Two ways to put debt on the auction menu
The market for private capital exits remains challenged, partly due to the persistent valuation gap between seller expectations and buyer appetite.
Some popular tools to close that gap shift risk onto sellers – eg. earn-outs or deferred consideration (ie. vendor financing).
Seller-arranged debt financings are becoming increasingly popular tools to help, but without those same risks to sellers. There are two main options:
- Portable financing – where the portfolio company’s existing debt facilities can survive a change of control, subject to certain requirements.
- Staple financing – where sellers work with potential financiers to present bidders with a debt financing package they can adopt (or enhance). Terms could be a short grid (a ‘paperclip’) or fully developed credit approved commitment papers.
The core structural difference between those two options is who ‘owns’ the debt. Portable debt belongs to the target pre and post-completion; staple financing belongs to the bidder (structurally identical to fully bidder-arranged financing).
More debt, more bidders, better prices?
Both options can help a sale process by:
- Increasing bid values by demonstrating the leverage the market thinks the asset can support. This is the seller’s opportunity to show the asset can carry more debt (eg. another turn of leverage) – and that extra debt can therefore support a higher bid price.
- Removing or materially simplifying what is an otherwise big workstream for bidders in an auction process: arranging its own debt financing. If the debt is ‘sorted’ and is anchored at a healthy leverage level, bidders can focus more on the M&A workstream and value.
- Improving access to debt financing – particularly valuable for bidders who are new to the market or who, by themselves, may not be able to obtain terms which the exiting sponsor (potentially a global player) can obtain.
How do the options impact normal sale process dynamics?
For most deals, staple financing is the more proximate to normal deal dynamics, minimising cross-over issues into the SPA negotiations that can arise with a portable financing.
There are three dimensions to that statement – summarised with quotes which are totally made-up but very easy to imagine:
- “Just because I’ve done you a favour on debt, don’t make your financing my problem!” – sell-side sponsor
Financing is normally the buyer’s issue – it’s up to them to source it, without any financing out in the acquisition agreement and usually on ‘certain funds’ terms (so events affecting the target do not impact debt funding availability).
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Portable financing
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Staple financing
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Real lived experience - portability creates issues that distract the M&A process. If the existing facilities are to remain, the buyer should ask (quite reasonable) questions like:
All of a sudden, your SPA negotiations could become bogged down with risk allocation on multifarious scenarios which could affect the existing debt facilities over what could be a lengthy pre-completion period. |
No substantive change to the normal dynamic. The staple is presented during the auction, but from there it’s up to bidders whether they ‘hit the staple’ - it then becomes their debt package (ultimately no different to fully bidder-arranged financing). |
- “I can do better than that!” – every buy-side cap markets team ever
We’ve rarely met a sponsor (and definitely never met a sponsor capital markets team) who thinks they cannot improve a debt package arranged by another sponsor.
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Portable financing
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Staple financing
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If a bidder wants to ‘improve’ portable financing terms, that requires amending the existing financing. Depending on deal dynamics, this can likely only be progressed late when it’s appropriate to connect the buyer with existing lenders (eg post-SPA signing). If the bidder wants a full suite of amendments, there could be a prolonged negotiation/consent process being run with existing target financiers in parallel with the M&A process. |
No substantive change to the normal dynamic. Staples are never ‘take-it-or-leave-it’. A well-developed staple is a starting point for bidders to iterate and finesse (eg. incorporate their own house terms). More importantly, the staple sets a floor for what sponsors can achieve in market – ie. for bidders who want to arrange their own debt financing rather than hitting the staple. That floor is relevant to pricing, terms/flexibility and (perhaps most importantly) volume as a potential driver of seller value. |
- “Wait – do I have committed debt or not?”- buy-side sponsor
Buyers and sellers want certainty - typically in Australia on a customary ‘certain funds’ basis - that debt financing will be available on closing without conditions precedent affecting the target which are independent of the SPA conditions.
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Portable financing
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Staple financing
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Portability clauses are always subject to conditions. Some are objective (eg. minimum equity in the capital structure, a leverage test) while others are less so (eg. where incoming sponsor identity conditions refer to slightly subjective tests – such as sector experience - rather than just being named on an agreed sponsor list). Most portability provisions include ‘outs’ for lenders on KYC or breach of a lender’s internal aggregation limit (or other policy parameters), meaning a consent/review process with the lenders is still required. That can reduce the funding certainty portability was meant to provide. |
No substantive change to the normal dynamic. If a sponsor hits the staple, as with any bidder-arranged financing, it is their responsibility to establish funding certainty. |
Get your staplers out
None of this is reason not to push for portability (especially if you are refinancing with a view to a near-term exit). This market has seen several successful portable – or virtually portable - deals in the last 12 months, and in parallel, an increase in staple financings being offered as part of sale processes. However, sellers and bidders should be aware that, while the two tools look similar, they behave very differently in a live deal – and those differences matter to sellers in particular.
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