Proskauer Rose LLP are most popular:


with readers working within the Banking & Credit industries

Hybrid Capital — financing instruments such as debt-like
preferred equity and Holdco notes that sit between pure equity and
traditional debt instruments — is becoming an increasingly
important product class for companies seeking private capital.
Issuers turn to Hybrid Capital to address growth and liquidity
needs while maintaining flexibility, governance control and
investor alignment.

This is the first installment in a series of “Hybrid
Horizons” articles we are publishing, focused on today’s
Hybrid Capital market. Our first article provides an overview of
market trends, which are discussed below.

Market Acceptance

Once a niche product for challenged financing situations, Hybrid
Capital has become accepted as a common feature in acquisition
financing and middle-market capital finance. As early Hybrid
Capital investments have matured and track records have been built,
both issuers and investors have become more comfortable with the
product class. Similarly, senior lenders have become more
comfortable with Hybrid Capital as non-leverage-impairing capital
supporting their loans.

Influx of Capital

In large part due to the market acceptance of Hybrid Capital and
investor desire for enhanced, risk-adjusted returns, the market has
seen an unprecedented amount of capital flow into Hybrid Capital
investment vehicles. A-list managers are raising funds with
double-digit billions of dollars to spend on Hybrid Capital, and
the trend of increased dry powder for Hybrid Capital has also hit
middle-market and lower-middle-market funds. This is evidence that
the market for Hybrid Capital has arrived and, in a self-fulfilling
way, evidence that it is here to stay.

Hybrid Capital as a Liquidity Solution

With today’s higher-interest rate environment, many
companies are turning to Hybrid Capital to enhance liquidity. Many
companies are refinancing debt with accruing or pay-in-kind Hybrid
Capital instruments, relieving them of the liquidity-draining
burdens of amortization and interest payments required by their
traditional debt financing. Similarly, proceeds of Hybrid Capital
are being used to fund upcoming debt payments or pay down debt in
order to obtain accommodations from lenders. Hybrid Capital’s
more traditional use as a financing tool for growth capital and
add-on acquisitions has also been boosted in today’s
environment, given its liquidity advantages over traditional debt
and its non-dilutive impact as compared to traditional equity.

Leveraged Distributions in an Exit-Challenged
Environment

The M&A market for private companies has been challenged for
several years, leaving sponsors invested in successful companies
without an attractive path to provide returns to their investors.
Hybrid Capital is one solution sponsors are turning to. It allows
portfolio companies to raise capital without ceding control, the
way a traditional equity infusion would be structured, and it
allows existing equity to retain upside growth without the dilution
associated with bringing in true equity dollars.

Special Situations

Hybrid Capital is a flexible tool that is often used to invest
in troubled companies. Interest rate increases, the recent poor
M&A market and operational challenges in some sectors of the
economy have left many companies with no viable path forward for
the current owners. Special situations investors often use Hybrid
Capital to structure rescue financing, which often includes
conversion features to achieve equity returns while retaining
priority treatment for investors concerned about potential
downsides. Increasingly, in the public markets, creative use of
conversion caps in convertible hybrid instruments can both
facilitate compliance with stock exchange rules and address
otherwise applicable SEC rules that may otherwise render a special
situation unsuitable for investment.

Conclusion

Many factors are driving the acceptance and increased use of
Hybrid Capital. Several factors, such as the influx of capital by
A-list investors and acceptance in the market, for example, combine
to suggest that the market will grow and be sustained for the
foreseeable future.


Hybrid Horizons – Hybrid Capital Market Trends

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.