Acquisition Finance
The single most important issue on any acquisition for a buyer is how to finance it. The choice of the most appropriate source of finance is often critical and if a buyer cannot fund the acquisition out of existing resources it has two real options - borrow money, e.g. bank loans (debt) or to issue shares (equity). This note deals with the issues in debt finance.
Introduction
Debt has over recent years been invariably cheaper than equity for most companies because of low interest rates. Therefore, if a buyer can borrow, debt will usually finance the acquisition and we have certainly found this in the acquisitions we have advised on in recent years.
Commercial factors
When considering debt, the main factor for the buyer will be the interest rate at which it can borrow. Currently, our tax system means borrowing is favourable because interest, unlike dividends, is tax deductible from profits. In assessing the cost of borrowing, the buyer should liaise with its accountants and tax advisers as such tax savings could be considerable.
The choice of debt as a financing option is often also influenced by the following:
Borrowing restrictions
The buyer may be limited in its ability to borrow by restrictions in its articles of association or by the terms of existing loan facilities. The majority of loan facilities, particularly from banks, will contain restrictions on any further debt being taken without the lender's consent (which, in the context of security documents, is often referred to as a negative pledge).
Availability and cost of finance
Will lenders be prepared to lend money to the buyer and, if so, at what rate of interest?
Types of debt finance
Loans
This is the simplest form of debt finance and the type we come across most. A loan may come from a single lender (a bilateral loan) or a group of lenders (a syndicated loan).
Loans are usually secured on the assets of the buyer or the target (and often both), provided that rules against financial assistance are complied with (although the Companies Act 2006, when implemented (which may not be until October 2008), will change the law on financial assistance.
Debt securities
This, basically, is any form of financial instrument issued in connection with a loan. The most common we come across are loan notes forming part of the consideration which will be issued by the buyer to the seller on completion of the acquisition. These can be secured or unsecured by lenders, often banks.
Considerations in debt finance
Ranking
In large acquisitions there is often a tier of lending and utmost on the lenders’ mind is how their debt ranks on the liquidation of the buyer/borrower. The tier of debt may consist of:
1. Senior debt from banks that will rank ahead of unsecured and subordinated debt on the insolvent liquidation of the borrower by virtue of security;
2. Mezzanine debt where loans ranks behind senior debt but are ahead of unsecured and subordinated debt by virtue of security and inter-creditor arrangements; and, finally
3. Other unsecured and subordinated debt which will rank behind senior and mezzanine debt and may include areholder/directors loans and refinancing after the acquisition has taken place.
Security
As acquisition finance is often risky, lenders will almost certainly require a comprehensive security and guarantee package from the buyer, and the target of the acquisition, as well as any other subsidiaries. A properly created and perfected security package will improve the position of the lenders on insolvency,
A guarantee given by a subsidiary relating to the borrowings of its parent will give the lenders direct access to the cash flows of the subsidiary, rather than relying on cash in the subsidiary being paid up to the parent by way of distributions.
There are complex legal issues that will need to be considered when taking security and guarantees and these include financial assistance (see above), whether the new security will be breaching covenants in existing security documents, e.g. negative pledges, and, what is not often considered initially, whether the security or guarantee is in the best interests of the company giving it (otherwise directors would be in breach of their duties).
Subordination
Senior lenders will not want to compete with other lenders of the buyer in the event of the buyer’s insolvency. This is normally achieved by subordination of claims of other lenders and will give certain lenders priority over other on the insolvent liquidation of the buyer.
How can Warners help?
We can deal with all the legal issues when acting for a buyer on taking the necessary funding from lenders by dealing directly with the lender, or each lender as the case may be, from an early stage in its due diligence process.
We can also act for lenders, including banks, on their funding of an acquisition, dealing with all the necessary security and subordination issues with other lenders and all the required due diligence work such lenders require.
For further information about how Warners can help you with these and other business issues, please contact a member of the Company Commercial Team.