Nov 16, 2020

Capital without compromise

Corporate governance and equity-backed loans

As climate change and social inequality dominate the headlines, corporate governance can seem like the forgotten corner of the Environmental, Social and Governance (ESG) world. In reality, though, governance is an integral part of what is rapidly becoming the dominant investment strategy of our times.  

This historic shift of capital towards ESG will continue to drive shareholder expectations for corporate transparency, including in situations when major investors in a company use their shareholdings as collateral for financing. Boards and minority shareholders should have no reason for concern about such transactions, though. When EquitiesFirst provides liquidity to major shareholders, holding a portion of their stock as security, we aim to entirely align our interests with those of the company and all its owners. Explaining this requires that we clear up some misperceptions about equity-backed lending.  

ESG momentum

First, though, we should consider the astonishing momentum behind ESG investing. In Europe, for example, PwC forecasts that ESG assets will account for up to 57% of total mutual fund assets by 2025, up from just over 15% at the end of last year. Most of the capital invested in these funds today goes to broad-based ESG strategies rather than to those based on its components, EY also found. That should mean governance has an equal priority to environmental and social factors for the managers of these funds. [1]

Growing shareholder activism around the world is also often driven by ESG factors. ESG is the focus of a quarter of the questions raised at companies’ general assemblies in Europe, for example, and of half the resolutions submitted by shareholders, according to research by Russell Reynolds Associates. [2]

Shareholder concerns

Among corporate governance considerations, directors’ share dealings have long been acknowledged to have a particular bearing on a company’s prospects – and therefore its share price – giving rise to the obligation to disclose any changes to directors’ holdings. For companies whose stock is closely held by a majority holder, purchases or disposals by these investors can impact on the share price.  

However, major shareholders can still unlock the value in their shareholdings without foregoing their long-term positions in the underlying companies. In partnership with a lender like EquitiesFirst, they can raise flexible capital through a sale and repurchase transaction structured as a non-recourse loan. Over nearly 20 years in business, EquitiesFirst has helped hundreds of business leaders and entrepreneurs preserve their long-term legacies and controlling interests in listed companies. 

Naturally enough, though, there can be concerns when a major shareholder assigns part of their holdings to another institution as collateral for a loan. Long-term stakeholders in the enterprise may fear that the lender will make use of the shares and voting rights to influence strategy or interfere with management. This type of activism can be highly disruptive and breed uncertainty around long-term planning and leadership.  

How we operate

EquitiesFirst does not engage in any of these activities when we accept stock as collateral for a loan. Quite the opposite, in fact.  

We are a financial investor whose objective is to maintain the asset in our portfolio until loan maturity (typically three years) and return it to its owner. The way we grow our business is through executing more tranches, growing our portfolio and being given more time with the asset. In this way, we can execute a patient and disciplined management approach to our portfolio positions and earn our economics over time.  

We accept shares in companies that are well-run and sustainable. Our business model depends on orderly, rational and consistent trading in the shares we hold, which maintains their value as collateral. Although the borrower relinquishes a portion of their shareholding, they know that the shares will be returned to them when the loan is repaid and that they retain exposure to the stock’s performance and its dividends.  

In most of our transactions, EquitiesFirst would never accept more than 20% of a company’s outstanding shares and we do not seek controlling interests in any companies. In order to minimise risk, we typically execute our transactions in a series of sequential tranches. Each tranche is entered into consensually by the borrower and lender. That protects us – and other shareholders – against a scenario in which the borrower would seek to inflate the stock price ahead of taking out the loan in order to maximise its value as collateral. 

Interests aligned

All of this helps to avoid conflict between major investors borrowing against their holdings and the interests of the growing number of investors focused on corporate governance. Therefore, the interests of the borrower, lender, minority shareholders and other stakeholders can be substantially aligned.  

Essentially, it is in everyone’s interests that the company is stable and performs well. That enables the borrower to repay the loan plus interest and regain the shares. That serves the interests of minority shareholders, boards and management teams – not to mention employees and wider communities.  

Disclaimer

The foregoing is intended solely for qualified, professional investors, as may be required by law, and is not intended for, and should not be used by, persons who do not meet the relevant requirements. Information provided herein is for information purposes only and does not constitute an offer to sell (or solicitation of an offer to purchase) the securities or investments referenced herein, or provide any particular advisory services (“Offer”). Any Offer shall only be made through the relevant offering or other documentation which sets forth its material terms and conditions. The foregoing does not provide or purport to provide investment advice and has been prepared by Equities First Holdings, LLC and its subsidiaries (together, “EquitiesFirst”) based on or derived from sources EquitiesFirst reasonably believes to be reliable.  EquitiesFirst has not independently examined or verified the information provided herein and no representation is made that it is accurate or complete. Opinions and information herein are subject to change without notice. Where figures refer to simulated past performance, that past performance is not a reliable indicator of future performance.


[1] www.pwc.lu/en/sustainable-finance/docs/pwc-esg-report-the-growth-opportunity-of-the-century.pdf

[2] www.russellreynolds.com/en/Insights/thought-leadership/Documents/2020-Global-and-Regional-Corporate-Governance-Trends.pdf