Leveraged Finance

Looking to maximise capital efficiency through large-scale mergers, and acquisitions? Leveraged finance is a solution that can provide the funding needed to support large transactions like this.

If this is an option you’re interested in exploring, Clifton Private Finance is positioned to be your partner for high-value capital funding.

Our established relationships with banks and lenders in the leveraged finance market, combined with our expertise in debt financing give you the access and support you need to manage high-value projects from concept to completion.

What is Leveraged Finance?

Leveraged finance (LevFin) is high-value capital where the level of debt relative to equity is greater than traditional corporate finance. It is used to fund major deals that are focused on higher-risk, higher-return transactions.

With a structure that balances debt size primarily against cash flows and future business performance, leveraged finance is suitable for acquisitions, takeovers, and business recapitalisation where the capital need exceeds the value of tangible assets.

LevFin enables you to combine your own equity with larger amounts of debt finance to undertake a significant transaction.

Financing transactions of this level represent a significant risk profile, most suitable for debt investors who specialise in risk-adjusted returns in leveraged credit markets.

Careful assessment and management are vital parts of leveraged finance, ensuring that lender concerns are mitigated through deal structuring.

Clifton Private Finance can provide a bespoke framework for your leveraged finance, assessing the marketplace for suitable lending partners and calibrating the deal for both senior and mezzanine levels.

The Benefits of Leveraged Finance

Leveraged finance offers you a way to make the most from capital and equity, opening up larger transactions and a wider portfolio of risk profiles. It maximises equity, enabling you to secure investment opportunities that would otherwise be out of reach. This can be seen by comparing two potential structures, one narrow, the other wide.

An Example of the Benefits of Leveraged Finance

Consider a company, XXX, with £40 million of available capital, looking to expand through acquisition. Without debt support, the financial leverage of such a company is limited. With leveraged finance, it balloons significantly.

Alone, XXX can purchase a £40m company outright. It will not have to repay debt and can use profits to grow the new business or support its own. However, its returns are limited. Should the company increase in value, the equity will have grown accordingly, though the capital’s potential is capped in direct correlation to that performance.

Not only that, but with a single acquisition that encompasses the entire investment capital for XXX, the risk is extremely focused. If the new company performs poorly or fails entirely, that equity is lost.

Alternatively, XXX can look to split its capital to purchase multiple companies, leveraging those companies’ cash flow to obtain LevFin funding. With the potential for high equity to debt ratios, the core £40m fund could be split multiple ways.

Through leveraged finance, the capital is deployed far more effectively, and the risk is shared more appropriately.

Leveraged finance offers:

• Opportunity to undertake more significant acquisitions
• Diversification of risk
• Greater capital potential

The Main Uses for Leveraged Finance

Leveraged finance is a funding solution for high-impact transactions, not operational expenses. Each deal is individual and structured with both medium-term repayments and a defined exit, either through refinancing or sale.

Its primary applications include:

• Leveraged buyouts (LBO) - A leveraged buyout is when a company acquisition uses a majority debt finance stake relative to equity. The target company assets and cash flow underwrite the funding, aligning performance with lender risk appetite. LBOs facilitate both new acquisitions and private takeovers of public companies.
• Mergers and Acquisitions (M&A) - In M&A, when a business expands through absorption or takeover of a competitor, LevFin is a valuable solution that provides essential speed and funding clarity. In competitive acquisitions, demand may increase EBITDA multiples used for valuation, raising the capital required and, by extension, the relevance of leveraged finance.

• Recapitalisations - Companies looking to reacquire shares or leverage the company to pay shareholder dividends can look to LevFin to provide necessary capital.
• Refinancing Debt - Well-structured leveraged finance can provide an effective refinancing option for current debt, including existing LevFin reaching the end of its term. In the latter case, an up-to-date evaluation of EBITDA can boost the business credit profile, improving pricing and releasing trapped equity.
• Capital Expenditure - While leveraged finance is a poor fit for day-to-day CAPEX, transformational capital expenditures that will significantly increase EBITDA may be suitable for LevFin. Examples include expanding manufacturing facilities or entering adjacent markets.

