Given the importance of an acquisition in the context of the broader organization and the potential complexity it involves, treasury should commit its best internal resources to handling it.
This article sets out the key factors treasury must consider in arranging and syndicating a bank acquisition facility. Treasury’s overall aim should be to:
- Enhance value, ensuring that the acquisition is completed in line with the company’s strategy
- Maintain financial flexibility, negotiating a facility that does not place overly onerous restrictions on management while it remains in place
- Optimize the balance sheet, syndicating and refinancing the facility as quickly as possible and in line with the company’s optimal debt maturity profile
- Manage relationships, treating banks fairly and maintaining transparency with them throughout the process.
The process consists of six key steps.
1. Understand the transaction and the company to be acquired (the target).
The transaction: Treasury needs a comprehensive understanding of the acquisition rationale, as the alignment between the transaction rationale and the company strategy will give the stakeholders (e.g. banks, ratings agencies) comfort, and this should benefit the terms of the financing. Treasury also needs to understand acquisition structure and regulatory environment, as this will drive, in particular, the bank strategy.
The target: A thorough due diligence should be done on the target company’s financial position, and in particular its debt facilities, as change of control provisions can have significant consequences if not properly managed. The risk profile of the combined entity’s (‘Newco’) debt maturity profile also must be considered.
Treasury also needs to assess the target company’s banking group, as this permits the assessment of potentially conflicted banks. These are banks that have a relationship with both the acquiring and target companies but may decide not to participate as a lender in the facility (i.e., when the transaction is hostile). This is critical in shaping the selected banking group to support the acquisition facility, and it will also give an early indication as to the likely financing execution risk, especially if a very large facility is required.
2. Structure the acquisition facility.
The terms of the acquisition facility should be structured in a way that maintains the company’s operational and strategic flexibility, and should not undermine the ability of the company to capture further investment opportunities in the future.
First, treasury must determine when the facility needs to be put in place (committed/signed). In the absence of specific regulatory requirements, the board can determine when funds must be committed. They might take the view that having committed funds when an offer is made can give them an advantage (e.g., against competing bidders), but the additional fees and costs must be acceptable.
Next, treasury should consider the size of the facility. This will be a function of the amount of cash in the offer, the potential impact of the change of control provisions, and the cash forecast (allowing for contingencies and an increase in the offer price). At this stage, treasury will not have access to the target company’s internal forecast, therefore reliance will have to be placed on its own estimates of the target’s financial position or the best available public information (e.g., broker notes).
Lastly, consider the structure of the facility. The amount, tenor and terms of each tranche will be driven by the size of the facility, as well as lender considerations, in particular the perceived ability to successfully syndicate and refinance the facility. The incentive should be to refinance quickly—this would typically mean higher fees for shorter tenors and lower fees for longer tenors. Keep in mind that longer tenors may improve refinancing risk but will inevitably mean more onerous provisions (covenants).
3. Engage the credit rating agencies.
Treasury should engage the rating agencies as early as is practical, probably after the board has endorsed the transaction. The aim is to get as much possible clarity from the agencies on what the credit rating of Newco is likely to be, as this will impact the terms and conditions of the facility and the supporting loan documentation, as well as the bank and syndication strategies.
Having this visibility becomes more important if the expectation is that the acquisition will be credit negative to the acquiring company, as the banks will perceive this as increasing the execution risk.
The rating agencies may, however, not be prepared to provide a firm view on the rating outcome, due to their own internal policies. For example, if the acquisition is hostile, they may be prepared to only have informal discussions, giving only a hypothetical view of the likely rating outcome. The best outcome in terms of certainty provided will be if the rating agency’s advisory service give a formal opinion. This will probably only be achievable if the acquisition is friendly.
4. Develop the bank strategy.
Treasury needs to decide on which banks to invite to be part of the facility, and in what capacity. The right advisor and mandated lead arranger(s) will contribute significantly towards a successful strategy. If a relationship model is followed (with the banks), then ensuring a fair spread of business between the banks will be a key driver in the selection process.
Prior to making a commitment to participate as a lender, banks will want to be comfortable with the credit of Newco, and will also want to fully understand the terms of the transaction. Treasury will provide the required information in the Information Memorandum, a document which normally requires an extensive verification process.
A bank is more likely to provide acquisition support if:
- The deal dynamics are supportive (i.e., there is credit rating certainty, stable market conditions, a short hold period, an acceptable return, and an acceptable likely level of ancillary business)
- A positive view is held of management’s credibility (i.e., management has a proven track record of commitment to financial policies and a strong relationship exist with the company)
- The bank’s internal position is supportive (i.e., not conflicted, and the commitment is not too large for its balance sheet).
5. Negotiate and agree the facility documentation.
It is desirable (if not a regulatory requirement), to launch the transaction on the back of (largely) agreed documentation. Usually the key commercial issues and legal principles will be agreed first, typically in the term sheet. This will be followed by negotiating the final, detailed documentation. Various letters will also be exchanged (e.g. mandate, commitment letters and side-letters).
The acquisition facility documentation drivers will:
- Ensure smooth execution of the deal, so that the availability period to draw down funds allows for sufficient time to meet all approvals and eventually a squeeze-out of minorities (more problematic if it is a hostile transaction).
- Preserve financial flexibility by minimizing restrictions on operations. This will ensure carve-outs exist for mandatory prepayments provisions (manage cash flows with as much freedom as possible), and for negative pledge and permitted subsidiary indebtedness provisions (flexibility to pursue projects and issue secured debt if required).
- Manage the liquidity and refinancing risk. Pay special attention to change of control and cross acceleration provisions in the target’s debt facilities, as it (if not waived) can have adverse cash consequences; there should be sufficient headroom and grace periods before a financial covenant is breached and becomes an event of default.
- Ensure that the company can reasonably adhere to all the provisions. Be wary of unreasonable (repeating) representations and warranties.
6. Develop and execute the syndication and refinancing strategy.
In developing these strategies, the company should: leverage from long-term relationships with its banks, minimize leak risk by dealing with a reduced number of banks at an early stage, avoid unnecessary costs, and aim to reduce the bank’s exposure as quickly as possible (by shortening any possible underwriting window and accelerating the syndication).
Syndication: An important issue to consider is whether the facility must be underwritten, or not. It may have to be if, for example, it is a very large facility that has to be in place when the offer is made (due to regulatory requirements or a board decision). An underwritten facility is not required if, for example, the bank’s aggregate funding hold levels exceed the required facility amount. In this instance, treasury can self-arrange the facility and proceed directly to syndication.
Refinancing: Following syndication, the aim should be to refinance the facility as quickly as possible (subject to market conditions) in order to get rid of potentially onerous provisions, enable the company to optimize its debt maturity profile, and cancel the bank’s exposure.
In summary, acquisition financing can be one of the most challenging aspects of treasury’s role—but it is also one of the most rewarding. By delivering a complex acquisition facility in line with—or even exceeding— management’s expectations, treasury’s importance as a business partner can be greatly enhanced.
Riaan Bartlett, CTP is a finance and treasury executive based in Pretoria, South Africa.
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