Letters, Documentation and More Evaluating Current Financing - - PowerPoint PPT Presentation

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Acquisition Financing Trends for Private Equity Sponsors and Strategic Buyers: Commitment Letters, Documentation and More

Evaluating Current Financing Options, Negotiating and Structuring Loan Terms

Today’s faculty features:

WEDNESDAY, AUGUST 5, 2015

Lawrence F . Flick, II, Partner, Blank Rome, New York Jeffrey A. Wurst, Partner, Ruskin Moscou Faltischek, Uniondale, N.Y .

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

Brian Schofield, Managing Director, Lampert Debt Advisors, New York

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August 2015 | 5

LAMPERT DEBT ADVISORS

Randy Lampert

President randy.lampert@lampertdebtadvisors.com

• 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

Brian Schofield

Managing Director brian.schofield@lampertdebtadvisors.com

• Completed over $2 billion of transactions as either principal or advisor
• Vice President – ICON Capital Corp., originated, structured and underwrote private debt

investments in numerous industries and special situations

• Highly developed lender/investor network capable of investing across the capital

structure

• Founder of Schofield Realty Group, a real estate finance, development, and brokerage

company

Lampert Debt Advisors is a boutique investment bank specializing in arranging debt financing for privately-

• wned, sponsor-backed and publicly-traded companies

August 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??

Purchase Price Multiple

9.3x 8.3x 6.6x 8.4x 8.2x 7.9x 8.8x 9.6x 9.8x 9.7x 2007 2008 2009 2010 2011 2012 2013 2014 1H15 2Q15

Leverage Multiples

5.6x 4.5x 3.3x 4.2x 4.3x 4.5x 4.8x 5.3x 5.1x 5.2x 2007 2008 2009 2010 2011 2012 2013 2014 1H15 2Q15 FLD/EBITDA SLD/EBITDA Other Sr Debt/EBITDA Sub Debt/EBITDA

August 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

Pro Rata and Institutional Leveraged Loan Volume Pro Rata and Institutional Spreads

L+0 L+100 L+200 L+300 L+400 L+500 L+600 L+700 2007 2008 2009 2010 2011 2012 2013 2014 1H15 2Q15 Pro Rata Institutional $0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 Institutional Pro Rata

$ in billions

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

August 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 2Q15 reaching $5.5 billion 2Q15 spreads averaged L + 179 bps, Commitment fees ticked up slightly in 2Q15 to 33 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 $9 $6 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 1H15 2Q15 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

August 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.

August 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

August 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

August 2015 | 12

SELECT RECENTLY COMPLETED TRANSACTIONS

$430,000,000

Business Combination

has merged with Exclusive Financial Advisor and Placement Agent

$250,000,000

Refinancing

A Monomoy Capital Partners Portfolio Company

Co-Manager

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: Strategies for Deal Counsel

Evaluating Financing Options, Structuring the Deal, Addressing Loan Documentation and Intercreditor Issues Lawrence F. Flick, II, Partner, Blank Rome, New York 212.885.5556 Flick@BlankRome.com Jeffrey A. Wurst, Partner, Ruskin Moscou Faltischek 516.663.6535 jwurst@rmfpc.com

Structuring the Transaction

• Cash Flow vs. ABL; Layers of Financing

– During downturn, cash flow loans largely disappeared and traditional cash flow lenders became ABL lenders. – Amend/extends often accompanied by conversion to ABL structure and/or additional

• covenants. Strongest borrowers were able to extend existing loans, reduce covenant

hurdles, and upsize facilities to continue growth. – More cash flow deals getting done, but ABL deals still very common, especially in lower middle market. – Important to understand real availability in ABL structures. Increasing lender discretion in borrowing base criteria versus borrower's desires for certain of access to capital. – Split collateral package loans. – Increase in sponsors providing mezz/sub debt or even senior debt in order to more quickly deploy capital; to be determined whether there will be an adequate supply of traditional lender loans to refinance sponsor financing.

• 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)

14

• Fraudulent transfer issues

– Traditional lenders increasingly focused on issue, particularly as leverage levels increase. – Many approaches: Target as borrower, acquisition entity as borrower with target assuming obligations immediately upon closing, new strategies to limit loans made to operating subsidiaries, stronger solvency representations. – Does not seem to be a standard approach at this time.

• Intercreditor issues

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

15

• 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.

• 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.

16

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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 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 Acquisition 2nd Lien Loan/Note (if applicable) Warrants (if applicable) (Term Facilities A, B and C plus Revolver) Equity pledge Equity pledge Rollover equity

18

Challenges of Borrower’s Counsel

19

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)

Commitment Letter Issues

• “SunGard” provisions
• Market flex provisions

– Increased sponsor resistance given increased competition among lenders. – Certainty of deal terms and shifting some or all of the syndication risk to lenders is critical for many sponsors.

20

Documentation Issues

• 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.

• Permitted acquisitions

– Often a critical negotiating point for sponsors, but rarely will lenders provide self-executing carveouts from negative covenants for material transactions. – 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.

• Permitted distributions

– Rarely will pure dividends be permitted, but important to negotiate rights to make tax distributions. – Need to look up 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. 21

• Equity cure rights

– Sponsors have different strategies. – If included, negotiations around amount of cure permitted, number of cures permitted, and time frame over which cure amounts included in covenant calculations.

• Solvency representations
• Defaulting lender provisions

– Typical remedies. – Lead lender(s) commitment to make loans for defaulting lenders. – Impact on availability of swingline loans.

• Consents to assignments

– Sponsor focus on the "relationship" and have approval right on new agent or material change in inter-lender provisions. – Limitations on syndication. – Assignments during default.

22

• Foreign subsidiaries
• Lender remedies – rights to credit bid

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