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MIDDLE MARKETISSUE
THE
Representing the Asset-Based Financial Services & Factoring Industries Worldwide August 12
IN THIS ISSUE:Done Deal: Junior Capital’s Role in Debt Financings P10
Challenges and Opportunities in the Middle Market P16
Reverse M&A: Structural And Legal Considerations P20
DEPARTMENTS:Collateral P6 / Policy Watch P24
UNCITRAL Update P26 / Brief P27 / Revolver P32
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D O N E D E A L : J U N I O R C A P I TA L ’ S R O L E I N D E B T F I N A N C I N G S
Junior capital has become an important component in many debt
financings and a vital source of capital to many middle-market
companies. How have its uses evolved and expanded in recent
years? What new types of products and structures are now available?
What are their advantages, challenges and potential pitfalls?
We invited four prominent leaders in the lending industry to discuss the
role of junior capital in today’s lending world. The roundtable participants
are: Cheryl Carner, managing director of Crystal Financial; David Gaito,
regional marketing manager and senior vice president of PNC Business
Credit, a division of PNC Bank, N.A.; Leonard Sheer, managing director
and head of Debt Capital Markets at Cowen & Company; and Timothy
Tobin, managing director of Corporate Retail Finance at GE Capital. The
discussion moderator is Peter Antoszyk, a partner in the Multi-Tranche
Finance Group of Proskauer Rose LLP.
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D O N E D E A L : J U N I O R C A P I TA L ’ S R O L E I N D E B T F I N A N C I N G S
Junior capital has become an important component in many debt
financings and a vital source of capital to many middle-market
companies. How have its uses evolved and expanded in recent
years? What new types of products and structures are now available?
What are their advantages, challenges and potential pitfalls?
We invited four prominent leaders in the lending industry to discuss the
role of junior capital in today’s lending world. The roundtable participants
are: Cheryl Carner, managing director of Crystal Financial; David Gaito,
regional marketing manager and senior vice president of PNC Business
Credit, a division of PNC Bank, N.A.; Leonard Sheer, managing director
and head of Debt Capital Markets at Cowen & Company; and Timothy
Tobin, managing director of Corporate Retail Finance at GE Capital. The
discussion moderator is Peter Antoszyk, a partner in the Multi-Tranche
Finance Group of Proskauer Rose LLP.
Cheryl Carner
Timothy Tobin
David Gaito
Peter Antoszyk
Leonard Sheer
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lenders can be very conservative. Then
there’s a sweet spot in the market, about
$75 million to $250 million of debt, where
a unitranche facility is underwritten by
one or two parties. This provides financing
certainty to an equity sponsor, eliminating
the need for a syndication process and
facilitating a buyout.
Carner: At Crystal, our junior capital
transactions have been used in all these
situations. Often, we see instances
whereby there is a term loan need that
exceeds a level as a percentage of the
total facility commitment that banks are
willing to provide.
Antosyzk (Moderator): Banks, commercial
finance companies, hedge funds, BDCs and
insurance companies have all been very
active in providing junior capital. Do you
see many differences in terms of their ap-
proach to pricing and underwriting?
Sheer: All of those funds have a similar
view of the world. The differences are the
quality and size of the credit. We generally
see banks financing the larger, higher-
quality companies with the cheapest form
of capital. The others do smaller, more
out-of-favor industries and companies, and
charge higher rates.
Antosyzk (Moderator): Cheryl, as a junior
capital provider, how does Crystal distin-
guish itself from competitors?
Carner: We try to be flexible and creative
in terms of how we structure our lien
positions and what types of asset classes
can support a loan. We’ve done bifurcated
collateral deals that Tim referenced earlier,
but there are some loans where we have
either a last-out position (e.g., FILO) or a
second lien. We have structured transac-
tions utilizing a wide variety of asset
classes, including machinery and equip-
ment, real estate, intellectual property
and pools of receivables. In addition, we
have been involved in more conventional
cash-flow facilities where we rely on the
enterprise value as the source of repay-
ment. Having all of these tools allows us to
work with companies on both ends of the
life cycle spectrum. Whether the use is for
buyouts, acquisitions and dividend recaps,
or for companies that are going through
some type of revitalization or transition.
Antosyzk (Moderator): We’ve talked about
the providers, now let’s look at junior capi-
tal structures. Which structures are most
prevalent in today’s market?
