Mind the gap: Funding complex deals when the bank won't go the whole way

Senior lenders are capping how much of a deal they will fund. Specialist lenders are funding the difference through junior debt, preferred equity and HoldCo loans.

Our debt advisory team talks to lenders every week, and one theme keeps coming up. Banks are still lending, within tighter limits. Concentration limits and lower leverage mean a strong deal can go to credit committee and come back short.

That shortfall usually meant finding more equity or shrinking the deal. Specialist lenders can fund that difference. The points below are relevant if you own or invest in property or run an asset-backed business whose borrowing needs have outgrown its bank.

The gap between senior debt and your equity

Few lenders provide junior or mezzanine capital, which sits between the senior loan and the owner's equity. That short supply puts the lenders who do operate here in a strong position, so how a deal is put to them has a direct effect on the terms.

Junior capital ranks behind the senior lender and ahead of your equity. It lets you borrow more against an asset without giving up ownership. Most lenders are comfortable working alongside senior debt providers, provided the intercreditor agreement (the contract setting out who is paid first and who controls what if things go wrong) is properly negotiated.

Two practical points to consider. First, lenders in this space generally want some interest paid in cash from day one. Deals where all of it rolls up (known as payment in kind, or PIK) are a harder sell. Second, a higher margin can still produce a better result for the borrower. Junior capital priced at SONIA, or base rate, plus 8%-10% costs significantly more than a bank loan at SONIA, or base rate, plus 4%-6%. If it reduces the equity you need to put in, the return on that equity can be considerably higher.

This capital typically starts at around £10m and is most relevant on larger financings. A specialist lender can also take a slice of a bigger facility, alongside a bank that has reached its own limits.

What a flexible structure can look like

Specialist lenders offer four main instruments:

• Senior debt, secured on the assets and ranking first
• Mezzanine or junior debt, filling the space between the senior loan and your equity
• Preferred equity, which receives a fixed return ahead of ordinary shareholders
• HoldCo loans, made to the holding company that owns the assets and usually secured on its shares

Depending on the portfolio's rental income, around 80% of the interest on the junior capital could be paid in cash, with the balance rolling up. Matching interest payments to rental income in this way is something a standard bank facility rarely offers.

Releasing equity to reinvest

Many owners we speak to hold property portfolios that have risen in value. Preferred equity lets them take capital out of those portfolios to fund new investments.

Preferred equity is paid a fixed return before ordinary shareholders, so its economics resemble mezzanine debt. Specialist lenders are often more willing than banks to back bespoke deals and founder-led businesses that fall outside standard lending criteria.

Opportunistic and special situations

Specialist lenders also back discounted property with a clear plan to add value, and will step into restructurings where an existing lender is reluctant to act.

Are you looking to finance?

Specialist capital is priced deal by deal. The terms you secure depend on how the deal is presented and how the layers are negotiated against each other. Small differences in structure can change your cost of capital and the restrictions you agree to.

Heligan's Real Estate and Debt Advisory teams work across banks and private credit to find and structure the right capital for each transaction. If your bank has reached its limit, or you want to release capital from a portfolio to grow, we would like to hear from you.