Leveraged finance is typically applied by private equity firms using LBOs to maximise capital efficiency, and larger corporates for M&A strategies and refinancing.

Typical Instruments Used in Leveraged Finance

Most leveraged finance is not a single loan. While single facility ‘unitranche’ structures may be suitable, the majority of LevFin involves a combination of debt instruments that are layered in multiple tranches, each priced according to risk and repayment priority (seniority).

When structuring a LevFin deal, Clifton Private Finance explores the market to assess lenders’ appetites, coordinating tranches and matching capital to seniority to reflect lender risk tolerances.

Core leveraged finance instruments include:

• Senior Secured Loans - At the lowest risk level in the capital stack, term loans form the backbone of many leveraged finance deals, providing the core capital that is often lightly amortised throughout the term prior to exit.
• Revolving Credit Facilities - While RCFs do not provide capital for the main leveraged transaction, they exist alongside the senior bank debt to provide an essential liquidity cushion. Well-managed LevFin often aims to keep an undrawn facility at the exit point to avoid unnecessary refinancing.
• Unitranche Facilities - A single blended loan may be used to simplify the capital structure in some deals. These combine senior and mezzanine characteristics when more complex tranche structures are unwanted.
• Second Lien Loans - Higher-priced secondary secured debt can be used to increase leverage before applying mezzanine level funding.
• Mezzanine Debt - Sitting below senior and second lien debt, mezzanine facilities provide lenders with a higher expected return for greater risk. Mezzanine debt structures can vary, with PIK (payment-in-kind) arrangements and equity warrants used at this level.
• High-Yield Bonds - Larger leveraged transactions may include public debt in the form of high-yield bonds issued in capital markets. These are typically offered at a fixed rate and are generally less restrictive than senior bank debt.
• Bridging Facilities - In some cases, bridging finance can provide short-term temporary funds pending bond issuance.

How Leveraged Finance Can Increase Equity Returns

Leveraged finance increases capital effectiveness, improving return by lowering equity deployment. The following illustrative example explores the core concept through two simplified scenarios.

In each, the goal is to acquire a company valued at £100 million that is predicted to grow to a £150m company in five years.

Scenario 1 - All Equity, No LevFin Buyout

With no leveraged finance, the buyer provides the full £100m as equity.

• Investment used (equity): £100 million

When the business grows as expected, the company is sold for £150m.

• Proceeds from sale: £150 million
• Gain (proceeds less investment equity): £50 million

This provides a return on equity of 50% (gain / investment).

Scenario 2 - 25% Equity, 75% LevFin LBO

In the second scenario, leveraged finance provides 75% of the capital required, with the buyer only needing to use £25m to secure equity.

• Investment used (equity): £25 million
• LevFin used: £75 million

Once more, the business grows and is sold for £150m. At this exit point, the LevFin is repaid.

• Proceeds from sale: £150 million
• LevFin repayment: £75 million
• Profit (proceeds less repayment): £75 million
• Gain (profit less investment equity): £50 million

Here, the return on equity is 200% (gain / investment).

This simplified illustration shows how leveraged finance can increase capital efficiency. However, consideration must be given to risk - should the company value fall, equity losses would be magnified following debt repayment.

Leveraged Finance Asset Classes

The leveraged finance market comprises three primary asset classes: leveraged loans, high-yield bonds, and collateralised loan obligations (CLOs). These classes interact to create both direct funding and market liquidity to raise and distribute capital.

Leveraged Loans

Leveraged loans represent the largest and most liquid segment of the leveraged finance market. These are typically floating rate senior loans that are secured against company assets.

As senior finance they are:

• First repayment priority
• Lower relative risk
• Lowest return, relative to mezzanine and second lien

Leveraged loans are often purchased by institutional investors, such as pension funds and CLO managers.

