acquisition financing: evaluating layers of capital, negotiating loan terms...

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Presenting a live 90-minute webinar with interactive Q&A

Acquisition Financing: Evaluating Layers

of Capital, Negotiating Loan Terms,

Navigating Regulatory Developments

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, DECEMBER 17, 2015

Lawrence F. Flick, II, Partner, Blank Rome, New York

Kelly M. Dybala, Partner, Sidley Austin, Dallas

S. Randy Lampert, President, Lampert Debt Advisors, New York

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December 2015 | 5

L A M P E R T D E BT A D V I S O R S

Randy Lampert President

[email protected]

30 years of experience, over $15 billion of debt financings completed for over 60 clients

Experience across a broad array of industries including technology, telecommunications, financial services, industrial, and consumer/retail

Co-founder of Debt Capital Markets Group and Head of Business Development at Morgan Joseph

Founder and Head of Leveraged Finance at Nomura Securities

Lampert Debt Advisors is a boutique investment bank specializing in arranging debt financing for privately-owned, sponsor-backed and publicly-traded companies

December 2015 | 6

M I D D L E M A R K E T AC Q U I S I T I O N F I N A N C I N G OV E RV I E W

Uber-competitive environment for attractive assets is driving valuations to all time highs…

…and resulting in leverage levels not seen since the halcyon days of 2007…or is it the other way around??

Leverage Multiples

5.4x

3.9x 3.9x4.2x

4.6x4.8x 4.9x

5.1x 5.0x5.3x

2007 2008 2009 2010 2011 2012 2013 2014 1Q-3Q15 3Q15

FLD/EBITDA SLD/EBITDA Other Sr Debt/EBITDA Sub Debt/EBITDA

Purchase Price Multiple

9.3x

8.3x

6.6x

8.4x 8.2x 7.9x

8.8x

9.6x

10.7x

12.1x

2007 2008 2009 2010 2011 2012 2013 2014 1Q-3Q15 3Q15

December 2015 | 7

TO O M U C H C A P I TA L , C H A S I N G TO O F E W D EA L S Dry powder abounds for both private equity sponsors and lenders, alike; however acquisition-related volume has been relatively soft

…creating a favorable pricing environment for borrowers

A lack of M&A activity has led to weak year-over-year acquisition related loan volume

Pro Rata and Institutional Leveraged Loan Volume

$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

Institutional Pro Rata

$ in billions

Pro Rata and Institutional Spreads

L+0

L+100

L+200

L+300

L+400

L+500

L+600

L+700

Pro Rata Institutional

December 2015 | 8

A S S E T - B A S E D LOA N S R E M A I N A K E Y C O M P O N E N T

Footnotes: (1) Data for 3Q14 unavailable; (2) Data for 4Q14 unavailable

ABL volume increased significantly in the 3Q15 reaching $15.7 billion

3Q15 spreads averaged L + 164 bps, Commitment fees ticked up slightly in 3Q15 to 35 bps

Intense competition amongst banks for asset-based facilities has resulted in extraordinarily favorable pricing for borrowers

Volume and Number of Deals ($ in billions)

$33

$21

$16

$13

$25

$19 $20 $20

$3

$7

$16

0

10

20

30

40

50

60

70

80

90

$0

$5

$10

$15

$20

$25

$30

$35

2007 2008 2009 2010 2011 2012 2013 2014 1Q15 2Q15 3Q15Volume Number of Deals

Average ABL Spreads (bps)(1)

L+000

L+050

L+100

L+150

L+200

L+250

L+300

L+350

L+400

L+450

L+500

December 2015 | 9

P R E VA I L I N G T R E N D S The prevalence of non-bank lenders, such as BDCs and private debt funds, combined with regulatory constraints impacting commercial banks, has underpinned the shift away from traditional bifurcated debt structures

Observation Commentary

Unitranche becoming more commonplace • Ease of execution combined with attractive pricing make unitranches very competitive • AAL rather than intercreditor • Pricing of L + 650 – 1000 depending on the credit

• Forcing junior capital (2nd lien / mezz) providers to be more flexible in order to win mandates • Tighter pricing, fees • 30-35% covenant cushions • Greater intercreditor flexibility

Covenant flexibility • Cushions of 25%+ for first lien and unitranche

Availability of delayed draw facilities for Acquisitions • Typically limited to 12-18 months for banks, longer for non-bank lenders

• Net neutral impact on pro forma leverage • Conditioned on prenegotiated metrics, e.g. purchase multiple,

line of business, geography, etc.

