medium · Private Credit & Debt 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 on the cured EBITDA, leading to 'fee inflation'.
- Equity cures dilute the lender's senior position by adding new debt-like instruments.
- The GP must commit its own capital for the cure, creating a conflict of interest.
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