Acquisition Financing: Evaluating Layers of Capital, Negotiating - - PowerPoint PPT Presentation

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Acquisition Financing: Evaluating Layers

• f 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

LAMPERT DEBT ADVISORS

Randy Lampert President

randy.lampert@lampertdebtadvisors.com

• 30 years of experience, over $15 billion of debt financings completed for
• ver 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-

• wned, sponsor-backed and publicly-traded companies

December 2015 | 6

MIDDLE MARKET ACQUISITION FINANCING OVERVIEW

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 3.9x 4.2x 4.6x 4.8x 4.9x 5.1x 5.0x 5.3x 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

TOO MUCH CAPITAL, CHASING TOO FEW DEALS

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

ASSET-BASED LOANS REMAIN A KEY COMPONENT

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 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 3Q15 Volume 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

PREVAILING TRENDS

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

PREVAILING TRENDS

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

LDA DEBT FINANCING AUCTION PROCESS

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

SELECT RECENTLY COMPLETED TRANSACTIONS

$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 Exclusive Financial Advisor and Placement Agent

$78,500,000

Acquisition Financing

has acquired Exclusive Financial Advisor and Placement Agent

$38,000,000

Recapitalization

Exclusive Restructuring Advisor and Placement Agent

$75,000,000

Recapitalization PAQ, Inc. & QSI, Inc. Operator of:

Exclusive Financial Advisor and Placement Agent

$77,200,000

Recapitalization

Exclusive Restructuring Advisor and Placement Agent

$66,000,000

Recapitalization

A Monomoy Capital Partners Portfolio Company Exclusive Financial Advisor and Placement Agent

$45,000,000

Acquisition Financing

has acquired Exclusive Financial Advisor and Placement Agent

Undisclosed

has acquired Exclusive Financial Advisor and Placement Agent

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 Flick@BlankRome.com Kelly M. Dybala, Partner, Sidley Austin LLP, Dallas 214.981.3426 kdybala@sidley.com

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

• perating assets)

16

Structuring the Transaction (cont’d)

• 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

Structuring the Transaction (cont’d)

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

Commitment Letter Issues (cont’d)

– 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

Commitment Letter Issues (cont’d)

• 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

Commitment Letter Issues (cont’d)

• 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

Commitment Letter Issues (cont’d)

• 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

Commitment Letter Issues (cont’d)

• 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

• nly with arranger consent (not to be unreasonably withheld or delayed)

27

Commitment Letter Issues (cont’d)

– 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

Commitment Letter Issues (cont’d)

– 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

Documentation Issues (cont’d)

• 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

Documentation Issues (cont’d)

• 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

Documentation Issues (cont’d)

• Equity Cure Rights

– Sponsors have different strategies – If included, negotiations around amount of cure permitted (lower middle market

• nly), number of cures permitted, and reductions of debt if equity cure is used to

repay the loans

34

Documentation Issues (cont’d)

• Solvency Representations

– Consolidated versus standalone – When made?

35

Documentation Issues (cont’d)

• 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

Documentation Issues (cont’d)

• 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

Documentation Issues (cont’d)

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