What Is Capital Solutions? Bridging the Gap Between Debt and Equity

There is an old parable about blind men and an elephant. Each touches a different part of the animal, and, naturally, each arrives at a wholly different conclusion about what it is. Capital Solutions can feel rather similar: speak to a restructuring lawyer, and you will hear about rescue financings and liability management; speak to a private equity partner, and the conversation will turn to hybrid capital structures and DPI generation; and speak to a funds specialist, and the discussion will centre on NAV facilities and continuation vehicles. Each perspective is valid, though none is complete.

This article—the first in our series—attempts to describe the whole animal. It is intended primarily for those working on the "live" side of private capital, namely, the providers of debt and equity who have heard the term "Capital Solutions" with increasing frequency, but have not yet had occasion to examine precisely what it means or why it has emerged as a distinct discipline.

The Gap in the Capital Structure

Put simply, "Capital Solutions" refers to bespoke financing that occupies the space between traditional senior secured debt and common equity.

That formulation is straightforward enough. But it is worth pausing on why this space exists and why it has grown so markedly in recent years.

For much of the last two decades, European leveraged finance operated on a relatively binary model: a company seeking acquisition finance would obtain senior secured debt (whether syndicated or, increasingly, from direct lenders), alongside mezzanine (and possibly other junior) layers of debt. The remainder of the capital structure would be funded by sponsor equity. All of these instruments were largely standardised, and the market participants understood them well.

What has changed is not the existence of the gap, but its width. Several structural forces help explain why this gap has widened. European banks, subject to successive waves of capital, liquidity and leverage regulation under Basel III and its progeny, have pulled back from sub-investment-grade lending more aggressively than their US counterparts. Europe's institutional loan and bond markets have historically been less deep, less liquid, and less consistently accessible than their US counterparts. As a result, when traditional banks retreat, there have been fewer scalable alternatives to take their place, particularly for complex, subordinated or hybrid capital needs. Private equity sponsors are also holding portfolio companies for longer, whether because of muted exit activity, geopolitical headwinds or reluctance to crystallise losses by selling at depressed valuations or because they now have the flexibility to hold out on good assets for a better return. Each of these situations requires forms of capital that are neither pure debt nor dilutive equity.

Capital Solutions is the market's response to that expanded gap and to the growing need (and demand) for more tailored and flexible capital structures ̶ whether to fuel growth strategies, to deal with specific issues or to provide liquidity solutions (for example, to deal with succession or minority issues).

What the Instruments Look Like

In practice, Capital Solutions encompasses a range of instruments, each tailored to the specific circumstances of the transaction. These include:

• Junior or Holdco PIK debt and other forms of subordinated debt, where interest is capitalised rather than paid in cash, reducing pressure on operating company cash flows;
• Preferred equity, which is more precisely described as equity enhanced through contractual priority and structured economic rights, providing investors with a fixed return, liquidation preference, and agreed information and governance rights but without the creditor remedies that attach to debt;
• Hybrid, convertible and exchangeable securities, which combine elements of debt and equity in a single instrument, offering investors downside protection through contractual coupons alongside upside participation through conversion or equity kicker mechanics;
• Structured warrants, options and synthetic arrangements; and
• Fund-level financing solutions, including NAV facilities and subscription lines.

The common thread here is simply function over form. Each instrument is designed to provide capital at a specific point in the structure where traditional senior financing or common equity simply does not fit, on terms which are privately negotiated and bespoke to the situation at hand.

Why It Matters

Capital Solutions transactions do not exist in isolation from the senior debt that sits above them and the common equity that sits below. They interact with all instruments within the capital stack, through intercreditor arrangements, contractual restrictions, and the economic incentives they create for sponsors and borrowers.

For example:

• Preferred equity rights at the Holdco level may require upstreaming of funds through the group structure to service the preferred return, requiring careful structuring of baskets and restrictions in senior financing arrangements; or
• A hybrid instrument with conversion rights may alter the ownership and control dynamics of the borrower group in ways that engage change of control provisions or alter the trajectory and liquidity strategy of a given business.

Used well, these structures can bring advantages for the entire capital stack; for example, by providing additional funding to finance an acquisition strategy or enhancing growth and equity returns without increasing the overall leverage profile of the relevant company in a manner that could put the company at risk from an even modest downturn in performance.

Understanding Capital Solutions is therefore a practical necessity for those who need to know what is happening in the layers of capital beneath, above, or alongside their own position. It is an area demanding expertise from experienced practitioners who see a broad range of transactions across the space.

Why Bespoke Documentation is the Norm

It is worth noting a feature of Capital Solutions work that distinguishes it from much of the European direct lending market. There are no LMA recommended forms for preferred equity. There are no standardised intercreditor templates for Holdco PIK sitting behind a unitranche. The Loan Market Association's comprehensive documentation suite (which provides the architecture for the vast majority of European syndicated and bilateral lending) was not designed for these instruments and does not extend to them.

This means that every Capital Solutions transaction requires its documentation to be built, in large part, from first principles. The terms governing priority, enforcement, governance, information rights, exit mechanics and downside protection must be individually negotiated and carefully calibrated, adding a further dimension of documentary complexity that demands close attention.

Where Mayer Brown Sits

Capital Solutions is not a new practice area at Mayer Brown. It is a new label for the convergence of disciplines that our platform has long possessed. Our market-leading cross-border structured finance, leveraged finance, restructuring and private equity practices are precisely the capabilities that Capital Solutions mandates draw together, providing the jurisdictional depth that these complex, multi-layered transactions demand.

In the articles that follow in this series, we will examine the specific instruments in detail: preferred equity and hybrid capital, sponsor liquidity and DPI generation, liability management and special situations, cross-border structuring, and the broader rise of private credit. Each piece will seek to do what this introductory article has attempted: to explain the legal and commercial issues clearly and precisely.

Capital Solutions is, ultimately, about providing the right capital, in the right form, at the right point in the structure, at the right time. The fact that this requires lawyers who can think across traditional practice boundaries is what makes it both intellectually demanding and commercially rewarding.

Michael Fiddy is co-head of Mayer Brown's global restructuring practice. Chris Street is a senior associate in the restructuring group in London. Mark Evans and Electra Callan are partners in the firm's private equity group in London. All are members of the Capital Solutions team.

This is the first in a series of articles on Capital Solutions from Mayer Brown. The next will examine preferred equity and hybrid capital in detail.