Take private transactions: financing
Introduction
Raising sufficient cash on acceptable terms to complete the acquisition of often large and widely-held enterprises is no mean feat. However, with diversified and well capitalised communities of investors and lenders ready to grasp opportunities, sponsors and their financiers need not look upon P2Ps as, in principle, significantly more difficult to finance than private M&A deals.
Certain features of P2P transactions would seem to present financing-related risks to both borrowers and lenders. Set out below are details on some of these features and how they are handled in a typical P2P. Methods of mitigating and managing risk have developed over some time, and this Part 3 will principally cover:
- the ability to carry out due diligence on the target;
- the structure and process of the takeover;
- the requirement for certainty and, often, speed of funding; and
- specific public company issues with credit support.
Due diligence
A PE sponsor which is “actively considering” an offer (as interpreted under the Code) may only widen the circle of insiders to six external parties – the so called “Rule of Six”. The risk of leaks and these regulatory limits mean that it can be difficult to approach more than one potential arranger of finance – a position much coveted by those active in public bid financing. With Panel agreement, additional arrangers can be approached if the first declines the opportunity – on a “one in, one out” basis.
As we highlighted in Part 1 of our P2P transactions series, public listed companies are required to disclose very significant levels of information in order that the market can price their shares. This allows the PE sponsor to assess immediately whether the market is undervaluing the potential target; and it allows potential providers of debt financing – for both the acquisition and ongoing needs of the business – to assess creditworthiness and at least indicatively size and price the debt they would be willing to provide.
Lenders’ access to further, non-public information will depend on the target’s willingness to engage in a confirmatory due diligence exercise with the sponsor. This will also be influenced by the Code: specifically the requirement that a target give equal access to any other (or later appearing) bidder, even if they are a competitor of the target.
If things progress to a point at which the PE sponsor has put forward an indicative offer price which the target board believes it could recommend to shareholders, and both the bidder and its prospective lenders are adequately bound to a non-disclosure agreement, the board’s reluctance can soften and additional information in response to focused due diligence requests can be forthcoming.
Lenders’ ability to influence the exchanges between bidder and target will be limited – often to an even greater degree than in competitive private M&A situations. There are regulatory as well as commercial considerations at play: a lender assessing whether it will participate in the financing of the acquisition might hold shares in the target (particularly if it is a bank with diverse operations), which again engages the Code’s requirements for equality – to ensure that one shareholder is not, by virtue of its role as a lender, given information or a “deal” different to that provided to all other shareholders. Effective information barriers between the relevant functions within the institution are often the answer. Lenders should, however, be ready to identify and carefully address these matters – compliance with the Code should not be seen as solely the responsibility of the bidder and its advisers. To be regarded as knowledgeable and collaborative in dealing with the framework for UK public M&A is helpful to a lender in winning mandates on future transactions undertaken by sponsors.
Once the takeover offer is declared unconditional as to acceptances, or the scheme of arrangement is approved, the target board may even be willing to present to prospective lenders on the target business – where that is thought helpful to any ongoing syndication of the debt facilities. Of course though, this would not assist the arranger(s) in coming to their decision to underwrite the acquisition finance at the earlier stage of the bidder announcing a firm intention to make an offer.
Structure and process
Bid structure
As Part 1 of our P2P transactions series explains, most P2Ps are carried out by means of a target scheme of arrangement which is recommended by the target board without any rival bidders appearing after the offer is announced. Allied to their more attractive route to obtaining full control of the target, schemes can be preferred by providers of senior secured finance for the shortening of the period (when compared to a takeover offer) during which such financiers are said to be “under-secured” – see Credit support below.
Bid conduct
Lenders will typically apply contractual control to how the bid is conducted. The positive and negative undertakings which result will usually be tailored to apply to a contractual takeover offer and a scheme of arrangement, depending on which is pursued, and build-in a measure of flexibility for the bidder to switch between the two structures or modify other terms of the offer (such as the price per share) within limits. However, this flexibility would be by way of exceptions to a general undertaking not to waive or amend the terms and conditions of the offer (including, in a contractual takeover offer, the usual 90% threshold applied to the acceptance condition).
To ensure such undertakings are effective to protect lenders from being required to fund a transaction on materially different terms, failure to comply with them will likely be a “major default” and, thereby, a draw-stop under financing arrangements documented on a “certain funds” basis. More on this in Cash confirmation and certain funds below.
