Senior Debt - YTL LLP

Introduction

This note outlines the different types of debt that may be used (senior, mezzanine, high yield, second lien and PIK) for a management buyout, and explore some of the salient features of a senior facilities agreement. Subordinated finance will be discussed in other notes.

If the management team is the existing one, the buyout will be a management buyout (MBO), if a new team, a management buy-in (MBI) and if a combination of the two, a buy-in management buyout (BIMBO). If a high level of debt is used to finance the acquisition, the buyout may be referred to as a leveraged buyout (LBO) and if driven by the private equity provider rather than by management it may be referred to as an institutional buyout (IBO).

Financing in buyouts

Buyouts are generally financed from the following sources:

Private equity – finance from private equity provider (institutional equity) and, to a lesser extent, the management team;
Debt finance – finance from financial institutions and other investors; and
Vendor loan – finance from seller. This would usually take place when the buyer is not prepared to pay the seller’s proposed price, but is prepared to pay a higher price subject to the target’s business performance.

Debt finance in buyouts

The debt finance will comprise (1) senior debt; and (2) junior debt.

Senior debt is the main source of debt in buyouts. It will comprise (a) acquisition finance (the funds required to complete the purchase of the business); and (b) working capital (the funds for the target to run its day-to-day operations). It is usually provided by a bank, or by two or more lenders (pension, insurance companies, or hedge funds) acting as a ‘club’, or underwritten by one or more lenders and then syndicated to other financial institutions and investors.
Junior debt is the secondary source of debt. Generally speaking, junior debt can be classified into: mezzanine debt, second lien finance, high yield debt and PIK debt.

In structuring a buyout, it is also common to see bridging loans or bridged by equity, and that subsequently financed by term loan.

Senior Debt – Documentation

Senior facilities agreement is the main document used in a senior debt arrangement. A senior facilities agreement would contain provisions that are commonly seen in standard facility agreement. Lenders will have recourse to the target group to ensure that:

Lenders receive periodic information of the target group;
Profits and cash generated in the target group would be first be used to settle lender(s)’ fees, interest and principal;
Comprehensive security package; and
Cash outflows and financial systems are controlled and monitors.

Subject to the structure of the senior debt, for instances, whether it involves single/multiple borrower(s), single/multiple guarantor(s), single- /multi-currency, and term/revolving facility, parties would generally use the documents provided in the Asia Pacific Loan Market Association (APLMA) as a starting point.

Set out below are some of the salient provisions in a senior facilities agreement that are not commonly seen in a conventional facilities agreement:

Conditions precedent

Can be divided into two categories:

initial drawdown
- provision of business plan, completion of due diligence, settlement of junior debt documents;

subsequent drawdown
- conditions that must be satisfied before each drawing. This would usually pertain to the continued accuracy of representations.

Pre-funding

Borrower may need to make payments at completion to multiple parties, and sometimes borrower may request that funds be available to it before the drawdown date.

Cancellation

It would only apply to undrawn facilities that remain available for drawing. And once the loan is cancelled, the undrawn facilities cannot be reinstated.

Interests

A margin rachet may apply.

Covenants

Covenants are used to ensure that the borrower, its group and the business operations meet the standard set by the lender(s).

Covenants can be divided into (a) positive undertakings; (b) negative undertakings; and (c) financial covenants.

Environmental and Social Governance

In recognizing the importance of environmental and social governance, ESG margin ratchets are incorporated in the documentations. This could be in the form of pricing adjustments linked to the performance targets of the target group in achieving agreed sustainability.

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