Auction processes for European target companies and divisions attractive to private equity buyers are increasingly competitive and demanding for all participants concerned: sponsors, debt providers and professional advisers.
The amount of legal work undertaken at the bid stage has increased significantly in the last year or so. Documentation, including term sheets, are generally much longer and are negotiated more heavily. More time is spent structuring deals and preparing alternative financing proposals.
It is more common for full documents or interim funding arrangements to be produced, often within very tight deadlines. The main reasons for this are:
– bidders demand rigorous legal, accounting and tax structuring advice and analysis from their professional advisers so as to maximise their leverage and therefore the offered price;
– in offering a maximum price and taking on high leverage, they want to be sure full due diligence has been done; and
#bidders need to show unconditional, and probably fully documented, financial arrangements to vendors to prove they can complete – and quickly.
The result for law firms is that they are advising more parties on potential bids and giving more in-depth advice than in the past, but few of these parties are ultimately successful. Most firms have reached the view that current work practices on auction processes are not sustainable in the long term, as they are running up many million pounds of write-offs each year.
Assuming each bidder approaches at least three investment banks to arrange debt finance for their bids, there would be 80-100 interested parties in the financing aspects of the auction. And some firms will be offside from the start by advising the seller, management, the seller’s M&A advisers or a staple financing provider.
Each party needs to receive independent legal advice and almost all will look to receive advice from one of the 10 or so law firms with Europe-wide capabilities, which are regularly involved in these processes. If instructions were distributed evenly, each law firm would have to field 10 or more separate teams with effective Chinese walls in place. Hardly any firms have sufficient resources to achieve this.
In order to deal with this situation firms sometimes have to turn away prospective instructions due to lack of resource or in order to reserve resource for favourite clients or those participants they believe are most likely to succeed.
Law firms will be reluctant to work on a pure contingency basis across many teams where only one can succeed. Free work is therefore now limited by firms. Where clients require extensive assistance, as is often necessary in order to create a fully competitive bid, some degree of cost coverage will be required. To minimise costs of unsuccessful bids, it is now usual for sponsors to direct all banks competing to provide finance to a single law firm that has to ‘tree out’ to cover all.
Rigorous conflict clearances and coordination are crucial to ensure conflicting instructions are not accepted, effective Chinese walls are maintained and often key clients of particular firms or particular lawyers are not left unadvised. Almost all instructions are now taken on a non-exclusive basis, with the main exceptions being found in public bids where confidentiality concerns are absolute.
Wherever possible, workflows that are generic to the transaction rather than specific to each bid will be carried out by single non-affiliated teams, the products of whose work will be shared commonly across all client-specific teams, and these team members will be available for generic consultations to all teams.
Additionally, it is now common for one team of lawyers in the jurisdiction of the target company to provide generic advice to all client teams working on the relevant transactions.
Interim funding arrangements
Another result of the competitive nature of recent auctions has been that, increasingly, sponsors are requiring their supporting banks to provide fully and unconditionally committed funding included, generally in a short form ‘interim’ facility agreement.
The main driver behind the need for these interim funding commitments is the need to show absolute, unconditional certainty of funding to the vendor in order to enhance the prospect of a sponsor’s bid. Other motivations could be where acquisition exchange must happen very quickly leaving insufficient time to negotiate and agree full documentation, or where the bidder does not want to incur full documentation costs. The majority of recent auction winners have had interim facility agreements provided by their financing banks to back their bids.
The key control for the arranging and underwriting bank(s) is that the funding will be repayable within a short period of completion. As a result it is not necessary for the funding commitment to be supported by significant representations, undertakings or defaults.
Often there will be only basic legal representations as to the binding nature of the repayment obligation on the borrowing newco. The committed funding provisions will be kept simple to avoid time and effort being diverted from the main acquisition process. There will generally be a single-term loan with a blended interest rate and, occasionally, a single currency cash revolver as a last-resort working capital backstop. A short-term facility will generally be unsecured, given that the borrower will be a clean newco, although occasionally a share pledge over the shares in the target company may be included.
The only conditions to the funding commitment will be an execution of the acquisition documentation and satisfaction of its terms, and provision of the agreed equity and subordinated debt funding to be provided by the sponsor funds. Simple drawdown mechanics will also be needed. Most leading private equity sponsors now have their own preferred detailed term sheets and credit agreements that banks are required to accept if they want a mandate.
Currently the funding commitment approach has only been seen in the market supporting bids by private equity sponsors. It will be interesting to see if the concept is adopted by trade buyers.