What is acquisition finance?
At its core, acquisition finance is a type of debt finance which is raised from financial institutions and other investors for the purpose of purchasing another business, where a buyer is unable to fund the transaction entirely from its existing resources. The buyer may be an existing company (with an established business) or a special purpose vehicle (SPV), newly formed to purchase all or part of the assets or shares of a target company.
The types of deal which involve acquisition finance include management buy-outs, management buy-ins, institutional buy-outs, leveraged buy-outs and of course, general 'corporate acquisitions' (being debt financed acquisitions made by 'trade buyers' (corporates) rather than a private equity house or management).
We are currently looking to structure a management buy-out. How might acquisition finance form part of the overall funding package?
In the context of a management buy-out (or a buy-in), finance will typically comprise both 'institutional equity' provided by a private equity provider (and to a lesser extent, by the management team) and, separately, debt finance.
The split between the 'debt' and 'equity' finance will be different on every deal – as will the make-up of a particular debt package, which may be provided from various different sources (for example, term loan coupled with an invoice discounting line).
An overall debt package is likely to be made up of a mix of senior debt and junior debt. In general, senior debt comprises the central and invariably largest part of the debt finance package and tends to include two elements:
(a) acquisition finance (that is, the finance required by the buyer to acquire the target business); and
(b) working capital (that is, the finance required by the buyer's group for day-to-day operations and capital expenditure requirements).
This senior debt may be provided by one bank or, in a larger deal, by two or more banks acting as a club or 'syndicated'. The senior debt will take priority over other unsecured or more 'junior' debt which is owed by the buyer.
What is 'junior debt'?
Junior debt is generally used as a 'top up' to the core element of acquisition finance – sitting somewhere between the senior debt and the equity. Whilst being subordinated to the senior debt, junior debt is often vital to enabling an acquisition to proceed. There are various types of junior debt (for example, mezzanine debt and PIK debt) – which we would be happy to discuss in more detail with you.
Mezzanine debt is generally provided by acquisition finance banks, or by other specialist providers or funds which have been set up to provide this 'gap funding'. Given the greater risk profile of mezzanine debt, a higher margin is payable than on senior debt.
Whilst not strictly 'acquisition finance', it is worth noting that over the last few years, buy-outs (and other M&A transactions) have been increasingly part-funded by the seller. This is typically the case where a buyer either is unwilling or cannot afford to meet the seller's price expectations on completion of the deal, but may be willing to pay 'deferred' consideration further down the line (for example, if the business exceeds certain performance levels after completion). A seller's debt is often, but not always, subordinated to the other elements of the acquisition finance.
You refer above to 'priority' and to debt being 'subordinated'. What does this mean?
Given that a transaction will generally involve a number of different secured and unsecured funders, a 'payment waterfall' is typically agreed between the various parties as part of the deal.
This pre-determined flow of funds and priority of distributions or allocations between the various debt holders and equity providers will override any different order of payments that would otherwise apply, automatically, by law.
At its simplest therefore, subordination is a contractual arrangement where one or more junior creditors (for example, a provider of mezzanine finance, or a seller who has partly 'self-financed' a transaction) agree not to be paid by the buyer group (the debtor) until the senior creditors (generally, the bank) have been paid. Effectively, the senior lenders are given priority over the more junior lenders.
There are different ways of achieving subordination. However, in the context of an acquisition or a buy-out, subordination arrangements are often documented in a deed of priorities or an inter-creditor agreement. We will oversee the preparation and negotiation of these documents and will help our clients understand the implications of the subordination arrangements, how these interact with any security the client has given or (as the case may be) taken and how they impact on the client’s right to a payment of deferred consideration, a repayment of debt or a right to receive (or pay) a dividend.
What experience do you have in this area?
We have extensive experience in providing legal support to banks, lenders and other investors who are financing business acquisitions or buy-outs, or carrying out re-financings. We also regularly advise management teams and corporate borrowers in respect of such transactions.
By nature, these transactions tend to be quite fast-moving. We are used to working within the timescales of these transactions, which are driven and dictated by the buyers and sellers. We have the capability and experience to handle complex structures and arrangements.
We are experienced in advising all parties (lenders, investors, buyer and sellers) on the following types of documents:
- Loan documents (in respect of senior, mezzanine or unsecured debt);
- Equity documentation (investment agreements, articles of association and loan note instruments);
- Guarantees and security arrangements;
- Ranking of debt/priority of security – for example, subordination and inter-creditor arrangements.
On debt transactions, we often work closely with our property finance team, as many of the transactions we act on involve property security.
We also support clients on the legal and company law aspects of raising equity finance – whether as listed companies (i.e. through rights issues, open offers or placings – see Listed Companies) or in circumstances where the buyer is a private limited company backed by private equity investors.