Hedge fund lending is increasingly common. Hedge funds still have large amounts of uncommitted capital that they are looking to put to work. Some companies, especially middle-market ones, are finding fewer avenues for loans. Hedge funds are filling this void.
Hedge fund lending is unlike traditional bank lending. Hedge funds are sophisticated entities prone to using creative lending structures, and they are not afraid of taking risk. Hedge funds are willing to lend when others are not— a valuable service, to be sure. But hedge funds expect higher returns. The desire to take risk and earn higher returns has led to complaints that hedge funds take advantage of companies and charge exorbitant interest rates. Hedge funds may also create complex financial structures, which may turn out to haunt the borrower.
More often than not, hedge funds demand a significant percentage of a company's stock either outright or in options or warrants. The interest rate charged by hedge funds can also fluctuate significantly being tied up to a company's performance or other triggers. This is far from your typical subordinated debt deal, where a lender simply lends money at a rate of interest.
Companies seeking capital from hedge funds should employ extreme caution. The terms and structures are simply not typical of what commercial banks offer. Hedge fund lending is a more sophisticated game. Part of this is because the companies in need of the loans are riskier because of their smaller size or distress. It is also because hedge funds are willing to push the edge in terms and structure. Smaller and distressed companies may simply lack the experience and wherewithal to deal effectively with hedge funds. They also may be too stricken to bargain effectively or capably.
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