December 2015 | 10

P R E VA I L I N G T R E N D S The prevalence of non-bank lenders, such as BDCs and private debt funds, combined with regulatory constraints impacting commercial banks, has underpinned the shift away from traditional bifurcated debt structures

Observation Commentary

Impact of leveraged lending guidelines • Tangible impact on banks’ appetite for leveraged credits • 3.0x senior / 4.0x total leverage for domestics • 3.5x – 4.0x senior / 5.0x – 6.0x total for foreign banks

Required Due Diligence • Quality of Earnings from reputable firm is almost universally required

• LDA has recommended clients engage the accounting firm early in the process to accelerate the closing timeline

December 2015 | 11

L DA D E BT F I N A N C I N G AU C T I O N P R O C E S S

Structure

Implement optimal structure based on real-time knowledge of current market terms and requirements and the company’s needs

Identification and mitigation of credit and transaction-related risks Specific covenants and inter-creditor terms established upfront to avoid “eleventh hour”

negotiations

Solicitation

Rapid deployment and comprehensive solicitation of investors for each financing layer Concentrated management meetings minimize distraction from running the business Successfully secure multiple proposals and commitments to enhance degrees of freedom

throughout the process

Closing

Seamless transition from commitment to closing Reduction in closing surprises and elimination of “drift” in terms Increased likelihood of successful closing

December 2015 | 12

S E L EC T R EC E N T LY C O M P L E T E D T R A N SAC T I O N S

$430,000,000 Business Combination

&

$250,000,000 Refinancing

has merged with

Exclusive Financial Advisor, Placement Agent, and Co-

Manager

$152,000,000 Recapitalization

Exclusive Financial Advisor and Placement Agent

Undisclosed Acquisition Financing

has acquired


$78,500,000 Acquisition Financing

has acquired



Exclusive Restructuring Advisor and Placement

Agent


PAQ, Inc. & QSI, Inc.

Operator of:



Exclusive Restructuring Advisor and Placement

Agent


A Monomoy Capital Partners Portfolio Company


$45,000,000 Acquisition Financing

has acquired


Undisclosed

has acquired


2100 Trust, LLC

Acquisition Financing: Evaluating Layers of Capital, Negotiating Loan

Terms, Navigating Regulatory Developments

Lawrence F. Flick, II, Partner, Blank Rome, New York

212.885.5556 [email protected]

Kelly M. Dybala, Partner, Sidley Austin LLP, Dallas

214.981.3426 [email protected]

Structuring the Transaction

• Cash Flow vs. ABL

– ABL Financing

• Typical ABL Loan: based on a formula (i.e. borrowing base)

– Important to understand real availability in ABL structures; tension between lender discretion in borrowing base criteria versus borrower's desires for certain of access to capital

– Split collateral package loans

• Benefits: Lower cost of capital; flexibility on investments/restricted payments

• Detriments: Level of reporting

14

Structuring the Transaction

• Cash Flow vs. ABL (cont’d)

- Cash Flow Lending

• Typical Cash Flow Loan: based on a cash flow anticipated to be generated

• Benefits: less reporting; often lesser collateral requirements

• Detriments: more expensive; frequently non-relationship lenders

- Mezzanine and/or High Yield

• Benefits: flexibility; usually no financial covenant

• Detriments: call premiums/no call

15

Structuring the Transaction (cont’d)

• Fraudulent transfer issues

• Use of holding companies

– Important to understand lender's requirements around org chart early in process.

– Most lenders require pledge of equity in borrower/operating company to facilitate transfer of control in default situation (exercise of pledge rights vs. foreclosure on operating assets)

16


• Intercreditor issues

– Many possible intercreditor issues, affecting subordinate and second lien lenders, sponsors (relating to management fees), holders of seller notes and earnout recipients

– Focus on when and to what extent subordinated lenders can exercise enforcement rights and the extent of the senior lender's ability to make decisions binding on subordinated lenders in enforcement proceedings

– Subordinated lenders focused on an exit strategy, a seat at the table during enforcement proceedings, and objective asset valuations

17

• Intercreditor issues (cont’d) – Seller notes and earnouts are often deeply subordinated, which is a key issue to be

handled; different approaches on timing of these discussions

– Seller notes and earnouts often subject to refinancing indebtedness, further prolonging the lifecycle

• Current Trend – IL/2L intercreditor market is moving in favor of the IL lenders

• caps

• no or limited restrictions on amending IL

18


Investors/

Sponsor

Parent

(Top Co)

Sub-Holding

Company

Senior Borrower

(Purchaser)

Target Company

Senior Lenders 2nd Lien Lenders

Subsidiary 1 of

Target

Subsidiary 2 of

Target

Subsidiary 3 of

Target

Equity Investment by way of

Loan Notes Equity Investment by way of subscription for

Share of Parent (including Preference Shares)

