The Top 4 Wins from Debt Structure Elasticity

Posted on: March 28th, 2019

Debt Structure Elasticity Debt is a major component of any deal structure, often doing yeoman’s work in funding a transaction. Without it, most deals would require significantly more equity or seller financing.

When in deal mode, most sponsors focus on reviewing objective criteria on the lender’s term sheet such as rate, term, maturity, prepayment to name a few. This is an important first step but the more serious concern is the degree of flexibility that a given loan structure provides.

Debt structures have big value when their elements can be flexed or stretched, such that they provide the borrower a high degree of elasticity. Elasticity allows a company to transcend the concrete terms of the loan and bring scalability and optionality to their lending arrangement.

This sort of an arrangement is particularly relevant in the case of acquisition financing, where a buyer has to manage through integration risk and performance shortfalls. There is usually a surprise or two post-closing that pushes out the initial budget a quarter or two. There may also be an extra expenditure or two that were not captured in the pre-closing budget. When you have a rigid debt structure, perhaps based solely on collateral with short term repayment, there is very little room to maneuver.

With an elastic debt structure, you can bridge any gap and bring new expectations into the relationships. Elastic debt structures are utilized by cash flow based lenders such as mezzanine, unitranche and second lien providers, where bespoke structure are part of their lending DNA. Here are the Attract Capital Top 4 Wins from an Elastic Debt Structure:

Allows for reset of covenants – most covenants are set at levels to be busted, and every company will have to reset them along the way. An elastic debt structure allows you to reset covenants to achievable levels, and not constantly be in default.
Provides a scalable financing facility – elastic debt structures are scalable and provide more financing for additional acquisitions. Moreover, layering of loans allows a buyer to tap future debt capacity as senior and junior debt capacity swells. Elasticity gives you more money for future acquisitions, a huge win for roll up deals.
Fosters growth cultivation – all acquiring companies need more time and money than originally estimated. Elasticity gives you confidence that your lender will work with you and continue to help fund your business, along the growth journey.
Saves time & money – when you have to swap out an old lender with a new lender, it takes a lot of time and fees. When you scale with your existing lender and upsize the facility, you move faster and build more value.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.