When initially approaching potential lenders it’s important to be clear about the level of flexibility you’ll need in your finance documents in order to accommodate future plans and aspirations.
Amending documents and renegotiating terms is a huge drain on resources (and in current climes, costly) and your aim should be to ensure financing terms will remain fit for purpose throughout their term. For established businesses and those refinancing this may be straightforward; for growing or adapting businesses (and those new to debt) it can be more challenging.
Key terms and incremental facilities
Flexibility can be incorporated into facilities on day one even in relation to key terms such as size. Mid-term amendments to fundamental terms can be costly both in terms of amendment fees and legal fees, as often security will need to be re-taken.
Incremental or ‘accordion’ facilities are now fairly commonplace and are used for extra headroom. They build the infrastructure of an additional facility into the finance documents at the outset, with the parameters (including commercial terms) left to be confirmed. The facility is uncommitted, but its anticipation avoids the need for any structural changes to the finance documents if additional lending is required (and assuming there is appetite from the lenders) during the remainder of the term.
Think too about whether prepayments are likely to be made during the life of the loan, and if contemplated, ensure there are limited restrictions around when you can do this and resolve (and ideally, avoid) prepayment fees by being upfront on the point. Also consider how and in what order the prepayments will be applied.
Pricing terms will be less flexible from a documentation perspective as they are pure commercial terms and market driven, but consider a margin ratchet if you’re expecting improved leverage over the term, and look carefully at any requirement for a minimum margin/fee level (known as an ‘aggregate yield restriction’) if you are including an incremental facility.
One of the simplest ways to ensure flexibility is to include ‘baskets’ or de minimis amounts to cover off events which remain uncertain. Most of the LMA ‘Permitted’ definitions which provide exceptions to negative covenants (Permitted Acquisitions, Disposals, Financial Indebtedness and so on) include a basket concept, under which amount the relevant action is either permitted or subject to fewer requirements. Typically this is an aggregate figure for each financial year and/or the life of the facility.
It is important to be able to justify the figure requested. Additionally, consider baking in the option to increase these “basket” figures during the term: for growing businesses this may be by reference to Adjusted EBITDA at the time of incurrence, for some it may be with flexibility to ‘carry’ any unspent basket into another financial year.
There is always the option of seeking lender consent during the term where your finance documents restrict actions you now need to take.
Who can provide this consent should be an area of consideration during the initial negotiations pre signing, particularly on a syndicated lend. Should a reduced percentage of lenders (based on their commitment) be able to provide certain consents/waivers? Can the Agent (acting on behalf of the majority lenders) consent to certain actions on their behalf?
We often include provisions which allow a borrower to ensure the commitments of a lender which either dissents or fails to respond to a request for consent (where the majority of other lenders are supportive) can be transferred (known as ‘yank the bank’) or disregarded (known as ‘snooze and lose’) respectively.
Following events surrounding Silicon Valley Bank, the importance of robust ‘defaulting lender’ provisions (and, for example, excluding them from any vote) has come into sharp focus and these too should be carefully considered at the outset.
Guarantor coverage and Agreed Security Principles
These provisions are of particular importance if company acquisitions are anticipated. Which companies in the Group will be required to become Obligors? This may simply be all group companies (for small non acquisitive groups) or certain companies only based on financial metrics. The metrics can include EBITDA, revenues or assets and turnover tests; typically when a company’s contribution to the consolidated amount hits an agreed threshold it is required to become an obligor, and there is usually a requirement that group companies representing an aggregate minimum level of the metric remain obligors throughout the term.
The upside of companies becoming Obligors is flexibility within the Group in terms of intra obligor permissions under the facility agreement e.g. assets can typically be transferred freely between them. The downside is they need to grant security; and in some cases – particularly if there are overseas companies/ assets or minority shareholders involved – it can be complicated and expensive.
A set of ‘Agreed Security Principles’ is particularly important if overseas assets/ Obligors are anticipated. The LMA sets out some basic requirements but in most cases we would recommend adding to these to ensure the same concepts and thresholds apply to future security as we would expect on day one. We would recommend seeking overseas advice at the outset if acquisitions overseas are anticipated.
Will funding from other sources need to be permitted in your finance documents? This is usually discussed at the outset along with any intercreditor position, but there are a few items that are sometimes overlooked.
‘Equity Cures’ are now commonplace – the ability to inject equity to ‘cure’ what would otherwise be a financial covenant breach. It might be that as well as equity, you need the flexibility for cures to be injected by way of (subordinated) debt, or even using any cash overfunding amount.
Think also about other facilities in the group post funding: credit cards, account guarantees, other bilateral facilities and arrangements which could all eat into your ‘basket’ unless expressly permitted.
Variables when future acquisitions are anticipated are far too many to include in this article, but it is worth noting that as well as flexibility in making acquisitions, you should also consider their impact on financial covenants, guarantor coverage, provision of consolidated financial information, the conditions precedent and subsequent required and in what time frame. Different regimes and restrictions could be considered depending on whether the acquisition is funded from the facility or not.
Maintaining an open dialogue with your lender(s) is fundamental – both during negotiations and the term of your loan. Whilst detailed discussions at term sheet stage can save a lot of time, energy and cost overall, you can’t cater for every eventuality. Focus on what’s important, and ensure you raise any consent or waiver requirement during the term as early as possible.