Important Questions for Acquisition Financing Term Sheets

Borrowers often see loans as a commodity product, with loans as widgets of the same size and price.  This may have been true 20 years ago, but today there are more types of lenders than ever before.

There are three major points of differentiation for these new lenders – they differ in their view of risk, the ways in which they manage risk, and in their cost of funds.  While borrowers might still think loans are one size fits all, our experience sourcing loans for our clients clearly shows this not to be the case.

Some lenders seek borrowers that are collateral light but cash flow rich.  Some seek specific industries they perceive to be less crowded.

Yet others are more interested in backing great management teams in rapidly growing markets.   These asymmetric market conditions result in lenders having completely different structural preferences and terms in their proposals.

If a cash flow lender likes the deal, he usually wants the money to stay outstanding longer and will have terms that discourage early prepayment.  Conversely, other cash flow lenders want to amortize the senior portion of a unitranche loan quickly to reduce the leverage and have highly technical cash flow sweeps.

Whatever your loan requirements, it is absolutely critical that you seek a loan from all these different types of lenders, as you never can be sure where your deal aligns with the moving target of lender preferences across the credit channels.

Once initial interest is established, each lender will provide a term sheet which lays out the particulars of their loan structure – the interest rate, loan amount, repayment profile, term, security, lien position, intercreditor terms, etc.

Lenders all have different forms for their term sheets as well as completely different disclosure approaches as to this information.  Some lenders are very detailed and provide 10 page term sheet, some are very high level and provide only a 1 page outline.

Each term sheet provides the opportunity for you to learn how the lender thinks about risk and how they make decisions.  So why you are analyzing each term sheet into a master spreadsheet, here are some things to keep in mind so you pick the right one.

1. What’s behind their term sheet process? – some lenders have multi-level approval and others allow anyone to issue one. Has the deal been socialized and vetted internally?  Has anyone with credit decision making authority weighed in on the deal yet? This is important to consider as ultimately, you want to know what the big wheel credit people are thinking, not the front line sales guy.
2. What is their credit approval process like? – term sheets are nice, but only closed deals matter. You want to query them on how they make decisions, who the decision makers are, and what their track record of approval is, assuming there are no unexpected diligence issues.
3. What is the Meta-language of the term sheet telling you? – term sheets all have an overriding theme. Some suggest, “We are control freaks and will be hard to deal with post-closing”.  Other suggest “we are very expensive and believe we are a premium capital provider”.  You need to pay attention to this as the lender needs to match the style and needs of the borrower for the relationship to work.
4. How do they make their money? – while all lenders receive interest and fees, some have other fees and warrants that add a lot to the overall cost. Ask them to explain their approach to pricing so you can zero in on how their pricing approach aligns with your loan cost expectations.  More expensive is, in itself, not a bad thing, if you are getting more of what you value from the lender.