We are receiving questions from market participants relating to the methodology and assumptions we apply when rating companies owned by financial sponsors. In the questions below, we highlight our key considerations relevant to assessing the credit quality of these companies.

This article accompanies our concurrently published FAQ on non-common equity: "How We Treat Non-Common Equity When Rating Companies," published Nov. 2, 2023. Or click here to view the report on our Private Markets website.

Frequently Asked Questions

How does S&P Global Ratings define financial sponsors?

We define financial sponsor-owned companies as nonfinancial corporate entities in which one or more financial sponsors own at least 40% of the entity's common equity or retain the majority of the voting rights and control through preference shares and where we consider that the sponsors exercise control of the company either solely or jointly. "Control" refers to the sponsors' ability to dictate an entity's strategy, financial policy, and cash flow. The strategic goals of the sponsors must be aligned for us to consider the sponsors to have joint control.

We define financial sponsors as entities that follow what we deem to be an aggressive financial strategy, such as using high levels of debt and debt-like financing to maximize shareholder returns. Typically, holding periods of financial sponsors range from five to seven years. Financial sponsors include private equity firms but not infrastructure and asset-management funds, which often maintain longer investment horizons and sometimes apply less financial leverage to their portfolio companies.

How do we factor financial sponsor ownership into our credit analysis?

Financial sponsor ownership directly affects our financial policy assessment and management and governance (M&G) modifiers. Additionally, the financial policy modifier informs our assessment of a company's financial risk profile for sponsor-owned companies.

Financial policy.  Financial sponsors often use various financial engineering or high debt leverage to meet investment return hurdles and amplify returns to equity. Accordingly, the financial risk profile we assign to sponsor-owned companies typically reflects our presumption of some deterioration in credit quality or steadily high leverage. Under our rating methodology, we assess the influence of financial sponsor ownership as FS-4, FS-5, FS-6, and FS-6 (minus) informed by our expectation of the aggressiveness of financial policy and assign a financial risk profile accordingly.

Generally, we will assign financial sponsor-owned companies a score of FS-6 or FS-6 (minus), leading to a financial risk profile assessment of highly leveraged under our criteria. A FS-6 assessment indicates that, in our opinion, forecasted credit ratios over the next two to three years will likely be consistent with a highly leveraged entity (e.g., S&P Global Ratings-adjusted debt to EBITDA of over 5x with modest levels of financial flexibility). In some cases, we may assign an FS-6 (minus) score for companies that we forecast to have credit ratios consistent with a highly leveraged financial risk profile, but that may also see credit metrics deteriorate materially from our forecast due to a very aggressive, sponsor-dictated financial policy.

In a minority of cases, we could assess a financial sponsor-owned entity at FS-5. This assessment will typically apply only when we project that the company's adjusted leverage will be aggressive (e.g., leverage less than 5x), and we perceive that the risk of re-leveraging beyond this level is low based on the company's financial policy and our view of the owner's financial risk appetite, with at least adequate liquidity and covenant headroom.

In even rarer cases, we could assess the financial policy of a financial sponsor-owned entity as FS-4. This assessment will apply only when all of the following conditions are met: other shareholders own a material (generally, at least 20%) stake, we expect the sponsor to relinquish control over the intermediate term, we project that leverage is currently consistent with a significant financial risk profile (e.g., leverage less than 4x), the company has said it will maintain leverage at or below this level, and we expect liquidity and covenant headroom is at least adequate.

In addition to what we expect to be aggressive leverage levels, we consider the financial sponsor's financial policy and track record. We evaluate how the sponsor's dividend policy could affect our financial forecasts and the likelihood that large or special debt-financed dividends will be paid out. We also consider the sponsor's history of maintaining the majority of its initial investment. We may also consider the sponsor's exit strategy, given that sponsors with longer retention periods are more likely to invest additional equity in the business (e.g., infrastructure funds).

We also look at other companies with the same financial sponsor ownership. Often, financial sponsors have investments in several rated companies. Reviewing the sponsor's behavior can help determine what to expect regarding either support or lack of support from the sponsor. If a financial sponsor has a successful track record of debt reduction or exhibits a less aggressive financial policy we may have a better indication of what to expect from its other companies that we rate. For larger financial sponsors with multiple funds, we may also consider the investment profile of the specific fund where an issuer is held.

Management and governance.  Our assessment of M&G encompasses the broad range of oversight and direction conducted by an enterprise's owners, board representatives, executives, and functional managers that shapes an enterprise's competitiveness and credit profile. We believe independent board oversight is a key governance factor for long-term success in balancing the interests of various stakeholders, including creditors. In our view, financial sponsors often pursue short-term aggressive business growth and financing strategies that promote their interests above those of other stakeholders, with an aggressive agenda of maximizing shareholder returns during a generally finite holding period. In practice, we typically assess the significant influence of financial sponsors as an identifiable weakness in corporate governance, unless effectively offset by a sufficiently independent board or executive management team.

Are there any exceptions to our treatment of financial sponsors in our analysis?

Under some circumstances, we may qualitatively consider the influence of financial sponsors to be less harmful to our assessment of a company's management and governance. This could be the case, for example, if there is no history of creditor-unfriendly actions, we don't believe there will be in the future, and the board includes a sufficient number of independent directors with demonstrated risk management and corporate oversight on behalf of all stakeholders. Another consideration is if there is a separation of CEO and chair roles, and whether or not one or more highly dominant shareholder representatives or the CEO overly influences the board's decision-making.

How do we treat sponsor-owned preferred stock in our ratio calculations?

We generally treat the preferred stock owned by financial sponsors as debt in our credit ratios if we believe the preferred stock lacks permanence, weakening the credit measures. For example, preferred stock instruments with exorbitantly high payment-in-kind (PIK) coupon rates represent a growing liability and are increasingly likely to be refinanced with debt in the near to intermediate term to avoid a ballooning obligation. Nevertheless, the lack of a required cash interest payment in this example benefits free cash flow generation and preserves liquidity during times of stress. This is quantitatively reflected in our reported payback credit measures and qualitatively in our financial risk analysis.

In some instances, we exclude preferred stock a controlling shareholder holds from our leverage calculations under certain conditions. We establish these conditions in our criteria for the treatment of non-common equity (NCE) financing in nonfinancial corporate entities, which applies to preference shares and shareholder loans.

Additional detail on our analysis of non-common equity and other forms of shareholder financing is found in the following criteria:

• The Treatment Of Non-Common Equity Financing In Nonfinancial Corporate Entities, April 30, 2018
• Hybrid Capital: Methodology And Assumptions, March 22, 2022
• Corporate Methodology: Ratios And Adjustments, April 1, 2019

We also published How We Treat Non-Common Equity When Rating Companies, Nov. 2, 2023.

Does S&P Global Ratings meet with financial sponsors of the companies it rates?

Although we don't require it, we encourage participation by financial sponsors when we meet with rated companies. Generally, financial sponsors tend to attend the initial management meeting for a new issuer and sometimes attend additional meetings. Engagement with financial sponsors can help improve the transparency and consistency in understanding of our rating assessment and our communication between the sponsor and management. We also look to the financial sponsor to broaden our understanding of a rated company's investment objectives and financial policy.