How to Use LPACs and Third‑Party Valuation Providers to Mitigate the Inherent Risks of Captive Debt and Equity Investing (Part One of Two)

PE sponsors develop expertise about industries and specific companies when their funds purchase portfolio companies. Much of that expertise goes to waste, however, when it is limited to equity investments in those areas. In response, many sponsors seek to leverage that knowledge by launching private credit funds that, in addition to lending to unaffiliated third parties, are authorized to provide financing to the same companies in which their PE funds hold equity stakes. Although it is a perfectly logical tactic from a business perspective, the practice introduces a number of legal and compliance risks that sponsors need to actively guard against. To help our subscribers identify and mitigate risks associated with pursuing captive debt and equity investments in the same company, the Private Equity Law Report gathered insights from a number of industry experts on the topic. This first article in a two-part series briefly addresses certain risks of captive investing and explores how third‑party verification of terms (e.g., valuation firms) can mitigate risks. The second article will describe how sponsors can reduce their stake, role in negotiations and ongoing management of a captive debt investment to avoid the inherent risks of captive investing. See our two-part series on simultaneous management of PE and private credit funds: “Use of Walls and Other Tactics to Manage MNPI Risks” (Nov. 3, 2020); and “Techniques for Properly Allocating Investments, Fees and Employees” (Nov. 10, 2020).

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