For FC Capital, short-term loans must contribute to long-term growth

We are in a unique cycle at the moment. The last 12 months hasn't been observed in our generation, nor the generation before us. We had rate rises almost every month. And for businesses, that's also a unique scenario, where you couldn't really plan with your borrowing costs. You have to plan now. 

You probably have three categories of borrowers at the moment. One is an investment grade market, where you're digesting a much higher base rate on a margin you saw just a fair margin. And now overall, the costs are probably tripled. So there's a question around 'how much do I want? Can I digest this? Should I take more?'

On the other element of the marketers, we have borrowers which are always used to these costs. You have a growing business in our segment. For the small and lower middle market, getting capital is always often hard. On the debt side, it got a little bit more expensive, but the alternative equity is so now, you value debt over equity. I'll probably say as a business owner, you would value your equity more than the debt you're getting. So if you have the right business model and you setup the business correctly and you have the right capital partner like a funder like us, you say, "Well, it's worthwhile having this type of capital on board and paying for it."

The third last category of borrowers is probably the ones who are struggling right now. And that's often where you already had high debt levels conceptually before the last 12 months happened. So any increase or hiccup in rates would've caused a problem and is causing a problem now. So where business probably get out of it by getting more equity, raising more capital, reducing the debt levels, or they will default. So what it means for us is we are playing in a cycle. If it's a cycle like pre COVID, after COVID, we looked at opportunities during COVID. We didn't really find a lot of attractive opportunities during COVID, but there's always an angle of investing, providing capital into the market. How we do it and how we select the borrower, that's a different story. So would I select a business which is majorly exposed to consumer spending at the moment as a potential borrower? Probably not. Would I select a business which is a regulated business like a healthcare business or a pharmaceutical business where I have stable cash flows? I'll say yes. It's still a good borrower, and I see growth in the market.

LW: How do short-term loans promote long-term growth?

So it really depends on how you do your due diligence and what you're going to invest in. Our capital serves the purpose. So it serves the purpose, not necessarily being the permanent capital. So I don't want to sit here with the borrower 10 years later and still look at the same amount of debt, the same costs. I think if this happens, something went wrong. So I think private debt can and will play an essential role in growing businesses, especially in our space, small or middle market, where ideally, most business owners want to see themselves in the next element of the market, be it the lower middle market or be it the middle market or the upper middle market.

So to get there, you need capital and basically a growth story. If you look into the EM, private equity space is three to five years. Usually, that's timeframe you need to incubate a business arm, business idea, business strategy. And that's where we come in. We say, "Look, that's our sweet spot. Three to five years, that's the capital we can make available." It'll help grow the business. It'll be there. It'll facilitate a execution strategy. In the end, I see ourselves exiting business.

We have done it in previous transactions, where we replaced a house bank, provided a senior facility. We upped the senior facility, and we got repaid after two years by the house bank in the way that we subordinated a quarter of our exposure as being mezzanine debt to facilitate an exit, which got repaid over six months. Three months later with that business, we bought their competitor and provided a senior piece on the acquisition, which then got flowed into their existing exposure with the house bank. So that's how we play. So we provide the capital, which is not obtainable by the banks, the riskier part of the capital. But we always get the equity support, which comes with our capital to facilitate this transaction or this opportunity the business usually has.

LW: How are investors rewarded for taking on liquidity risk?

Talking about liquidity in a private debt market, I would always say, "Look, if somebody asks on the private debt market for liquidity, you look in the wrong space." That's why it's a private market. That's why there's no liquidity. You may find you have secondaries on the larger funds, where you can have secondary liquidity when we talk about the really large funds. But usually we are doing factor as in the returns required on the investor side, factor in the illiquidity of their investment essentially.

And how I would compare it is compare the private equity space to the private debt space. Super illiquid over years, no returns until there's an exit or a liquidation event of your position. In our space, I would even say we have liquid in the sense that we pay distributions. Private debt, if done the right way, has a monthly, quarterly, semi-annual distribution. So there's liquidity there, not necessarily liquid underlying, but that's what you get a premium for. And usually, in any instrument you would price in our space would have a liquidity premium factored in.