What are the most commonly used debt finance capital structures across small, medium and large financings?
Available debt mainly depends on the size and type of the business, the track record of the private equity fund, its relationships with the financing banks and the quality of the due diligence material. Sources of debt finance for private equity transactions differ substantially for domestic private equity buyers, who typically finance all equity or seek debt finance from domestic banks, and international private equity buyers, who are able to tap international markets. On mid- and small-cap transactions there is usually just senior and institutional debt as the additional transaction costs associated with mezzanine debt are often not supported by the limited transaction size. On large-cap transactions it is a matter of pricing whether mezzanine debt is applied. High-yield is usually only considered for post-completion refinancing but not for the financing of the (original) purchase price.
Leverage levels for large-cap buyouts have gone up to around five to six times EBITDA and relative debt to equity ratios of 50% to 70%. Mid- and small-cap transactions are sometimes financed through equity only. Leverage levels and debt to equity ratios for mid- and small-cap transactions tend to be lower than for large-cap buyouts (40% to 60%).
Debt financing can take the following forms:
Senior debt. Senior debt typically includes:
- a term loan (to finance the acquisition and the costs of the acquisition); and
- a working capital facility (to fund the working capital requirements of the target).
The term loan is sometimes divided into "alphabet loans", a term loan "A" repayable in annual instalments and a term loan "B" repayable by a single bullet repayment (that is, a lump sum payment for the entire loan amount at maturity). Given the different risk profile, interest on each tranche of the alphabet loans is different.
Mezzanine debt. Mezzanine debt may be used to fill the gap between senior debt and equity invested. Mezzanine debt carries higher interest, ranks after senior debt but before institutional debt (if any) and has the benefit of second ranking security and usually an equity kicker (that is, shares, options or conversion rights in the debt issuer).
Institutional debt. The private equity fund's financing is typically split into an equity component and a debt component. The reason for that is that the funds will usually try to maximise interest deduction against the acquisition vehicle's taxable profit. There is no statutory thin cap rule or court rulings on the subject providing guidance on what that maximum is, but practice of the tax authorities suggests debt-to-equity ratios of 3:1 to 4:1.
High yield bonds. High yield bonds have been used in pan-European deals. We are not aware that they have been used in Austrian deals so far.
Across all sizes of transactions, loans from a syndicate of banks is the most popular source for debt financing. Corporate bonds are not usually used as instruments for senior financing because the issuance of corporate bonds secured by collateral require the involvement of a trust bank under Japanese law, and the completion of such collateralization and involvement of a trust bank introduce complexities to the transaction.
However, mezzanine financing is sometimes offered in the form of a subordinated bond or convertible bond (that does not require collateralization), or preferred stock, in addition to a subordinated loan.
Debt financing are often carried out through term loans.
Bank loans and high-yield bond financing are the most commonly used sources of debt financing of acquisitions in the medium and large cap space in Norway. In the recent years, there has been a highly efficient and liquid high-yield bond market in Norway, making bonds an attractive financing alternative to traditional bank loans. Bond financing is most often being applied as a take-out financing alternative, and so that the banks provide bridge financing on the closing of the relevant acquisition.
Such financing may be combined with a refinancing of the target company's existing debt, typically with a term loan and a revolving credit facility.
Direct lending structures with financing from specialized lending funds are also seen from time to time, but remains a small portion of the overall financing provided by third-party lenders.
In the small cap space, the majority of the acquisitions are carried out without any third-party debt financing or with only smaller portions of external debt.
In large Swiss debt financings senior-term loan(s) to finance the acquisition and revolving credit facility to finance the target's working capital are the most common structures. Such term and revolving facilities are frequently provided by a syndicate of Swiss and foreign banks. A syndication including Swiss banks only would be more typical for a mid-sized financing.
