A loan to own transaction is the acquisition of a secured debt position in order to influence control and ultimately acquire ownership of a target business (and its assets).
"The M&A year has been defined by “loan-to-own” takeovers, standoffs between shareholders and boards on company valuation, and increased regulatory scrutiny: dynamics that will continue into 2013." (M&A loan-to-own deals here to stay, James Eyers, Australian Financial Review, 5 December 2012).
Loan to own transactions are becoming more and more common – but what do they involve, and when are they appropriate? In this two-part article we give a basic description of a relatively straightforward loan to own transaction, and some practical tips to assist you in evaluating and ultimately structuring and implementing a loan to own transaction.
What is a loan to own transaction?
Not new to the M&A market, loan to own transactions have been adopted in a number of significant transactions in 2012, the most notable and publicised being the acquisition of Nine Entertainment. While distressed assets continue to work their way through the global markets, loan to own transactions will continue to have a place in the M&A landscape in Australia as an alternative to acquiring business assets from controllers and other formal insolvency arrangements.
At its simplest, a loan to own transaction is the acquisition of a secured debt position in order to influence control and ultimately acquire ownership of a target business (and its assets). Broadly, this type of transaction typically occurs either on a consensual or a contested basis. That is, either the existing shareholders of the target business support the transaction (generally because their equity is worth less than the value of the secured property or there is some other leverage position that induces the existing owners to give up control in return for some advantage, eg. releases from personal liability) or they do not (perhaps because they may believe the company can achieve a better return through a traditional administration or receivership).
By far the majority of loan to own transactions are contested transactions as it is unlikely that agreement with the existing shareholders will be cut upfront and more likely it will be arrived at through negotiation throughout the course of the transaction.
Advantages of loan to own transactions
Why is a loan to own transaction something you might consider? When compared against other formal administration and receivership procedures/appointments:
a loan to own transaction can be relatively quick to structure and implement. The due diligence phase and the documentation in relation to a sale of debt and securities will be considerably less time - and labour - intensive than a full commercial and legal due diligence of the business or property being acquired;
there may be significant tax benefits in terms of duties (though this must be properly considered and assessed on a case by case basis);
a loan to own transaction may alleviate the need for a receiver and therefore the receiver's need to satisfy its statutory obligations to achieve a market price for the assets. This could result in a discount in terms of the acquisition price; and
there may be other strategic advantages for a buyer and the creditors and for the ongoing viability of the target.
Typical steps in a loan to own transaction
While there may be any number of variations, depending on the final nature of the transaction and the commercial agreement reached between the parties, generally the steps to put together a pitch for a loan to own transaction in relation to a private company are:
- Confidentiality: Enter into confidentiality agreements. Typically the bank or secured creditor selling the debt will provide a standard draft for the buyer to accept. Broadly a buyer should consider the scope of the confidential information, its rights to share that information with advisers and that there are no unusual or onerous terms such as indemnities, non-compete/solicit clauses or other restrictive terms in favour of the bank.
- Due diligence: Bound by confidentiality obligations, the buyer may then conduct some basic legal, accounting and financial due diligence in relation to the loan agreement, security documentation and other material agreements of the target. It is worth considering at this stage whether it will be necessary to obtain consents from counterparties to any material agreements in respect of change of control as a result of the proposed transaction. Similarly, if receivers or other controllers have been appointed, a buyer should consider how those parties should be dealt with for the purposes of the transaction.
- Shareholder agreement/consent: In parallel to the due diligence, a buyer might commence negotiations with the existing shareholders to ensure their agreement/consent to any such transaction will be forthcoming and given on acceptable terms. This agreement will require significant attention and negotiation to ensure a successful outcome of the transaction. Once an agreement is struck, a buyer might also prepare a draft form of shareholder agreement or share sale agreement to take effect on completion of the transaction. Whether there is a shareholder agreement or a share sale agreement will depend on whether the existing shareholders will be a part of the target company going forward.
- Documentation: If the due diligence is acceptable and a deal is struck with the bank/secured creditor and existing shareholders, then the parties will prepare the documentation for the transfer/novation of loan and security documentation. Typically the transfer documentation will be relatively straight forward and operate in accordance with the principle that "a trade is a trade". That is, if the transfer would fail for any reason, for example failure to obtain a third party consent, the parties must find a way of settling the transfer (eg. sub-participation or cash settlement).
- Settle the trade and swap the debt for equity: The transfer document should be conditional on the debt for equity swap or sale documentation. A debt for equity swap may include provisions for a debt forgiveness, release of existing securities/guarantees and issue of new equity to lender, whereas a sale agreement may be a simple sale and purchase agreement with usual provisions.