invests into the assets of the Fund and the transactions.
Fund investors will be distributed any proceeds (net of expenses) from the underlying investments when they are received by the Luxembourg investment vehicle.
8. timing and next steps
The deadline for applications for the Fund’s first close is Wednesday, 31 August 2022.