Depending on the targeted leverage, larger capital financings are often supplemented by mezzanine loans and less frequently by second lien loans and payment-in-kind (PIK) financings. Even though the issuance of notes are mostly arranged through the London market and, thus, rarely governed by Swiss law, we have in the past accompanied larger Swiss acquisition financings where secured bonds were placed in the Swiss market.
Smaller debt financings in Switzerland may often be limited to one or two senior term loans granted on a bilateral basis.
Traditional bank-led leveraged loan financing remains the most common source to fund small, medium and large private equity transactions in the Netherlands. Small and medium sized deals are usually financed with senior debt, to a lesser extent in combination with mezzanine or second lien financing, with funding gaps commonly being filled with vendor and/or shareholder loans or earn-out arrangements. Larger private equity transactions are increasingly structured as a term loan B, a non-amortising, secured term loan, with investors being a mix of traditional bank lenders and institutional investors. In larger internationally arranged financings we do more often see senior financing being combined with mezzanine or second lien financing or high-yield bond issuances.
For a more detailed description of matters related to financial assistance rules please see question 18 below.
Small and mid-cap deals have seen strong competition between traditional banks offering senior financing and credit funds providing unitranche or similar facilities. For larger acquisitions and refinancings, sponsors have a wider range of options and will consider both term loan facilities in the London market and New York senior secured (or unsecured) notes. The very largest financings may also access the US loan market. The split between these instruments depends primarily on investor demand at the time and so differs from deal to deal. Many transactions see complex structures combining term loan facilities, senior secured notes and senior unsecured notes.
In Belgium, debt financing for private equity-backed structures is usually obtained through a traditional secured term loan facility, often supplemented by the involvement of mezzanine investors. We have seen an increase in the use of borrowing base facilities to finance working capital needs which complement the term loan facilities that are mainly used to finance acquisition costs.
Loans are usually syndicated either before or after the deal is done. For post-closing syndication, one of the main concerns for lenders is establishing a mechanism for transferring loans without costs or formalities while ensuring that the full security package benefits any new lenders. It should be noted in this respect that Belgian law has improved significantly in this area, with the entry into force in 2018 of an extended security agent concept.
This is a question of more commercial nature and such information are not generally available to legal advisors.
Debt finance capital structures in Portugal commonly involve a high degree of leverage, with debt to equity ratios reaching 80%/20%.
On the debt side, financings will typically involve senior secured loan facilities (usually composed of an acquisition facility and a revolving facility) with securities granted over movable assets, property and (when the financing has recourse to shareholders) parent company guarantees or shareholder equity subscription obligations.
On the equity side, shareholder loans and other forms of subordinated debt/quasi-equity are very often used to meet banks’ equity ratios.
In what concerns especially the private equity sector, since the average value of private equity transactions in Portugal is small, deals involving private equity investors are made usually through a fund's equity, raised from its investors. Consequently, debt financing of transactions is less frequent, and it is usually reserved for the largest transactions.
Typically, private equity transactions are financed by a combination of debt and equity. The portions of debt and equity vary depending on various factors such as relevant sector, geography, size of the deal, market conditions and availability of debt and thus it will differ from case to case.
The type of debt varies but bank loans remain the most common form of financing although there has been increasing competition between traditional bank lenders and non-bank, or alternative, lenders and funds which has resulted in a wider array of debt products being offered on the Swedish market. The form of bank debt is generally a combination of: (i) term debt used to finance the acquisition and refinance the target companies’ existing indebtedness; and (ii) working capital (typically structured as a revolving facility) to fund the working capital requirements of the target companies.
Traditionally, Swedish private equity funds have enjoyed a strong banking relationship with designated “house banks” supplying funding to them on attractive terms.
Small and mid-cap transactions
The Swedish finance market is highly relationship-driven and the large Nordic commercial banks have been, and indeed still are, the biggest lenders for small and mid-cap transactions. However, there has been a funding gap and as a result thereof the Swedish market has experienced a growing direct lending market where debt funds and other alternative capital providers are increasingly active.
