The most obvious downside to the credit contraction is that it’s become increasingly hard to leverage a buyout. Debt, when it’s available, is expensive, and, noted elsewhere in this issue, purchase price multiples haven’t budged even as leverage multiples have dropped.
In a recent note to clients, law firm Debevoise & Plimpton offers a solution: Use the debt that’s already there to make a deal work. After all, most companies already carry some form of leverage, and any existing credit facility will almost certainly have a much more favorable interest rate than would any new issuance. By keeping the facility in place, a sponsor could reduce the amount of new leverage needed to finance the transaction or even eliminate the need to issue new debt.
Sounds good, but it ain’t so easy. As Debevoise attorneys Gregory Woods and David Wicklund observe, buying a company triggers change-of-control provisions in nearly every credit agreement. A frequent change of control provision requires noteholders to be paid off in whole, and typically at a premium, when a new owner acquires the company. So why would lenders pass up a chance to get their money back, and more, by keeping their debt in place?
The suggested remedy: negotiate—and be prepared to pay up. An LBO firm looking to keep the existing debt will clearly face an uphill battle with lenders, but it is possible to obtain their consent, Woods and Wicklund write. And manufacturing that consent will likely require a sponsor to agree to a combination of fees and increased interest rates to satisfy skeptical creditors.
It’s important to remember, however, that interest rates on senior debt have widened significantly over LIBOR in the last year; credit that was issued in 2007 at LIBOR plus 350 basis points or less now often runs 200 basis points higher. A package of higher interest rates and fees could still cost the sponsor less over its investment period than the cost of issuing an entirely new debt package at today’s higher rates.
Sponsors could also appeal to lenders’ economic interests. Particularly for struggling companies, lenders may prefer this sort of arrangement—which facilitates a deal—in lieu of keeping on their books loans that are underwater and could continue to lose value as the credit crunch deepens. Deal or no deal, in other words.
There’s another option, too. Sponsors could bypass change-of-control provisions by buying a purely economic interest in a company rather than a controlling interest. Of course, in that instance instead of losing the “L” in “LBO,” a sponsor would keep the “L” and lose the “BO.”
None of these are perfect solutions, Woods and Wicklund write. But they do argue persuasively that it’s time to get creative.