How Lenders Quietly Rig Acquisition Financing Terms in their Favor

Despite the high professionalism of acquisition financing lenders, there are still tricks up their sleeves. Some are industry conventions that are seldom questioned while others are unique to specific acquisition financing lenders. The segmented process of raising acquisition financing naturally creates the opportunity for lenders to rig terms in their favor.   While most terms are fleshed out and agreed to upfront, a good number of them are ventilated only in legal documentation, once you are down the road and past the investment committee approval stage. This makes it hard to negotiate and borrowers usually accede to them.

While the lenders are in good faith and fair dealing, these silent rigging tactics lead to a lower quality deal for the borrower. These fall into four categories – extra fees, costly processes, one-sided rights, and overly sensitive covenants. All acquisition financing deals have an upfront fee as well as a prepayment fee. This is well defined in the term sheet and agreed to by the parties. Some deals also require a make whole fee, which compensates them for a minimum return if they are taken out early. Make whole fees are defined in complex detail that measures the opportunity cost of lost income.

Make wholes are used by lenders as an extra income grab on their way out of a deal, and they usually do not explain the calculation in the term sheet. Acquisition financing lenders frequently require their borrowers to provide them with inspection rights for third parties. This costly process is not well defined up front.  It is commonly subject to lender discretion and the Company must cover 100% of this cost. Acquisition financing lenders also are fond of having the absolute discretion to call a default, if they see a material adverse event occurring. This is a one-sided right and gives them huge leverage over the borrower, especially in an underperformance scenario.

Finally, a common game acquisition lenders play is in not giving the company enough breathing room to make their covenants. Rather than discount projected performance a healthy 20% or more for the covenant, they will set a higher bar resulting in a higher probability of covenant default. While each of these rigging strategies is not a big deal breaker on their own, the cumulative effect of them results in a degraded deal and greater risk for the borrower.