During the past decade, the Swedish market has seen an increase in corporate bonds (high-yield and investment grade) as well as other alternatives to bank financing such as alternative debt providers and financing through preference shares. However, bond debt is not yet customary in private equity transactions in Sweden and bank loans thus remain the main source of financing also for large-cap transactions.
Small and mid-cap deals have seen strong competition between traditional banks offering senior financing and credit funds providing unitranche or similar facilities. For larger acquisitions and refinancings, sponsors have a wider range of options and will consider both term loan facilities and senior secured (or unsecured) notes. The split between these instruments depends primarily on investor demand at the time and so differs from deal to deal. Many transactions see complex structures combining term loan facilities, senior secured notes and senior unsecured notes.
Large cap deals have seen much larger second lien capacity, oftentimes privately placed with direct lenders but for the largest transactions the bank/bond structure remains the most prevalent.
Third-party debt financing continues to be available for acquisitions of Chinese companies by private equity investors. One key challenge, however, is that a PRC target does not generally have the ability to give credit support (by way of guarantee or security over its assets) to a lender of offshore acquisition finance debt. Many of the going-private transactions of US-listed Chinese companies have involved debt financing, but their terms have showed little consistency, reflecting varying commercial and structural challenges. The acquisition debt has typically been borrowed by an offshore acquisition vehicle with the borrower giving security over its assets (including shares in its offshore subsidiaries) to secure repayment of the debt. The lenders have been a wide range of financial institutions, from international investment banks (such as BNP Paribas, Credit Suisse, Deutsche Bank, Goldman Sachs and JPM, alongside China Minsheng Bank and ICBC International in the case of Giant Interactive) to policy banks and other PRC banks (such as Ping An Bank Co., Ltd. and Shanghai Pudong Development Bank Co., Ltd in Wuxi Pharma, China Development Bank in Harbin Electric and CITIC in Tongjitang).
Secured bank loans on senior terms are the most common source of debt across companies of all sizes. The main difference across small, medium and large capital financings is the provider of debt; small and medium-sized deals rely on one or a consortium of Nordic banks while international commercial banks provide debt financing for larger deals. Alternatively, mezzanine financing is occasionally used in larger deals and medium financings. Debt capital market alternatives in forms of public offerings or private placements are also used in larger private equity deals, in infrastructure deals involving sponsors, and for refinancing. More recently, some Nordic and Finnish financial sponsors have raised credit funds to fund deals and to lend directly to small- and medium-sized companies.
Bank loans remain the most prevalent source of financing for French acquisitions, either through syndication or club deals. Such financing is often combined with a refinancing of the target company's existing debt, typically with a term loan and a revolving credit facility.
As an alternative source of funding, acquisition financing has been carried out through private placements and high yield issuances (associated with a bridge financing) thus allowing them to access institutional investors and diversify their financing sources. Certain borrowers also finance acquisitions by unitranche structures.
The French finance market in relation to small cap transactions mainly consists of bank loans.
Small-cap deals have traditionally seen the greatest variety of structures. Aside from a particular focus on German particularities, a frequent capital structure in small-cap deals is a senior bank financing with a mezzanine financing provided by a debt fund.
In the mid-cap range there has been a strong competition between traditional banks offering senior financing and debt funds offering unitranche financings (see also the discussion of debt funds below).
For large acquisitions sponsors have frequently relied on a mixture of both term loan facilities in the London market and New York senior secured (or unsecured) notes. The split between these instruments depended primarily on investors’ demand at the time and so was different from deal to deal. Some deals have even seen complex structures combining both term loan facilities, senior secured notes and senior unsecured notes. Sponsors on large deals have also been able to push for intercreditor agreements providing for extensive hollow tranches, giving the sponsor a variety of possibilities to bring in new (senior or subordinated) financing (facilities or notes) into the capital structure.
