DealLawyers.com Blog

In a tough deal financing market, PE buyers have increased the amount of equity they’re willing to invest in order to fund add-on transactions. Here’s an excerpt from a recent PitchBook article:

It has become less common to see add-ons fully funded with borrowed money. They are often structured with a variety of financing methods that can include cash on the acquirer’s balance sheet, additional equity issued by the PE owner and its co-investors, or a combination of debt and equity, said David Hayes, a partner at law firm Reed Smith.

Some PE managers don’t tap as much debt as is available, choosing instead to inject more equity into add-ons so that they can rein in leverage of platform companies and help them stay compliant with credit covenants.

By putting in more equity, they hope to create a combined business that has a more manageable capital structure that has some breathing room to deal with the economic uncertainty down the road, said Nitin Gupta, a managing partner at Flexstone Partners.

In the past, if a PE firm pursued an add-on with the purchase price of 6x to 8x over EBITDA, they may have taken 6x to 6.5x of leverage and put in 1.5x to 2x of equity, or possibly no equity at all. Now, firms will do that same deal with 3x to 4x of leverage and the rest in equity, Gupta said.

The article points out that one of the factors driving PE buyers to inject more equity into their deals are the “most favored nation” provisions in their existing debt agreements. These provisions are common in middle market credit facilities and allow lenders to reprice existing debt when new loans are incurred with higher interest margins than those under the existing facility.  Since interest rates have risen sharply over the past year, even a small amount of incremental debt could trigger a significant increase in interest costs.

– John Jenkins