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 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.
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.
Thought I'd give this another shot but with some more food for thought...
Why would a current Sponsor / Shareholder make an infusion?
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"
Flex Caps and Limited Equity Cures (Originally Posted: 01/30/2008)
I was reading this article, and was curious what these were. Is anybody willing to explain? Sorry if I've posted on the wrong forum...
From: http://www.thedeal.com/servlet/Satellite?pagename=hpa&p=M4YD5AR1&c=TDDA…
"Data aside, the LBO business will obviously continue in some reduced form in 2008. Arrangers, in fact, say they continue to work on a trickle of new underwritings. Certainly, underwriting has become a slippery term lately. [FLEX CAPS], if they exist at all, are expansive. Beyond this, arrangers are loading up new deals with all the items in the bear market arsenal: leverage limited to 5.5 times, coverage in the 2 times area, several maintenance tests, covenant headroom set at 15% to 20% (compared with 28% in 2006 and 24% in 2007), prepayment fees, B+/B1 spreads of LIBOR + 375 to 425, BB-/Ba3 spreads of LIBOR + 275 to 325, original issue discounts of a point or more, [LIMITED EQUITY CURES], etc."
Flex caps: Sometimes, lenders have the right to increase the spread on their debt between the time that they sign a binding term sheet and deal closing, based on changes in the market or other developments. This is called flex. During the boom years, many deals had no flex at all (the lender was bound to the spread they initially quoted), or flex only up to a certain number of bps (a "flex cap"). What the writer is saying is that now lenders are demanding very broad or unlimited flex, so they're not exposed to market changes between commitment and closing.
Limited equity cures: If a covenant in a deal gets broken, triggering a default, the equity investor sometimes has the right to cure the default (i.e. by using equity to pay down debt to restore compliance under an LTV covenant). The author is saying that lenders are now limiting the rights of the equity to cure defaults, allowing them to get at the collateral more easily.
I hope this helps.
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.
Likelihood of Equity Cures (Originally Posted: 05/23/2013)
Hi Chaps,
I'm looking at a distressed sit. (unfortunately not my usual space, would enjoy my job a lot more if it were...) and trying to weigh up the probability of the sponsor curing what seems like a pretty sure fire breach. Or debt buy-backs for that matter, but I deem this less likely.
Are there any tell-tell signs that the sponsor will step in? How would you asses to what level the sponsor will stand behind the company? Just because its done it before, will it do it again?
For background, the sponsor has owned the company before, sold to a different sponsor, went through a RXing, lenders took the keys and finally sold it back to the original sponsor. In addition, the sponsor has already injected a significant amount of equity since the initial acquisition.
Cheers,
O
a lot of things to look at, none of which alone will give you much information: 1) Fund specific info: Out of what fund was the investment made and in what stage of the lifecycle is that fund (how much longer can it invest)? How much dry powder does the fund have (could they cure if they wanted to)? Typically, it is difficult to invest in the same portfolio company out of two different funds (different LPs).
2) To what extent have they cured previously?
3) How much will be necessary to cure? We are seeing very interesting (crazy?) things happening in the debt markets. The threat of the portfolio company refinancing out of good-yielding paper in order to cure a minor covenant may force the price of the covenant cure down.
4) Are you SURE there is going to be a cov default? You have read the indentures and know the Cap Terms?
5) What other investments does the fund have? The fact that this is round 2 for the sponsor with the same portfolio company would suggest to me some level of conviction/view behind the investment.
Like I said, you won't get a perfect picture, but this should get you most of the way there. Remember -- don't fight it. If the fact pattern seems to suggest that the sponsor will cure...they probably will.
That's a good overview. Thanks. My struggle is to ascertain at what point the Sponsor hops off and has had enough, which is sort of, but not wholly, autonomous of their ability to cure.
Can't really get my head around the sponsors actions, sold at 6.7x, then bought at 9x years later and after a restructuring....
Further, can't be certain on default definitions, i'm looking for cross default under the bank debt, but the prospectus' coverage of the covenants is weak and there has been covenant resets (looking for a cash default).
P.S. i hate indentures, used to bank debt docs
Any more takers?
Voluptas rerum totam inventore voluptas. Ipsa minima dolor est ab. Sequi ut totam nostrum deserunt accusamus tempore nihil. Ea quia consequatur ducimus sed ut. Necessitatibus tenetur nihil ut iure aut.
Iste nulla sequi et optio culpa expedita. Asperiores sit autem unde ad et iusto.
Qui qui libero nihil consequatur sed eum voluptas. Numquam sit aut est quia. Libero et quia sed ut sit nostrum voluptatem. Rerum alias in assumenda itaque dolore saepe explicabo. Culpa occaecati quos enim reiciendis recusandae cum aut. Sed natus quia fuga voluptatem placeat ex nostrum.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...