Private Credit Questions
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Is it common for the sponsor to negotiate whatever covenants he is comfortable with as a part of the package are those mostly dictated by the lenders?
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By general basket, iN the credit world, does it mean restricted payment basket or something else completely?
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Why are lenders usually not willing to allow equity cures / infusions or does the behavior / reception vary by direct lenders and private credit lenders?
2-way street, there is negotiation involved, but usually ends up being a compromise
There are 2 main basks: builder basket and grower basket; restricted payment basket is a sub segment where ex. if you have availability under you builder basket you can make a restricted payment, dividend, pay down unsecured debt, make a capex investment, etc subject to no event of default, pro-forma compliance with the overall leverage test, etc.
Lenders are willing to allow equity cures, at least in the private credit world. Usually no more than 4-6 during the holding period and no more than 2x consecutively
Thanks man, that was helpful. Drilling deeper into this third point, why aren’t the lenders willing to allow more equity cures? Why is it not unlimited?
In more upper market deals, it often does become unlimited. However, think about it from the lenders point of view. If a company keeps tripping its covenants and defaulting and the loan documentation allows for unlimited equity cures, how are you going to get back at the table so you can take action against the borrower? Doesn't make sense from a lender point of view; it's analogous to putting a poster over a giant hole, the problem doesn't just magically disappear.
Think about it - if the borrower trips a financial maintenance covenant based off of total net leverage, it usually means their earnings profile (the denominator in the leverage ratio) has deteriorated. An infusion of cash / equity essentially fixes the problem in the numerator (net debt), but doesn't address the fundamental issue of declining earnings.
Thanks can anyone give an example of a builder or grower basket? E.g. Does capex spending from retained cash get classified as a builder basket or grower basket?
Thank you Analyst2 in PE. loanboy043 I went through your posts and you are clearly knowledgeable about this space. Thanks for being willing to chime in here. A couple of quick questions that would be helpful to hear thoughts on - why are ebitda add backs so looked down upon by lenders? How is the definition of ebitda so hotly contested (can you be specific)? Why do lenders limited growth capex (wouldn’t that grow the pie if the lenders have an option to convert loan into equity upon a certain price / date?
Because leverage metrics end up being understated when you have a substantial amount of EBITDA add backs and the definition of EBITDA is fundamental in many ways from determining the size of the financing package and ties into covenant levels, RP/basket sizing, etc. Not all EBITDA adjustments are controversial though, things like stock-based comp, non-cash impairment charges, transaction expenses are usually viewed with less scrutiny. The controversial adjustments typically relate to items like prospective cost savings and recurring "non-recurring" restructuring charges which may or may not be capped at a certain %. From a traditional lending point of view (no option to covert debt to equity), lenders don't like substantial growth capex investments because they don't benefit from any upside and there is always the risk that the capital investment doesn't result in growth / incremental earnings after all that money has been spent which reduces the likelihood of lenders being paid back.
thanks @Regularfreak" ! 1) Creating an online course(s), in this space, including: Leveraged Finance 2.0: Advanced Course - Doc Negotiation, Aggressive vs. Market Terms-- =which answers some of these questions such as EBITDA Add-backs, fees, market flex, MFN, incremental, negative covenants, RPs, etc with common examples. And I added to the outline a Doc Negotiation Case Study. Stay tuned. Working on getting the 1.0 course live 1st tho. Would love any ideas, feedback on what courses ppl want, or topics 2) EBITDA Add-backs - send me your email i'll send you some published materials from legal firms on this topic..here's some below. lemme know if thats enough or u need further clarification w/ real examples
Synergising synergies - Introduction The definition of EBITDA has always been a fundamental negotiation point in the leveraged finance market; ultimately, a legal construct as opposed to one derived from any recognised accounting standard. In recent years, however, negotiation has increasingly focussed on the scope of EBITDA add-backs, particularly synergies and cost-savings, with sponsors demanding greater flexibility to increase EBITDA quantums. However, some market participants are concerned that the pendulum has swung too far and that such add-backs may simply conceal increased leverage. The following discussion seeks to shed light on such synergies and cost-savings, analysing how such discussions are no longer confined to the top-tier (or large-cap) arena, having slowly permeated the mid-market space and finally, touching on some of the key concepts in leveraged facilities agreements that are impacted as a result.
Why EBITDA? Cash Flow Lending •Lender is focused primarily on Cash Flow in making credit decision (secondary focus on assets) •Most Common Cash Flow Ratios: •Fixed Charge Coverage Ratio •Leverage Ratio •EBITDA is a modified Cash Flow calculation that gauges recurring operational strength. •EBITDA is more “comparable” when evaluating different companies than cash flow from operations, which is impacted by several factors that differ across companies (interest, tax, working capital). •EBITDA is viewed as best proxy for cash-generating power on a comparable basis. •EBITDA measurement is backward looking and generally covers past twelve months. This “flattens” the numbers so that companies with seasonal businesses can stay in compliance.
EBITDA 101 – The Basic Add-Backs •The gimmes: •By definition: Interest / Tax / Depreciation / Amortization •Current transaction fees and expenses (can be capped and have an incurrence time limit) •Non-cash charges (in addition to depreciation/amortization) but not accruals •The asks: •Equipment lease payments (the portion that is equivalent to interest payments on financed equipment) •Extraordinary, unusual or non-recurring losses •Future fees and costs in connection with Permitted Acquisitions, Permitted Dispositions and Permitted Debt •Future amendment fees •Management fees •Restructuring and integration expenses •Realized or anticipated cost savings (“synergies”)
3) Capex - i'll let someone else maybe weigh in? but normal syndicated loans definitely dont just convert to equity.