Disclosure of financing terms
Another, very direct, impact of the Code on debt financing is the requirement that transaction documents be publicly disclosed (via a website) promptly following the bidder announcing a firm intention to make an offer. Strictly, the documents cannot be redacted and must cover substantially the full suite of finance documents – including, if it exists, mandate and syndication documentation struck between the sponsor and arranger(s) that contains sensitive fee and flex arrangements. The arranger(s) (and, indeed, the sponsor) will likely not want to make these public for fear it would compromise their position when negotiating (i) the economic and wider commercial terms on which syndicate lenders will participate in the debt facilities and (ii) in the arranger(s)’ case, the terms of financings for similar businesses acquired or to be acquired by other sponsors.
Acknowledging the sensitivity of this information, the Panel has, on a number of occasions where a syndication is intended, given dispensation from the strict requirement to publish flex arrangements as part of the initially disclosed suite of finance documents. However, the dispensation has generally lasted only until the offer or scheme document is published – at which point the flex arrangements must be disclosed if they are still relevant to an ongoing syndication. This leaves quite a short period following an initial public announcement in which to syndicate the debt successfully before the flex arrangements are made known, particularly when one considers the challenges in conducting adequate due diligence early in the process (as noted in Due diligence above).
Speed and certainty of funding
Choosing the right instrument
When a leak (or the possibility of a leak), or simply the bidder’s tactics, dictate a need to press ahead with a P2P bid on a shorter than usual time frame, there is precedent for the bid being launched off the back of finance documents which are reduced in number and size from the norm. Theoretically quicker to negotiate, there are examples of “interim loan agreements” (as they are often called) being put in place with arrangers at very short notice.
These are not much different to instruments used in similarly time-pressed circumstances in private M&A. In both situations, full documentation would usually replace the interim suite as soon as possible after signing and generally, though not necessarily, before funds are drawn. With a P2P, even though the documents are in short form they must still satisfy the requirements of the Code as to certainty of funding (on which, see Cash confirmation and certain funds below).
If the sponsor intends that longer term debt financing for the group be sourced in capital markets through the issuance of high yield bonds, this may lead to an “interim” suite of loan finance documents which is similar to that used where the sole motivator is speed. The planned take out of this bridging finance – which is usually provided by one or two arrangers hoping to earn the role of also arranging the HYB – would be attempted after funds have been drawn to complete the acquisition, so as to offer greater certainty for bond investors as to the investment proposition and, more immediately, greater certainty as to the availability of debt financing for the purposes of the acquisition.
Also relevant to the choice of instrument are the extent and terms of facilities required to refinance existing target group debt or as an additional working capital or other credit line. Facilities of this sort which are not earmarked for payment of the purchase price will not have to be made available on a “certain funds” basis, but they are still of great importance to the successful completion of the acquisition. This is not only because of the operational issues that will quickly arise in an under-funded business, but also the defaults that will arise in respect of both existing debt (where there is a mandatory prepayment triggered by the change of control) and new acquisition debt (for which the “clean-up” period described in Clean-up below will be of limited assistance).
Cash confirmation and certain funds
The financing for the acquisition of a UK listed target needs to be committed on a “certain funds” basis and conditional only on a limited number of standard conditions (see below) when the bidder announces a firm intention to make an offer. Robust evidence for this is provided by the “cash confirmation” that the Code requires from a financial adviser (typically that advising the bidder), which confirms that the bidder has available to it sufficient cash resources to satisfy full acceptance of the offer whilst it is live. The financial adviser must act responsibly and take all reasonable steps to assure itself that the cash is available in order to avoid being liable to make up any shortfall in the event of that not being so. This, as well as the adverse reputational consequences should a deal not complete as envisaged, result in a rigorous due diligence exercise on the part of the financial adviser (who will normally appoint an independent law firm to assist) covering, in the case of a PE bidder, the executed debt and equity funding documentation.
Save for relevant regulatory clearances, certain funds debt financing generally should not have any conditions precedent to its drawing (for acquisition purposes, at least) that are outside the bidder’s control. This will mean there is no separate “market MAC” condition to the availability of the financing; however, the lenders would obviously not be required to fund in the (unlikely) event that the bidder successfully invokes a protective condition to its offer to acquire the target (for discussion of which, see Part 1 of our P2P transactions series). Certain other rights which are usually available to lenders, and which would otherwise affect drawing of acquisition facilities, will also be suspended.
Any perceived insufficiency in the due diligence capable of being conducted by lenders in advance of an offer comes into sharp relief when the facilities agreement is drafted to record that “major defaults” (the absence of which will usually remain as a condition precedent) reference only the special purpose vehicles (SPVs) incorporated in order to acquire the target. They generally do not extend to address important matters related to the standing and value of the target group.
