As more financial buyers have entered the mergers and acquisitions market and auctions have become more prevalent in the sales of companies, financing of acquisitions— primarily the conditions associated with the closing of the financing— has become a focus for sellers and an important component of the competitive process. A seller with fewer conditions associated with its financing has a significant advantage in the auction process.
Prior to the summer 2007 contraction in the credit markets, significant closing conditions had virtually been eliminated from financing commitments. It was a sellers’ market for the sellers of companies and a buyers’ market for the private equity funds seeking financing for their transactions.
With the collapse of the subprime mortgage market and the collateral damage to the financing markets as a whole, this situation changed, leaving three types of transactions in the market: i) fully underwritten and pre-syndicated deals that contractually had to close; ii) fully committed deals that were not yet syndicated, where lenders were faced with syndicating loans below par; and iii) transactions that had not yet been underwritten, leaving buyers desperately in need of funds to close the deal.
In the first instance, there was substantial pressure to close quickly and avoid any risk of a material adverse change or other event that could derail the closing. Sellers were benefiting from substantial up-ticks in price based on the number of buyers in the market, buyers were benefiting from excellent pricing and favourable covenant packages, and lenders were eager to close fully syndicated transactions.
In the second instance, in many cases substantial renegotiations have taken place, including sale price, interest rates, leverage, equity participation and capital structure. Some buyers have been able to obtain a substantial reduction in the cost of the acquisition, while some lenders have been able to require a more significant level of equity, better pricing and additional levels to the capital structure.
In the last instance, many deals simply did not close because of inability to obtain funding, and for deals that did find funding sources, the conditions, covenants, leverage and pricing were similar to those seen prior to the heated acquisition market of two years ago. Pricing in the sales of companies has also been adversely affected as a result of fewer buyers in the market, fewer lenders willing to fund transactions and a higher cost of funds.
Even with the contraction in the financial markets, there are many remnants of the prior frothiness. Buyers are even more focused on the ability of the seller to obtain its financing and close, with commitment letters still being parsed by both the buyer and seller. In addition, borrowers, sometimes feeling burned in connection with prior deals that failed to close or that were repriced or restructured, are focusing even more on locking in their lenders.
Clearly the contraction in the financial markets created uncertainty in the financing of transactions. However, as is often the case, with uncertainty comes opportunity. The lack of easy financing has put downward price pressure on a number of sellers. Transactions that were caught midstream, with a need for a more creative capital structure, can present well-priced opportunities. In addition, the requirement of a healthier capital structure with more debt below the first-tier lenders is providing opportunities for mezzanine lenders, equity players and other alternate sources of funds. At the end of the day, private equity funds still need to invest funds, lenders still need to book loans and each continues to seek the solid transactions still in the market. As before, the terms and conditions of the financing of those transactions will remain a key component of each transaction.