For the US what's the standard on EBITDA add-backs? Uncapped synergies and 18-24m period?
EBITDA Add-backs - market terms
i can definitely email some good examples here. lemme start w/ a deal launched vs. flexed (very badly tho)
Launch - no cap (100%) Flexed to: 15% cap on PF cost savings beyond $72 million of synergies, with 12-month look-forward
middle market wont be uncapped / 100%. will be less.
broadly syndicated - uncapped / 100% / 18-24m, 36m very aggressive (flex to 25% / 18m, 24-36m pretty aggressive for flex)
heres some examples, with the market flex language in the fee letter to flex to
co #1 - 100% / 36m (flex to 25% / 24m) 25% cap on synergies in connection w/ Permitted Acquisitions, and.or b. For New Contracts Addback, reduce the look-forward period from 36 months to 24 months
Co #2 - 100% / 24m (flex to 25% /18m co #3 - 100% / 36m (flex to 25% / 18m) EBITDA Definition - Add-backs Expected Cost Savings (flex to 25% / 18 months) (i)25% - after giving effect to such adjustments (ii)18m - actions taken or expected to be taken within 18 months after the specified transaction
following. would appreciate those PDFs if you have!
Appreciate if you can share some documents for some self study! Thanks!
Thanks loanboy043 a couple of follow ups please - 1. With respect to ebitda add backs, how does pe firm make an ask for that? Their Ebitda add backs / true ebitda is determined by the QoE reports that the auditors no, which the lenders ask for. And arguably, all these add backs should be reflected there, no? So how can the PE sponsor go to the lender and tell them ebitda is actually higher? If these add backs are included, then the PE firm would need to a higher cheque? 2. How is the capacity of General basket determined - what are the underlying calculations traditionally been done?
@freak good points, good questions- you clearly know a decent amount about the space and are inquisitive. 1) EBITDA - I’ll follow up with a fluffy qualitative answer. maybe someone can chime in. but it’s up to negotiation long story short, and market terms, but you are protected with flex to less aggressive terms to feel more comfortable...sorry terribly worded answer I can follow up when I’m in a better position...
2) RP - Gen Basket - I’ll follow up with a pretty good quantitative answer w some examples and where u can find them to comp out quickly - especially RPs if u wanna become an expert and have an interview in 48 hours (that’s how I learned it)—Moody’s covenant quality assessments. I’ll follow up when I’m by my computer. probably better to send in email
Would be quite helpful if someone in PE can share more on these. Thanks!
EBITDA Add-back QofE addback example
QoE Add-back (Reg S-X) – Acquisition or Investment a. adj consistent with reg S-X or contained in a QoE in connection with an acq or inv made available to the admin agent conducted by financial advisors (which are either nationally recognized or reasonably acceptable to the admin agent (“Big Four” accounting firms are acceptable)) (this clause (b), the “QofEAddback”),
RPS - moodys loan cov quality assessment - includes gen basket.. Score: Weakest (5.00) Restricted Payments (§6.06): » Cumulative credit builder basket: RPs ≤ the cumulative credit (i) unswept excess cash flow (which may not be negative), plus (ii) equity proceeds and cash contribution plus (iii) retained declined proceeds. Builder basked access is not subject to any conditionality. Reduced by dividends, investments and debt prepayment made using the basket. Start date January 1, 2016 for CF accum & August 3, 2015 for other Amts; accumulated amt is not disclosed.
» Other key quantifiable carve-outs include: (a) general RPs ≤ the greater of $90m and 0.50x EBITDA (provided, that such RP is subject to no event of default if made to investment funds managed by affiliates of Apollo Global Management, LLC or Gores Holdings, Inc., or any of their affiliates); and (b) employee stock purchases ≤ $15m per fiscal year (increases to $30m following a qualified IPO).
» Other key non-quantifiable carve-outs include: (a) RPs ≤ 6.0% of the market capitalization of any qualified public offering; (b) any RP ≤ 4.30x pro forma total net leverage; and (c) uncapped RPs made using excluded contributions.
Transactions with affiliates (§6.07): » $20m carve-out from arm’s length requirement (negative) and no disinterested director approval or third party fairness opinion required (negative, but market norm).
general basket typically a % of EBITDA (or % total assets)
General Basket - example (aggressive example) the covenants with respect to indebtedness, liens, investments, dividends and prepayments of subordinated debt shall each include a separate general basket of: with respect to indebtedness, the greater of $XX / 60% EBITDA with respect to liens, the greater of $XX / 60% EBITDA investments, the greater of $XX / 60% EBITDA with respect to dividends, the greater of $XX / 30% EBITDA and prepayments of subordinated debt, the greater of $XX / 30% EBITDA
my lev fin 2.0 advanced course im creating will cover this and have practice examples w/ this.
Thanks, pls share input on this
Not all add backs are QoE validated, depends on the scope of the QoE. For example, add backs for cost savings are often just based on the sponsor's analysis (especially if it's a top tier sponsor). Sponsors can ask for whatever they want during a negotiation, ultimately it comes down to lenders to decide whether they are willing to accept it. The equity check may or may not need to be higher, would depend on minimum equity requirements.
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