Subscription for Share of

Sub-Holding Company and

Structural Intra Group Loan

Subordinated

Loan/Bond/Note

Downstreaming of

funds

Senior Loan

Acquisition

2nd Lien Loan/Note (if

applicable)

Warrants

(if applicable)

(Term Facilities A, B and C

plus Revolver)

Equity

pledge

Equity pledge

Rollover equity

19

Mezzanine/High

Yield Lenders

Investors/

Sponsor

Parent

(Top Co)

Sub-Holding

Company

Senior Borrower

(Purchaser)

Now Merged

Target Company

Senior Lenders 2nd Lien Lenders

Subsidiary 1 of

Target

Subsidiary 2 of

Target

Subsidiary 3 of

Target

Mezzanine/High

Yield Lenders

Equity Investment by way of

Loan Notes Equity Investment by way of subscription for

Share of Parent (including Preference Shares)

Subscription for Share of

Sub-Holding Company and

Structural Intra Group Loan

Subordinated

Loan/Bond/Note

Downstreaming of

funds

Senior Loan

2nd Lien Loan/Note (if

applicable)

Warrants

(if applicable)

(Term Facilities A, B and C

plus Revolver)

Equity

pledge

Equity pledge

Rollover equity

Dividends

?

Management

Fees, Tax

distributions, etc

?

Payment of Notes

to Seller(s)

20

Commitment Letter Issues

• Commitment papers for acquisitions have remained fairly consistent since 2010

• “SunGard” provisions/limited conditionality/funds certain

– Continue to be standard

– Post-closing collateral delivery scope and deadline negotiated usually with agent ability to extend

– Cross-border collateral packages have significantly narrower closing date deliverables

– Specified Purchase Agreement Representations

– Specified Representations regarding Borrower and credit documents expanded, sometimes including:

• Solvency

• Patriot Act/FCPA/OFAC

• No violation of laws, charter, material contracts

• Collateral perfection/priority

21

Commitment Letter Issues (cont’d)

• Market flex provisions

– Lenders rely on flex to optimize borrower-friendly terms in underwritten term sheet

– Certainty of deal terms

• Conditions: limited and financial conditions (minimum EBITDA, maximum leverage) are not seen outside of the lower middle market

– No Market MACs (and commitment periods sometimes exceeding four months)

– Close attention to:

• acquisition agreement terms (and permitted amendments thereof)

• delivery of bank documentation and marketing period

22


– Issue of whether all representations are made on the closing date with potential for “Day 2” default

• Unlike European practice, U.S. deals do not typically provide for a “clean-up” period

23


• Provisions providing enhanced flexibility in credit documentation and mechanical provisions have also become more standardized

– Accordion usage and structuring

– Partial refinancings

– Amend and extends

– Non-pro-rata buybacks

• Greater flexibility in covenant baskets

– Bond-like debt incurrence and restricted payment exceptions

– Sometimes package for first-lien bank documentation is looser than traditional high-yield bond package

– Sometimes greater flexibility for investments in non-guarantor subsidiaries

• Equity cures nearly universal

24


• Defaulting lenders not tolerated by borrowers or agents/arrangers and language quite standardized, based largely on LSTA model with some enhancements for borrower protection

• Willingness of lenders in some deals to forego MD&A and/or lender calls

• “Funds certain” treatment of future acquisitions has become fairly standard

25


• Seller involvement in commitment paper negotiation and lender involvement in acquisition agreement negotiation a given, with “Xerox”-style lender protective provisions in acquisition agreements customary

• Seller focus: Conditionality of commitment letter

– Matching MAE standards

– Limiting their obligations to assist with the financing

– Required financial statement and other deliverables

– Marketing period

– “Drop-dead date” on commitment letter the same as or later than the acquisition agreement

– Ensuring there are no financial covenant conditions

26


• Lender focus on acquisition:

– Attention to acquisition agreement terms before signing commitment papers

• Specificity as to acquisition agreement changes that are “materially adverse to lenders”

• Specificity as to required deliverables for marketing condition

• May be a built-in notice mechanism to request and identify missing information

– Acquisition documentation must be satisfactory to arrangers

– Waivers and amendments that are adverse/materially adverse permitted only with arranger consent (not to be unreasonably withheld or delayed)

27


– Specification of changes that are not adverse/materially adverse or that are per se adverse/materially adverse may include:

• reduction in purchase price almost always reduces equity to minimum, then pro rata to debt/equity

• increase in purchase price unless funded by equity or amounts available on the committed facilities

– Key elements of recent acquisition agreements that are relevant in the acquisition finance context:

