Everyone wants what they can’t have. And it is so hard to let go of the past.
As you know, I spend a lot of time trying to help sponsors find capital and, at the same time, trying to help investors with capital put it to use. This leads me to hear the laments of all sides.
The prospective investor invariably seeks to invest in things that are hard to get, i.e., a really nice and pretty safe preferred equity or high-yield debt piece where heads they win and tails they also win. Perhaps a 15% to 20% IRR ahead of a good chunk of sponsor equity.
And the sponsor seeks the exact opposite; namely, a nice 90/10 or even 95/5 deal where the investor and the sponsor are pari passu.
Well it just ain’t happening no more!
Okay, I am exaggerating. Of course it is happening, but it has gotten a lot harder to make it happen. Even major – super cool – sponsors are having a tough time finding an investor teammate. And those with capital are shunning risks they don’t have to take. So where does this leave us? It leaves us in the land of what I would call:
Deal Structuring 2.0
This means that no one gets exactly what they want, but with some creativity, deals can still happen.
What does this mean?
It means that the parties – and their lawyers – need to earn their keep in putting deals together. To this end, my partners and I put together (internally) a Toolbox of ideas for deal structuring where there is capital sought. There are a fair number of ideas in the Toolbox – here are a few.
Some ideas are super simple.
For example, if there is a need for, say, $50M in equity and the sponsor wants to put up $5M and get the other $45M from the investor, consider if $25M is preferred equity to shrink down the overall need for equity. The remaining equity is now only $20M and the sponsor’s share is 20%. Yes, that is super simple and you hardly need my brilliance to put that together.
Other ideas are still super simple but less obvious.
For example, consider making the sponsor’s piece 25% of the deal, i.e., $12.5M, and have the sponsor still contribute $5M and the remaining $7.5M come from a GP capital provider. This may partially dilute the sponsor’s promote (depending on the internal promote split within the GP); however, the LP might like this more.
Another simple idea is to push for a so-called stretch senior. This may cut the equity need from $50M to $25M and up-size the sponsor’s percentage to 20%, albeit with a higher interest rate. The overall cost might still be less than an LP would demand.
Other ideas are trickier to effectuate.
As an example, consider ground lease structuring. This is pesky to put together, but can unlock a great deal of dollars that are otherwise hard to find.
Another example is PACE financing. No one was thinking about it a few years ago, but now it is on the table.
And the government taketh (quite a bit), but sometimes it giveth as well. Accordingly, sometimes Tax Incentive Financing, aka a TIF, or other governmental incentives, can plug a financing gap.
Finally, I mention that Crowdfunding, EB-5 funding, Opportunity Zone investment, and similar areas are still around.
The foregoing thoughts are stated from the point of view of the sponsor, but a lot of this can also come from the investor as well. When approached for “plain old” 90/10 financing, suggesting ideas for different structures makes a lot more sense than just passing on an otherwise good transaction with a good sponsor.
Perhaps some of the ideas I threw out above may seem obvious, or pretty obvious; however, it often surprises me how parties miss these ideas, likely because they are used to the 90/10 structure.
And finally, I always think of it as a personal – intellectual – challenge to come up with creative structuring ideas for a project. As long as the overall pricing is agreed to, the structure should never stand in the way.
Bruce Stachenfeld aka The Real Estate Philosopher®