Debt Structure

Debt structure refers to the way in which the loan financing is shaped, formed and embedded into a transaction, most frequently an acquisition. The choice of debt structure is a critical one for the success of a transaction and the growth of the acquisition. There are four major variables to consider when structuring and the best debt structure is the version that optimizes for each variable based on what the market will bear. Debt structuring principles are essential to build balance, flexibility and soundness into the transaction.

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The major debt structuring variables include:

Debt Structure Loan Type

Loans break down into two types, asset-based and cash flow-based. Asset-based loans are structured off the level of asset collateral. Cash flow-based loans are structured off adjusted EBITDA. Cash flow-based lenders utilize a multiple of adjusted EBITDA to size their loan. For this reason, cash flow-based loans provide more capital within a debt structure and are used frequently in acquisition financing. Cash flow loans can be senior debt, subordinated debt or a combination of both.

Debt Structure Pricing

Loan pricing depends on risk which is a function of the debt multiple, deal quality and equity contribution. Debt structures with principal repayment in a balloon have higher pricing than debt structure with principal repayment over the term. The larger the loan amount is relative to the EBITDA, the closer to the equity level the loan is resulting in higher pricing. Conversely, the lower the multiple, the closer to senior debt the loan is resulting in lower pricing. Acquisition financing for middle market deals ranges from 9.0% to 12.5%.

Debt Structure Term and Principal Payments

Acquisitions are complex projects and require time scales reflective of their unpredictable nature. Standard terms for acquisition debt structures are 5 to 6 years, giving a company a long-term runway to acquire, integrate and incubate value. Some of amount of principal repayment is required with senior debt structures. Principal repayment is completely back ended with junior debt such as mezzanine debt. Longer term to maturity combined with no principal repayment provides a highly nurturing debt structure environment.

Debt Structure Scalability

Many debt structures have built in scalability enabling them to fund additional acquisitions. This is an important strategic weapon for companies doing roll-ups that are competing with other acquirers who are funded by large funds. The ability to scale a debt structure with a delayed draw term loan brings high value to the acquirer.

Frequently Asked Question

1. Who determines the shape of the debt structure, the acquirer or the lender?

The company’s capital raising investment banker is the best person to design the structure. This advisor knows what the market will bear and how to customize the structure for long-term success.

2. What are the general multiples and covenants used?

Acquisition financing debt multiples are 3.0 to 4.0 times depending on the deal size. Debt service (also known as Fixed Charge) covenants range from 1.15 to 1.25 times.

3. Is it best to have several lenders or one lender in your debt structure?

The more lenders, the harder it is to close and to manage lender relationships post-closing. One lender can often provide all the capital needed, and though more costly, they will move quicker and scale more reliably post-closing.

4. How important is cash flow growth when modelling the debt structure?

Cash flow growth is extremely important. Acquisitions in theory add more cash flow to a company. The lenders expect the increase in cash flow growth to be large enough to pay down their loan.

5. Should I be more price sensitive or more capital sensitive in my structure?

While price sensitivity is important, capital access is the make-or-break issue for acquiring companies. They need to have capital access to close and capital access to continue to fund acquisitions.

6. What is a delayed draw term loan and why is it important?

This is a loan that can be used for additional acquisitions after the initial closing. Usually available for 2 to 3 years post initial closing. It is a very important strategic tool for roll up acquirers.

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