The investment process

A credit fund sees far more deals than it does. Sourcing is how deals arrive: private equity sponsors looking for lenders, investment banks and advisers running a sale, and companies the fund already knows. Screening is a fast first look: does it fit the fund's strategy and size, is the leverage sensible, is the industry one the fund will lend to? Most deals stop here.

For the ones that pass, the lender sends a term sheet or indication of interest with the main terms, and starts due diligence: reading the sponsor's materials, a quality of earnings report from accountants (which tests the EBITDA and its add-backs), legal and insurance reviews, industry research, calls with management, and often calls with customers. The aim is to find what could go wrong and whether the structure protects against it.

Then comes the investment committee (IC) memo, which the deal team writes for the senior people who approve loans. A typical layout: summary (the ask and the recommendation), business (what the company does and how it makes money), investment thesis (why this is a good loan), risks and mitigants (what could go wrong and what protects the lender), financials (history and projections, leverage and coverage), structure (security, covenants, reporting), returns (pricing and expected yield) and the recommendation. A good memo is honest about the risks: every deal has them.

If the IC approves, lawyers draft the credit agreement and security documents, conditions are met, and the loan closes and funds. Then portfolio monitoring starts and lasts for the life of the loan: monthly or quarterly financials, compliance certificates showing the covenant tests, regular calls with management, and an internal risk rating for each loan. Loans that slip go on a watch list for closer attention, and the team acts early: a call, a request for a plan, an amendment, before a small problem becomes a default.

In the returns section, a quick yield figure is the coupon plus the OID spread over the expected life. On the memo below: SOFR 4.25% + 5.75% = 10%, plus 2% ÷ 3 years, about 10.7%.

IC MEMO: Northgate Pet Supply (a made-up company)
$60,000,000 five-year unitranche to fund a private equity buyout

1 Summary      Lend $60m, first lien on all assets. Recommend approve.
2 Business     Distributes pet food to 1,400 independent stores in
               six states; 18 years trading; top customer is 3%.
3 Thesis       Steady demand, many small customers, and the sponsor
               puts in equity worth about 45% of the price.
4 Risks        We see no meaningful risks in this credit.
5 Financials   Revenue $210m, EBITDA $14m (three audited years),
               leverage 4.3x, interest coverage 2.3x.
6 Structure    Max total leverage 5.25x, tested every quarter;
               monthly financials; no dividends while over 4.5x.
7 Returns      SOFR + 5.75% (SOFR 4.25%), 2% OID: about 10.7% a
               year over an expected three-year life.