medium · Private Credit underwriting-credit-analysis
A direct lending manager claims 'Active Management Premium' as a source of alpha. During due diligence, an LP observes that the manager frequently uses its 'Equity Cure' rights to avoid covenant breaches in its portfolio.
Why might this be a 'Red Flag' for the LP?
- Frequent equity cures can mask deteriorating operating performance, delaying necessary restructuring and reducing ultimate recovery.
- The incentive fee is calculated using the higher 'cured' EBITDA figure, effectively inflating the fee base beyond actual performance.
- Equity cures dilute the lender's senior position by layering in new, subordinated, debt-like instruments beneath the facility.
- The GP is contractually required to fund the equity cure from its own balance sheet, which creates a clear conflict of interest for the manager.
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