Debt advisory: Holding the cards in sell-side processes

Denise Ko Genovese
23 February 2017

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Vendors are increasingly calling upon debt advisers to sound out potential lenders prior to a sale process. In part two of our series, Denise Ko Genovese explores the popularity of the practice in a liquid market

Click here to view part one of our series on the growing prevalence of debt advisers in European private equity

In the mid-market, debt advisers are notably more present in sell-side processes where they are called upon by an outgoing sponsor to "warm up banks" in a so-called "lender education process". This is a chance for a select group of prospective banks and funds to get a head start on the credit they will potentially lend to, without having an idea of who might be bidding.

Though sceptics would say the incumbent sponsor is simply trying to give the semblance of control and create a floor from which debt bids should begin, others say it is useful and bolsters confidence in the credit to show there is a group of lenders ready and waiting to finance a buyout.

ECI's David Ewing says this strategy is fairly standard these days when selling a company. A sponsor selling can portray confidence in its company by demonstrating where people are leverage wise. In addition, it can fast track the process somewhat to show a group of banks waiting in the wings.

"It isn't a perfect process, but it can help to focus efforts and getting information early and having access to management is a plus," says the direct lender. "If you can have a first stab at terms, you can enhance the deliverability of a package, which can be crucial in a competitive processes."

The debt adviser – as part of the sell-side team – controls this process. It can be a "friends and family only" invitation with only six to eight lenders invited and only two management meetings arranged; or, in a contrasting scenario, two days of meetings organised and up to 50 lenders invited.

A staple can give buyers the confidence to make a pre-emptive, all-equity bid, safe in the knowledge that the risk of not being able to get debt in place is minimal" - Debt advisory source

"We recently went to both types, but the latter can be very time consuming for management, and it is questionable how much value it adds to the process as a whole," says the direct lender.

Taken a step further, the bank-education-process can sometimes lead to a more formal arrangement in the guise of a "soft staple". Staple financing packages were once the mainstay of the large-cap LBO market, where banks put forward their credit committee approved terms, which, if accepted as the staple financing package, were valid for whichever sponsor acquired the business. It was also a fallback option, a type of underwritten debt package. If the credit failed to syndicate, the staple financing banks would be left holding the debt.

The soft staples currently bandied around in the mid-market are less formal, but are also stronger than guidance or a rough term sheet, and there will be some level of credit approval.

"A staple can give buyers the confidence to make a pre-emptive, all-equity bid, safe in the knowledge that the risk of not being able to get debt in place is minimal," says the debt advisory source.

But just as a lender education process can speed up a process, it can also backfire on the sponsor and its debt adviser. If the leverage estimates are very low, this will inevitably impact valuations, since the debt underpins the bid and, in some cases, has the power to scupper a process and have an auction pulled from the market.

In the driving seat
"Right now there is lots of cash to deploy and everyone [debt providers] is falling over themselves to get in a deal," says the UK bank lender. As a result, terms can get very aggressive and, at times, they are clearly dictated by the adviser, to the extent that it can feel they are the ones driving the process. Ultimately, they have all the cards in hand as they handle the communication.

In some processes, both bidders and banks being warmed up are kept very separate, with both sides signing non-disclosure agreements not to approach anyone from the other side, which can cause frustration with lenders, especially if this becomes a protracted process.

"We [lenders] want to talk to sponsors as soon as possible, but they [advisers] sometimes want to keep us apart for increasing lengths of time," says a second bank source. "Some advisers are infamous for doing this."

But the first bank lender source counters with a positive: when lenders and sponsors do finally get matched up and bundled together, the roles being dished out can be easier to accept, as all parties get the impression things have been done in an orderly fashion. "Conversely, we have been in situations where the end result was not as discussed and that is very frustrating," the bank lender says.

Just as the debt markets have progressively strengthened in the past couple of years, so has the debt advisory market. Once deemed a luxury add-on, but by no means a necessity, the service has become hard to avoid to help navigate increasingly sophisticated and numerous financing propositions, put forward by a sea of increasingly diverse lenders.