The financial adviser’s own financial due diligence is to complement the legal due diligence carried out by the independent law firm it appoints to pore over the contractual terms of the debt and equity funding documentation put in place by the bidder. However, they are much the same thing where a PE sponsor-backed SPV is bidding to take a public company private, as there is little else on which to assess its financial position (and, thus, the likelihood of an insolvency-related “major default” draw-stopping the acquisition facilities) than the quality of the contractual undertakings to put it in funds.
When those undertakings are by alternative lenders, such as credit funds, rather than banks (as is often now the case under acquisition facilities for both private and public M&A), the cash confirming financial adviser will usually undertake additional due diligence on the non-bank lender’s structure and funding.
How extensive this exercise becomes depends on a number of factors. For a credit fund it should, in principle, be similar to that undertaken for the PE fund which is committing the equity for the acquisition. In each case, the primary source of funding – whether investor capital calls or a connected bridge facility – would be investigated. That is, unless a simpler backstop funding option can be presented which circumvents this. Early engagement with what will be required for a Code-compliant cash confirmation to be given is critical, especially if there is more than one credit fund (whether managed by the same or different managers) that will be a lender of record.
The Code is effective in compelling the sponsor and those underwriting the debt financing to get comfortable with completing the acquisition of the target before an offer has even been announced. This requires as close collaboration between sponsor/borrower and arranger(s) as is possible in the circumstances – bearing in mind the information sharing requirements mentioned in Due diligence above.
The potential for prolonged twists and turns in the timetable for the takeover of a public company (which Part 1 of our P2P transactions series describes in more detail) means that, whilst lenders are generally flexible and co-operative, they will require a hard longstop date to be included in the loan facilities agreement – bringing to an end the period during which committed acquisition finance is made available to the bidder on a “certain funds” basis. How long this availability period should be is dependent on whether and what regulatory conditions apply to the acquisition and whether it is likely to be recommended, hostile or become competitive due to the emergence of another bidder. It must not jeopardise the cash confirmation. In practice, it is typically at least six months in length; and whether and what the arranger and lenders are paid in the way of ticking and/or commitment fees during that period are matters for negotiation.
Our work here is not done
Credit support
The statutory prohibition on a target company giving financial assistance for the purchase of its own shares continues to apply to public companies (whereas it has been largely repealed for private companies). For P2P transactions, this means that, until an acquired target company is re-registered as a private company, it and its subsidiaries are subject to the prohibition and unable (primarily) to guarantee and grant security for the facilities which have been drawn by the bidder to complete the acquisition.
As a result, lenders are legitimately concerned with the process and timing for re-registering the target as a private company. Initially, their recourse would typically be limited to the contractual obligations of the SPV bidder (as borrower) and its SPV holding company (as guarantor) and security granted over the assets of each SPV (which only really becomes significant upon the bidder acquiring an interest in shares of the target). Additionally, once the target is controlled by the sponsor, it and its subsidiaries could, whilst the target is still a public company, guarantee and grant security for any facilities made available by the lenders for the purpose of refinancing existing target group debt or as an additional working capital or other credit line.
However, this next stage of credit support cannot extend to the acquisition facilities until the target is re-registered as a private company – which is another reason why carrying out the P2P by way of scheme of arrangement is attractive to lenders. In that case, with full control of the target obtained upon the court order sanctioning the scheme being filed with the Registrar of Companies, re-registration of the target as a private company can proceed immediately, and is sometimes achieved the same day – with upstream guarantees and security granted as soon as possible thereafter. A relief for lenders, as they will then have more direct recourse to the assets of the operating business for which they have provided financing.
Clean-up
As explained in Due diligence above, the opportunity to conduct due diligence in respect of the target business may be quite limited on a P2P. The sponsor will be concerned with hidden matters which, even if fairly inconsequential to the decision to proceed with the acquisition at a specific valuation, might result in an immediate breach of the representations and undertakings, or otherwise give rise to an event of default, under the finance documents.
Although now not unique to P2P financings, a “clean-up” period after completion of the acquisition is usually agreed: to allow a more thorough investigation of the operations of the target group and deal with any problems. Many of the representations, undertakings and events of default will be disapplied in respect of the target group, provided that the relevant matter is not so material that it cannot be ignored, is capable of remedy and was not procured by the bidder. At the end of the clean-up period the suspended representations, undertakings and events of default will apply fully to the target group.
