Traditional banks have been lukewarm when it comes to deploying capital in the healthcare industry—a sector known for its regulatory complexities and reimbursement risk even during the best of times.
It should come then as no surprise that the period during the recent U.S. financial crisis was particularly difficult. Credit tightened significantly, leaving small and mid-sized healthcare providers and vendors scrambling to finance their growth strategies. The healthcare reforms that followed only served to heighten uncertainty, exacerbating the issue.
Challenging conditions aside, lending did not dry up completely. In fact, compared to other sectors at the time, total healthcare M&A activity fared relatively well. What the overall numbers obscure, however, is the amount of extra effort that was required to secure much-needed financing. With fewer lenders specializing in the industry, healthcare vendors and providers were forced to approach multiple lenders to successfully complete their deals.
A Variety of Financing Remedies
As credit conditions may be poised to tighten again, the BDC (Business Development Company) business model appears to offer an important advantage over traditional lenders: a wider range of financing solutions.
Leading BDCs enjoy diverse sources of liquidity, ranging from secured/term debt and SBIC financing to securitization financing and long-term credit facilities. Since each pocket carries its own cost and covenants, well-established BDCs are able to offer a superior product suite that runs from low multiple, senior secured debt all the way to straight unitranche or mezzanine finance.
Traditional banks, on the other hand, are prohibited from offering one-stop financing or unsecured lending. For companies looking for a streamlined and efficient way to access a comprehensive array of financing alternatives, working with a BDC can remove some of the headache—and execution risk—that stems from dealing with multiple lending partners.
BDCs May Be the Cure
Structural dynamics and demographic trends tend to drive a continuous need for financing in the healthcare industry, whether to underwrite mergers and acquisitions or fund capital expenditures. Yet, unique risks—from strict regulation and a heavy emphasis on government payment sources to the idiosyncrasies of healthcare receivables—create a steep learning curve.
That is why healthcare companies require stable lenders with a strong, ongoing commitment to the sector. They need financing partners who possess the insight and wherewithal to lend—even during difficult market environments. With its sole mission to facilitate private financing to small and mid-sized businesses, the BDC is better positioned to meet this mark.
Established by Congress to foster small business growth, BDCs are obligated to offer to provide managerial assistance. Because of this, BDCs industry knowledge tends to run more than surface-deep—a stance that underscores their position as a more suitable lending partner. In fact, it is not uncommon for top-tier BDC professionals with a healthcare specialization to speak at industry conferences, attend Congressional testimony and keep highly regarded industry consultancies on permanent retainer.
Consider a Specialist
BDCs’ distinctive model confers certain benefits, such as an authentic underwriting specialization in industry verticals like healthcare. With a deeply honed, industry-specific underwriting expertise, BDCs may be better equipped to differentiate between good credits and riskier ones—a far cry from the conservative, one-size-fits-all approach that many traditional lenders take. For instance, it is not uncommon for a bank to broadly categorize healthcare lending as ‘real estate lending’ as opposed to ‘business lending.’ From this standpoint, it is not hard to see why the sector suffered during the last downturn.
It appears that BDCs’ strong focus on underwriting discipline has borne fruit. For example, over the past five years, the average cumulative loss rate for BDCs was only 111 basis points (bps) per year—a figure that stands considerably below the 155 bps per year that banks have averaged.
Looking ahead, if the U.S. economy enters another soft patch and credit conditions deteriorate, a select group of BDCs seem better positioned to continue to support this sector. In addition to their flexible financing solutions, many BDCs have used the intervening years since 2008-2009 to shore up their balance sheets.
These niche players can also draw upon hard-earned underwriting expertise to analyze underlying company fundamentals—increasing the likelihood of successful deal completion.
Get a Referral
When considering a BDC specialist, it should be emphasized that they are not all the same. Some BDCs experienced difficulties during the recent economic downturn when reliance on short-term revolving bank facilities left them stranded. When looking at a prospective BDC, companies would be wise to choose one with modest balance sheet leverage, diverse sources of funding, a meaningful hold size and significant ongoing capital availability.
Greg Browne is Managing Director at Fifth Street Finance.