Q & A - The legal view

Simon Tinkler, partner, Clifford Chance (ST)

Mark Spinner, head of private equity, Eversheds (MS)

Ashley Allton, partner, Norton Rose (AA)

Brian Gray, partner, Linklaters (BG)

Martin Bishop and Andrew Masraf, both partners, Pinsent Masons (MB and AM)

How have debt terms changed since last summer?

AA: Pricing has increased, both in terms of arrangement fees and margin. We see pricing being 'flexed up' during the syndication process, particularly on large transactions. This is in stark contrast to the frequent 'flex down' experienced in early 2007. Debt structures have also changed; we are seeing a greater proportion of the loan being placed onto an amortising basis although bullet strips still remain.

BG: Leveraged multiples have gone down and the cash equity component in deals has gone up - banks now often look for 35-40% equity. In some cases the equity actually going into the deal has been as high as 50%. The structure of debt has also changed. It is now more traditional with no second lien or pure PIK. And of course, the margins and upfront fees have gone up as well.

Jumbo deals may be off the table, but how difficult is it to get debt for larger deals in the mid-market?

MS: Debt over £300m is tough to find and is only available for the very best deals. Over the past three or four weeks greater caution has been exercised across the mid-market too, however, the true nature of the dealflow situation is difficult to judge because some sellers are rushing to get deals through before the CGT changes in April.

AA: The mid-market is still active with deals able to be funded on a club basis rather than relying upon wider syndication. However, there are suspicions that a number of lenders are withholding their consent to certain post-deal matters, in the hope that they may be bought under 'yank the bank' clauses at par, when the debt is trading at a significant discount in the secondary market.

BG: It was encouraging to see the Biffa deal getting underwritten. Large deals which previously relied on the institutional market for syndication are finding it difficult to get underwriting, particularly in sterling - the BC Partners deal for Migros is an interesting recent jumbo deal which was able to be structured as a club deal relying on local banks.

ST: Getting debt has become difficult in general. Banks which were the regular funders for the bigger deals are definitely nervous even if they had a good relationship with the private equity house in the past. It might actually be easier to get the incumbent bank to roll over the debt rather than trying to find a new one.

MB/AM: The syndication market would appear to be extremely difficult at the moment and, where previously there was strong competition between banks for deal mandates, with banks often prepared to underwrite debt themselves, club deals have become more prevalent. As you might expect, an increase in the number of parties involved in any deal process can often lead to greater complexity and delay in execution.

What role do you see mezzanine playing in the coming months?

BG: We are seeing more deals with a mezzanine tranche than in the recent past and specialist providers are regaining ground in the underwriting market.

ST: Mezzanine always fills a gap and I expect it to increase in popularity, but it is unlikely there will be a flood of mezzanine debt. It will be interesting to see who will actually provide mezzanine - the bank or a private equity house. Generally speaking for smaller deals you will get mezzanine from the main lending bank and for deals around £250m mezzanine will be provided by a third party. Above this size mezzanine availability is currently stretched.

MS: I believe the role of mezzanine will increase and we will also see syndicates of mezzanine providers on a single deal.

Has the balance of power between banks and private equity firms reverted to what it was in the early 2000s?

AA: It is interesting to note that where consents and waivers are being sought under pre-crunch documentation (for example, for bolt-on acquisitions), the lenders are not seeking to renegotiate the earlier documentation, but looking for substantial waiver/consent fees from the borrower. This said many pre-credit squeeze concessions still remain in documentation.

BG: Not really, in our experience. Those sponsors who are still active are able to create competitive tension among underwriters - just not so much as a year ago.

MS: Private equity houses are complaining about the position of the banks because they can no longer dictate terms like they could at the end of 2006. Banks are also asking for more due diligence.

What sectors are most attractive to private equity houses in a slowing economy?

MB/AM: To some extent, that depends on how insulated the sector (or the particular part of the particular sector) or the company is. Look at the healthcare sector for example. That has been a popular investment choice for private equity investors for some time, principally because of the availability of a solid asset base and strong cashflows arising from long-term contracts with public sector bodies. Sectors like retail and construction might be viewed differently at the moment, but even there, there are still investment opportunities.

AA: Popular sectors for bank lending at the moment seem to be energy and infrastructure. The nature of these businesses means they are more likely to weather any downturn, and therefore are more attractive to the banks from a credit perspective. One sector out of favour at the moment seems to be high street retail.

ST: There are sectors where you won't see many deals, such as those with a property angle. On the other hand, some private equity houses think this is the time to buy in the financial services market.

MS: Private equity as an investment is still very attractive. In the past, funds that invested in economically difficult times have performed really well. They buy cheap and sell high. In the end, private equity houses often see value in underperforming management teams, strong cashflow, easily scalable businesses and businesses that can grow quickly. Despite the way in which they try and market themselves most remain generalist investors.

Have the changes in the CGT affected the sell-side calculations of GPs?

MB/AM: From what we have seen, the volume of deals does not appear to have increased significantly as a result of the forthcoming CGT changes. Where the change in CGT rate is a commercial concern for parties, there has been understandable pressure to complete deals which were planned or already underway.

ST: I do have some clients that were driven by the deadline in April, because of management tax angles, but it is not a significant amount. GPs are always interested in delivering the maximum return for LP. The question for management is whether it is better to sell now to avoid higher taxes or to sell later when the markets have recovered.

How should sovereign wealth funds be defined?

BG: SWFs aren't like other investors, although where we come across them they are acting more in the mould of a private equity house. It depends on which fund you look at. There are SWFs that do a lot of buyouts and others hardly ever do them.

ST: It is difficult to be generic regarding definition. We are currently helping to put guidelines together for organisations on this subject. The question that often needs to be answered is what measures the fund has taken to ensure it is politically independent.

Which groups will private equity firms find themselves competing with for deals over the coming months?

MS: Rumours abound that SWFs and Middle Eastern funds are looking to invest directly and not just through funds-of-funds, and are also willing to invest smaller amounts of money to do deals. The worry is that the mid-market will become even more competitive with the SWFs and Middle Eastern funds taking a longer term view of their investments allowing them to pay fuller prices.

MB/AM: Trade bidders with strong balance sheets and low borrowings, and therefore the potential to raise more third party debt, may see the market moving towards them, particularly if prices soften over the next few months. Interestingly, we have seen some trade bidders putting together private equity-style equity incentive structures to reflect the expectations of incumbent management teams who have already experienced the upsides of private equity investment.

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