High-Yield Bonds

Publicly issued debt securities, high-yield bonds, are used to raise capital through wider capital markets as an alternative to bank-arranged loans.

These are typically unsecured, with a fixed rate and longer maturity, sitting below senior debt in the capital stack.

They represent:

• Secondary or tertiary repayment priority
• Greater investor risk
• Higher yield than senior leveraged loans

High-yield bonds are purchased as a higher-risk/higher-return option by asset managers, insurance companies, and institutional bond funds.

Collateralised Loan Obligations (CLOs)

As part of the structured finance market, CLOs are one of the largest buyers of leveraged loan portfolios. Their activity provides essential liquidity to the LevFin market that supports depth of demand, capacity, and scale.

For companies seeking leveraged finance, direct interaction with CLOs is not required.

Structured Finance vs. Leveraged Finance

Leveraged finance is funding designed for acquisition or targeted expansion. It exists to facilitate M&A, LBOs, and specific CAPEX with long-term investment potential. It concentrates capital and structures risk to execute a large-scale transaction.

In contrast, structured finance is a method of raising capital by packaging financial assets into securities. It redistributes risk through pooled assets and issued securities.

These two high-value funding methods do not compete, but are complementary. In some cases, structured finance is used as an exit strategy to refinance leveraged finance at the end of its term.

Corporate Finance vs. Leveraged Finance

Leveraged finance is a subset of corporate finance, specialising in high-leverage, performance-driven acquisition funding.

As a corporate finance broker, Clifton Private Finance provides market access and financial execution through expertise in multiple corporate finance tools, configured to meet our clients’ financial strategies.

Speculative-Grade Debt vs. Investment-Grade Debt

Speculative-grade debt is provided to companies with:

• BB+ / Ba1 credit ratings or below
• Higher risk of default
• Higher yield

Investment-grade debt is provided for:

• BBB- / Baa3 and above credit ratings
• Lower risk of default
• Lower yield

By its nature, leveraged finance is typically speculative grade, as it represents higher leverage debt relative to cash flow. Conversely, investment-grade debt is a more conservative proposition, leading to a larger pool of institutional buyers.

This is reflected through risk-based pricing, with speculative-grade borrowing relatively more expensive for corporations seeking leveraged finance.

Key Participants in the Leveraged Finance Market

The leveraged finance market comprises a wide range of parties, each performing a distinct role. These include:

• Corporate borrowers - These are the mid-market and large companies, including sponsor-backed businesses, seeking leveraged finance to execute a large-scale transaction.
• Private equity firms - Financial sponsors provide the equity and drive acquisition strategy alongside the corporations, often using LBO structures to improve capital efficiency.
• Investment banks - Banks and arrangers structure and underwrite leveraged loans, pool and syndicate debt to institutional investors, and coordinate bookbuilding to market high-yield bonds.
• Institutional investors - Pension funds, insurance companies, asset managers, credit funds, and hedge funds purchase the leveraged loans and high-yield bonds, and invest in CLO tranches that constitute the assets of the leveraged finance market.
• CLO managers - CLO managers purchase leveraged loans and structure special purpose vehicles that support liquidity to the market.
• Alternative credit funds and direct lenders - Private credit funds can compete with banks, often offering unitranche facilities and supporting sponsor-backed deals.

Clifton Private Finance works with the many parties that make up the leveraged finance marketplace, sourcing capital and structuring proposals to coordinate high-value leveraged finance deals for our clients.

Secure Leveraged Finance with Clifton Private Finance

Clifton Private Finance supports your business in securing the leveraged finance it needs. Our experienced advisory team will work alongside your CFO to develop a comprehensive strategy for M&A or LBO transactions, exploring the market and negotiating with the institutions that provide the debt support that will optimise your capital.

As your leveraged finance partner, we’ll guide you throughout the process from the first consultation through to exit. Book a consultation with us today.