• Financing covenants

• Exclusive jurisdiction

• Damages caps

• Limited third-party beneficiary language for lender

28


– Lenders are involved in bid process, reviewing drafts of the purchase agreement and any amendments in “real time”

– Financing Covenants

• Buyers are obligated to use commercially reasonable efforts/reasonable best efforts to consummate the financing or arrange for alternative financing

• Issues arise around extent of permissible amendments to commitment papers without seller consent and terms of any replacement commitments

29

Documentation Issues

• Accordions – Long-time feature still an important area of focus:

– “most-favored nation” provision almost always set at 50 bps and applies only to term loans that are pari passu in right of payment and security

– Sometimes have 12 to 18 month sunset on MFN (with flex to remove sunset)

– revolving accordions fairly common

– “free and clear” basket in addition to leverage-based cap

– sometimes include increase for voluntary prepayments

– availability as subordinated and unsecured or second lien facility frequently negotiated

– availability to fund acquisitions or other general uses – introduction of “SunGard” funds-certain principles for accordion use in acquisitions

– ability to issue notes, and sometimes loans, in lieu of upsizing loans under the accordion

30

Documentation Issues (cont’d)

• Financial covenant definitions

– Increased sponsor focus on covenant compliance and cash-flow sweep provisions (extensive negotiations on EBITDA add-backs and other inputs driving covenant compliance and cash-flow sweep numbers)

– Sponsor demands for flexibility to contribute additional capital without mandatory pre-pays, undertake equipment and other operational financing options, and to execute growth strategy through add-on acquisitions

– Trend towards negotiating definitions at term sheet/commitment letter stage

31


• Permitted Acquisitions

– Critical negotiating point for sponsors

– Focus on issues other than the basket: can process be streamlined, amendment fees agreed to up front or waived, etc.

• For negative covenants generally, sponsor focus on avoiding yet another costly amendment: certainty on covenant compliance, flexibility for growth/ordinary course event, tying together negative covenants so that an exception to one is an exception to all, predetermined amendment fees for non-default amendments

32


• Permitted Distributions

– Need to analyze the org chart to understand the complete picture around tax distributions

– Consider need for carveouts in respect of dividend accruals on preferred stock, management fees, earnouts, and equity repurchases from departing employees

33


• Equity Cure Rights

– Sponsors have different strategies

– If included, negotiations around amount of cure permitted (lower middle market only), number of cures permitted, and reductions of debt if equity cure is used to repay the loans

34


• Solvency Representations

– Consolidated versus standalone

– When made?

35


• Defaulting Lender Provisions

– Typical remedies

– Re-allocation of commitments of defaulting lenders

– Impact on availability of swingline loans and letters of credit

– Borrower remedies

36


• Syndicate composition – Disqualified lenders excluded from syndicate – scope, ability to identify and

remedial provisions are discussion topics

– Competitors generally excluded, with usual approach to permit borrower to update list of competitors

– Treatment of affiliates still varies, with some tension around identification of affiliates

– Exclusion of “bona fide debt fund affiliates”

– Negotiation around policing assignments, outcome if an impermissible assignment is made, posting or other availability of “DQ list” to lenders

– Agent institutions prefer specific disclaimer of duties to monitor or maintain

• Consents to Assignments – Sponsor focus on the "relationship" and have approval right on new agent and

assignments

– Assignments during event of default or subset thereof (i.e., payment and bankruptcy only)

37

• Foreign subsidiaries

• Lender remedies – rights to credit bid

38


Regulatory Constraints Overview

• Leverage Lending Guidance

• Foreign Corrupt Practices Act, OFAC, Anti-terrorism

• Flood Insurance

39

Regulatory Constraints – Leveraged Lending Guidance

• Intended to reduce systemic risk

– Guidance looks at loans banks underwrite for distribution as well as loans to be held

• Leveraged Loans now include 3x senior leverage, 4x total leverage

• Criticized Loans now include:

– Leverage > 6x

– Inability to repay senior secured debt or half of total debt in 5-7 years from base cash flows

– Regulators are scrutinizing both of these, as well as covenant lite loans

• Effect: rise in non-traditional players in the middle market

40

Regulatory Constraints – Flood Insurance Rule

• Amended regulations for loans secured by properties in special flood hazard areas, with Federally subsidized flood insurance available

– “Special flood hazard area” = Area within a floodplain having 1% or more chance of flooding in any given year. Delineated on maps issued by FEMA.

41

Regulatory Constraints – Other

• Foreign Corrupt Practices Act, OFAC, Anti-Terrorism

– Representations

– Covenant

• Compliance programs

42

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