Hi all,
Could someone shed some light on arranging senior and subordinate debt for a PE transaction. I've been/am on 2 PE transactions, one is just completing and the other just kicking off, but I feel I haven't got significant exposure to the 'behind the scenes' (as an M&A adviser) of the lending for LBOs.
A couple of questions:
What is the process that the bank and more flexible credit lender go through when agreeing upon the covenants that support their debt provisions for a private equity investment?
Specifically,
1.1 Are the bank debt agreements and creditor agreements agreed at the same time / are they merged or does one always come first? (reasoning being, I'd expect these agreements to have significant influences on each other, (stock covenants, covenants for metrics eg: DSCR, potential equity warrants for the subordinate....))
1.2 Can someone outline the details of the process/timeline of these agreements being drafted: including the discussions with the PE house; the discussions between the two lenders if applicable; and what role an adviser might have specifically in helping the two lenders come to an agreement.
2.1 Do the banks and creditors have their own relationships? I'm well aware PE holds longstanding relationships with lenders to attain discounts for cheap/bulk debt packages, but do the banks and credit funds also possess these relationships; my thinking is one bank might specifically be compatible/familiar with creditor's covenants, know their strategies well ect ect...
2.2 Does the bank choose which senior lender/creditor has seniority over their investment, of course they can refuse to work with a particular creditor, and I think i'm right in saying the decision of who provides the debt is the PE's, but how commonly do banks refer a creditor for a particular transaction?
Thanks for chiming in.
Based on the most helpful WSO content, here's a breakdown of your questions regarding arranging senior and subordinate debt for an LBO:
1. Process of Agreeing Covenants Between Bank and Credit Lender:
1.1 Timing of Agreements: - Bank debt agreements and subordinated creditor agreements are typically negotiated in parallel but are not merged. The senior lender (bank) usually sets the tone for the covenants, as their position is more secure in the capital structure. Subordinated lenders (e.g., mezzanine or second lien) will then negotiate their terms around the senior lender's framework. - The agreements influence each other significantly, especially regarding intercreditor agreements, which outline the rights and priorities of each lender in case of default or restructuring.
1.2 Process/Timeline: - Initial Discussions: The PE firm engages with both senior and subordinated lenders early in the process to outline the capital structure and financing needs. - Drafting Agreements: Senior lenders draft the credit agreement first, focusing on covenants like DSCR (Debt Service Coverage Ratio), leverage ratios, and permitted payments. Subordinated lenders then negotiate their terms, often requiring equity warrants or higher interest rates to compensate for their riskier position. - Intercreditor Agreement: This is a critical document negotiated between the senior and subordinated lenders, defining payment priorities, standstill provisions, and enforcement rights. - Role of Advisers: Advisers (e.g., M&A or debt advisory teams) help facilitate discussions, ensure alignment between lenders, and provide input on market-standard terms. They also assist in modeling the impact of covenants on the deal's financials.
2. Relationships Between Banks and Creditors:
2.1 Bank and Creditor Relationships: - While PE firms maintain strong relationships with lenders, banks and credit funds also have their own networks. Certain banks may have preferred relationships with specific credit funds due to familiarity with their strategies, covenant preferences, and risk appetite. This can streamline negotiations and improve deal execution.
2.2 Bank's Role in Choosing Creditors: - The PE firm ultimately decides on the lenders, but banks may recommend or refer specific subordinated lenders based on their experience and compatibility with the transaction. For example, a bank might suggest a mezzanine fund they’ve worked with on similar deals to ensure smoother negotiations and alignment on terms. - Referrals are not uncommon, especially in complex transactions where the senior lender wants to ensure the subordinated lender's terms won't create conflicts or jeopardize the deal.
If you're looking to deepen your understanding, reviewing intercreditor agreements and studying case studies of LBO financing structures can provide valuable insights. For more details, you can explore threads like this on WSO:
URL: https://www.wallstreetoasis.com/forum/investment-banking/how-to-prepare…
Sources: https://www.wallstreetoasis.com/forum/investment-banking/how-to-prepare-for-restructuring-technical-questions?customgpt=1, Undergraduate Opportunities - Credit Funds, Private Credit Resources and Prep, How to Prepare for Restructuring Technical Questions, Mezz Debt vs. Traditional Debt Financing
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