Debt portability provisions — reasonably common in high yield lending but historically rare in bank financing — have been recently seen in an increased number of US transactions, as deal terms react to a buoyant financing market. What should deal teams consider when seeking to include such provisions on European deals?
What Are Debt Portability Provisions?
Debt financing documents typically contain a change of control feature that triggers an event of default, or requires a mandatory prepayment or offer to purchase, upon the sale of the borrower or issuer of the debt (referred to in this article as the company) to a third party. As a result, the credit markets generally expect that all material existing debt will be refinanced on the sale of the company.
In some cases, the need or obligation to prepay debt is coupled with call protection for particular tranches of debt, which adds a premium to the cost of refinancing existing facilities. The total amount of this cost — underwriting fees for the new replacement facilities and call protection payments — is effectively borne by the seller, as a prospective buyer will factor costs into the purchase price. Debt portability provisions waive the change of control provisions if certain criteria (including leverage ratios and ratings conditions) are satisfied.
Why Should European Sponsors Seek Debt Portability?
The principal financial advantages of debt portability are three-fold: they reduce transaction costs with net savings flowing to the seller; they may accelerate the time to closing as there is no need to arrange new replacement financing; and they eliminate uncertainty about the ability of the buyer to raise the debt financing for the acquisition on acceptable terms. In addition, portability features enable the sponsor to conduct an auction in an extremely efficient manner, as bidders do not need to communicate with numerous financing sources.
Debt portability, however, may not be equally effective in all cases. Sometimes, the prospective buyer wants greater flexibility (such as more debt incurrence capacity) or different terms (such as customised baskets based on sponsor precedent) than what the company’s existing debt documents provide. In other cases, the buyer may desire to raise incremental debt to fund a higher purchase price, meaning some marketing effort will still be needed and the speed-to-closing advantage of portability will be reduced. Notably, certain debt investors disfavor portability provisions — including those provisions in a syndicated financing could affect pricing or execution.
The Expected Sale Process
If negotiating debt portability provisions, the company must anticipate how terms will work in tandem with the expected sale process, to ensure seamless intersection with acquisition agreement conditions precedent.
Because the company negotiated the portability provisions and its equity holder stands to benefit the most from the feature, a buyer may expect the seller to bear the risk that the portability feature works as expected at the closing.
From a seller’s perspective, ideally all seller or company debt porting conditions precedent would be met at the time of signing, in order to provide certainty that the debt will port at closing, or at least to ensure that seller is not responsible for any failure to port.
Will European Practice Follow US Trends?
In our view, debt portability provisions will remain a feature of selected European deals, being most effectively sought in opportunistic financings in which market conditions are favourable and the expected exit is in the near term.