The bridge equity structure has gained prominence in the US over the past year and has started to make an appearance in the European buyouts market. Conceptually similar to bridge debt financing, it involves a bank taking a portion of the sponsors’ equity commitment on a short-term basis until permanent equity investors are found.
In the context of a public offer, the sponsor will require a firm commitment to fund the equity from the bank, similar to its own commitment, in order to fulfil its cash confirmation requirements. Ideally, the bank would aim to sell any equity commitment before closing, avoiding a funding requirement.
If not, the bank will be required to fund the commitment and purchase an agreed amount of equity in the acquirer (usually an SPV set up by the sponsor), and then seek to sell the equity purchased within a given time.
For the banks, the provision of bridge equity can sometimes be the price of admission to a lucrative role on the debt financing, but with the significant downside that they may well have to use their own balance sheets and be left with unwanted equity stakes.
For the private equity firms, the obvious advantage is that they reduce the size of their equity cheque and free up resources for other transactions. It also avoids the need to create bidding consortia to spread the equity risk – which have been the subject of increased scrutiny in the US recently.
How parties protect their positions
The key to a successful bridge equity financing is the way the selldown of the bank’s equity is managed. Sometimes, the bank will decide to keep a portion of the equity for itself as a “hold” or “core” position.
In most cases, however, the banks will be asked to provide equity commitments in amounts greater than they would be prepared to hold permanently, so there will inevitably be a syndication or sell-down process of the excess, otherwise known as the bridge equity.
In most cases, there will be agreed general sell-down principles applicable throughout the sell-down period. These might require that sales are only made to sophisticated and qualified investors, and are structured so as not to create any tax or regulatory issues, for example.
Often the sponsor will want to syndicate bridge equity first to limited partners in its own funds and require that they are given preferential treatment in the initial stage of the sell-down period.
Control of the sell-down process is another key issue. Both parties would normally like control – the sponsor because it wants control over the identity of its co-investors, and the banks because they want to reduce their exposure to the bridge equity quickly and with little interference from the sponsor.
Information rights to assist any sell-down are also important. Banks will usually require sponsors to provide certain information and related rights in connection with their sales prior to the closing of the transaction, and further information rights after closing, often including legal opinions and comfort letters, once the sponsor has control of the target in order to assist to the fullest extent the sell-down process and marketing effort.
In certain European jurisdictions, “acting in concert” rules may have a significant impact on the structure in the context of a public offer.
A sponsor will want to limit the entities deemed to be acting in concert with the principal bidder. This is of particular concern where other independent arms of the bank have holdings in or make open market purchases of the target securities during the offer period.
Similarly, rules relating to equal treatment of shareholders in Europe may hamper marketing efforts where potential purchasers of bridge equity already have positions in the target.
The fees that a bank receive are generally based on a percentage of its bridge equity commitment. Banks often receive a fee based on their total bridge commitment; a second fee based on the amount of actual funding by the bank on closing (if any); and other fees based on the amounts that have not been syndicated by specific time periods.
Additionally, the bridge equity banks may also receive a fee if the transaction is not consummated and where a break-up fee is actually paid to the acquirer.
From a practical perspective, while the banks are most concerned with the sell-down arrangements, they are also concerned with their relationship with other investors (the sponsors and any other co-investors that have taken equity stakes in the deal) both before and after the closing of the transaction.
This is dealt with in an interim agreement in the period up to closing and a shareholders’ agreement post-closing. The interim agreement will often include provisions on expense sharing, the funding of commitments, and the rights of investors if the offer price for the target shares is increased.
The shareholders’ agreement will govern the investors’ relationships post-closing. This agreement contains standard provisions such as tag-along and drag-along rights, pre-emption rights, and veto rights over certain specified corporate actions.
The agreement is of interest to bridge equity banks if they are left with a portion of bridge equity after the end of the sell-down period.
While the bridge equity role is sometimes considered part of the entire debt financing package provided by a bank, because of the unusual nature of the financing, these transactions require experienced equity capital markets and M&A personnel at both the banks and their legal counsel to ensure the sell-down of bridge equity will be both viable and successful.