Equity Cures
Hoping to open up a discussion on equity cures.
From my point of view one can see an equity cure as the right of the borrower / sponsor to buy their way out of a covenant breach. As such, which form of cure, from a lender's (or borrower's) perspective, do you prefer to see?
In one corner we have the cure adding to EBITDA and hence curing your EBITDA / net debt covenant (assuming there is one). We could also have the cure being used to repay debt as a mandatory repayment (and hence, curing most, if not all, covenants), and finally as an addition to cash balance, to sit there doing nothing but again curing most ratios with net debt involved. (if there are any other variants, please pipe up, always good to see more.)
I suppose the main argument is that if used to repay debt there is no future benefit to the company, its decline in cash flow or earnings that triggered the cure may continue, only to breach another covenant at some point. But, the interest burden may be decreased sufficiently to allow sufficient re-investment to generate future profits. But, as a lender you have some money back, at par, but do you want your money back? Are you trying to put assets to work / searching for yield in a place you thought you’d found some? If used as an addition to cash there is the possibility of future investment in earnings generating assets? This does, however, assume a basic level of competency on managements part. Or the cash could be applied, depending on the docs to a repayment via a cash sweep (which may or may not be 100% of excess cash flow)?
Or are all cures just pushing back the inevitable?
What do you like to see? Would be good to hear your thoughts.
I'll chime in with my two
I'll chime in with my two cents here. Generally, if a company's performing well overall, has a clear growth path up front of it, and the banks buy into the story and "get it," then a slight miss on a covenant won't be the end of the world. Things happen, shifts in timing occur, and it's tough to predict on a quarterly basis how things will shake out with supreme accuracy. In this sort of case, banks will waive a covenant or reset covenants (which involves some back-and-forth with management / sponsor). Of course there are fees involved, but the bank would rather be a partner in growth and profitability, not a hindrance.
Equity cures / equity infusions come if there's real trouble on a foundational level. As far as I know, which luckily is limited since the companies I've worked with have performed pretty well for the most part, an equity cure type of action definitely does not occur in a vacuum. At that point, the banks would typically look for some real action plans vis-a-vis restructuring operations and a plan to return the company to good health / profitability. Unless the company is falling off a cliff, the banks will tend to work with the sponsor / company to work on solutions, and not look to liquidate / take control or whatever. So, ideally, any sort of equity infusion / equity cure on the part of the sponsor won't simply delay the inevitable, instead it'll be a sort of "rock bottom" for the company to rebound from and emerge, ideally, healthier and built to grow.
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Thought I'd give this another
Thought I'd give this another shot but with some more food for thought...
Why would a current Sponsor / Shareholder make an infusion?
- Relationships with constituents
- Concern for effect on other transactions and/or fundraising efforts
- Ego/Pride
- Financial value maximization
- Particularly in today's market, to preserve a non-replicable capital structure, and thereby a highly leveraged "option" for shareholders on the upside value of the enterprise (given positive volatility of the business, new investment constitutes a well valued call option)
- Unique sponsor incumbent advantages (NOL preservation, regulatory or licensing barriers for any new sponsor, synergistic holdings in complementary companies, etc.) provide a better new investment opportunity than the market would normally allow
- Purchasing debt in the secondary markets as an infusion, particularly bank debt (not a "security"), can provide additional benefits through (i) capturing a discount, (ii) allowing the company to maintain covenant compliance or (iii) deferral of interest on purchased debt to lessen liquidity issues (and/or subordination or equitization)
ALL distressed situations can be made non-distressed by the simple application of shareholder money, but unless structured carefully and objectively, these investments are often sub-optimal, and can represent throwing good money after bad
Enforcing a prior senior rescue investment in subsequent restructuring negotiations implicates all the issues of equitable subordination, "Deep Rock" doctrine and the like - vital to obtain legal advice on these issues at the time of first "rescue"
Personally I think equity
Personally I think equity cures that add to ebitda are ridiculous and makes 0 sense. On the other hand, if it goes toward paying down debt I can see that as being more relevant. Lowers interest expense and puts more equity behind the leverage, so there's a real benefit.
Personally I think personally
Personally I think personally the equity cures that add to ebitda are ridiculous and makes 0 sense. On the other hand, if it goes toward paying down debt I can see that as being more relevant. Lowers interest expense and puts more equity behind the leverage, so there's a real benefit.
Great points. If the the
Great points. If the the company has a strong growth profile/story, a covenant breach early on while the company "ramps up" wouldn't be the end of the world, and an equity cure could effectively give the company a cushion from which to grow off of.
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