The main sources of debt finance capital are loans or credit facilities granted by credit or financial institutions operating in Greece (short- and long-term facilities including revolving credit facilities, term loans, standby letters of credit, bank guarantees and factoring facilities). Following the enactment of Law 3156/2003, which introduced certain tax exemptions to bond loans, most term loan facilities are structured as bond loan facilities. Under Greek law bond loans are only issued by companies that have the form of a société anonyme. Bonds issued under a Greek bond loan are debt securities, which can be subscribed by private placement or through a public offering. The vast majority of bond loans in the Greek market are subscribed by private placement. Large Greek corporates though have issued bonds, which are traded on European stock exchanges (mainly Ireland and Luxembourg).
The Greek SME sector has also access to capital provided by different types of the EU's assistance programs and funds allocated in the framework of the Greek Government projects assisting small and medium-sized enterprises. International financial institutions, such as the European Investment Bank, the European Investment Fund, the European Bank for Reconstruction and Development and the International Finance Corporation, have been active in the Greek corporate lending market, providing either direct loans to Greek corporates or loans and guarantees to Greek credit institutions.
Capital financings in Ireland typically take the form of either long-term (i.e. four to five years plus one year option to extend) or short-term loan facilities akin to a bridge that may be refinanced by a bond on larger financing. Revolving facilities are very commonly made available for working capital purposes.
It is becoming increasingly common, in the mid-market space, for local financings to include mezzanine/subordinated debt. However, such financing structures are more often seen at the higher end of the market in US or UK originated transactions involving Irish counterparties.
As alternative credit providers move into Ireland, venture capital financing has increased, particularly in the fin-tech and pharmaceutical industries. The increase in activity in the Irish property sector has also resulted in the use of alternative financing structures, such as note issuance programmes, which enable investors who might not otherwise be permitted to lend into Ireland to build up market share.
In Luxembourg, traditional bank debt is still commonly seen across all types of financing. High yield bonds and PIK Notes are also frequently seen in the financing of transactions in the Luxembourg legal market.
In the recent deals we have handled, debt financing usually takes the form of a combination of debentures, preference shares and secured lending granted by a banking syndicate.
The most commonly used debt financing options are as below:
- Long term loans from banks. This option is a suitable option across small, medium and large funding requirements. However, the end use of loan under this option is highly regulated and banks in India are not allowed to lend for land acquisition, capital market transactions, acquisition of own shares by the borrower, subscription to or purchase of shares/debentures, including that of subsidiaries /SPVs, etc.
- Long term loans from Non- Banking Finance Companies. This option is again a suitable option across small, medium and large funding requirements. It is however a costlier option in terms of interest rate(s) as compared to loan from banks. Further, most of the end use restrictions that are applicable to loan from a bank are not applicable to loan from a Non- Banking Finance Company.
- External Commercial Borrowing (ECB) from offshore lenders– ECB can be availed in the form of bank loans, loans from foreign equity holders, floating/ fixed rate notes/ bonds/ debentures (other than fully and compulsorily convertible instruments), trade credits beyond 3 years, foreign currency convertible bonds, foreign currency exchangeable bonds, etc. ECBs are highly regulated in terms of eligible lender, eligible borrower, end use, all in cost ceiling. Some of the end use restriction for ECBs are (a) Real estate activities, (b) Investment in capital market, (c) Equity investment, (d) Working capital purposes except from foreign equity holder, (e) General corporate purposes except from foreign equity holder, (f) Repayment of Rupee loans except from foreign equity holder, (g) On-lending to entities for the above activities.
- Issuance of non-convertible bonds (listed or unlisted) which are subscribed by financial institutions and foreign portfolio investors are subject to compliance with relevant guidelines of the Reserve Bank of India and the Securities and Exchange Board of India, as applicable. This option is also subject to compliance of deposit regulations under the Companies Act, 2013. This option is more suitable to medium and large funding requirements.