Tobin: In retail ABL deals where the junior
lender is underwriting a second lien se-
cured facility, we’re still seeing the second
lien lenders require that the combined
senior and junior debt stay within an
expanded borrowing base. Often the
second lien lenders are allowing advance
rates for inventory, and AR assets reach
the high 90s. Sometimes other assets will
be added into the second lien borrowing
base, including IP, which never would have
happened years ago.
Gaito: The bifurcated collateral structure
where the asset-based lender has the
accounts receivable and inventory while
another lender has the term assets, such
as IP or real estate, is becoming more
commonplace. Then there are traditional
first-in, last-out deals that are tranched in
many different ways. You generally have
an asset-based lender on top, who might
have a piece of the term, and then there is
another tranche or two between the ABL
and a true junior capital provider.
Sheer: In the high yield market, we’re see-
ing a preference for first lien, second lien
structures. If you’re looking to maximize le-
verage, you start with the second lien and
still retain an option to add an unsecured
debt tranche.
Antosyzk (Moderator): At Proskauer,
we’ve been very active, particularly with
“unitranche” deals. I find, however, that
the “unitranche” structure is not very well
understood. How would you describe a
“unitranche” and what are the advantages
of a “unitranche” structure?
Carner: Unitranches can generally be
characterized as either cash-flow or asset-
based-oriented. Instead of an execution
Antosyzk (Moderator): The use of junior
capital has evolved considerably over
the last five years. To set the stage, what
do we mean today when we speak of
junior capital?
Carner: Historically, junior capital generally
meant unsecured mezzanine debt. Today, it
is a much more nuanced term and can take
many other forms, such as a FILO tranche,
a second lien tranche or even a unitranche
facility. When I receive an inquiry for junior
capital, I first ask questions to understand
the need or objective of the financing and
can then assess how the various options
within the broad realm of junior capital
can fit what they’re really looking for.
Tobin: On a number of retail transactions,
in addition to the second lien on the inven-
tory, A/R and other borrowing base-related
collateral, we are seeing the junior lender
obtaining a first lien on IP, FF&E and other
assets that haven’t traditionally been in
the borrowing base. These so-called “split”
or “bifurcated collateral deals” are becom-
ing more commonplace.
Antosyzk (Moderator): Are certain types
of deals, industries or assets more suitable
for the use of junior capital?
Sheer: We’re seeing that dividend recaps
and LBOs tend to require the junior capital
component much more often than acquisi-
tions or financing for general corporate
purposes. Sponsors utilize junior debt to
maximize their leverage and minimize
their equity contributions.
Tobin: Alternatively, in addition to LBOs,
we see the use of junior capital as an ad-
ditional source of liquidity for companies
that have hit a bump in the road and who
need incremental funds to effectuate their
turnaround.
Gaito: We’re experiencing a growing need
for unitranche financing, which combines
senior debt and some form of junior capi-
tal, in two particular areas. The first is in
out-of-favor industries and/or in situations
with unusual collateral, including interna-
tional assets and IP, where many U.S.-based
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provider, I expect that we are likely to have
some different concerns should operat-
ing performance deviate from plan. A
cash-flow lender may be more focused
on EBITDA leverage, while I’m always go-
ing to be focused on cash and liquidity. I
would expect an asset-based junior debt
lender to be focused on the borrow-
ing base and corresponding liquidity,
because, like us, they are likely to view
those assets as their primary source
of repayment. In either case, I look for
someone who trusts us to do our job as
the administrative and collateral agent.
Antosyzk (Moderator): Given that lenders
at different levels in multitranche financ-
ings have competing interests, their rela-
tionships are often governed by complex
intercreditor arrangements. How do you
approach these discussions?
Carner: Communication is critical. It starts
with clear definitions and an understand-
ing between both parties of their roles and
their respective lien or collateral positions.
Any misunderstandings in these areas can
cause a deal to go sideways or unravel.
When we’re in a junior position, we’re
very focused on our first lien partner as
the steward or agent of the relationship,
both in terms of dialoguing with senior
management as well as monitoring the
company’s collateral and finances. We
want to make sure that we have a high
level of comfort with their capabilities,
their thought processes and culture. It’s
also critical to have experienced counsel
on both sides, as they can make things
go much more smoothly.
Gaito: The interesting thing about these
arrangements is that they’re a zero sum
game. Whatever the senior first-out gets,
the senior second or last-out loses, and so
one of the critical issues is voting rights,
particularly in regards to liquidating col-
lateral. Who has the right to access the
collateral? Who can do what and when?
This issue becomes even more complicated
with a bifurcated collateral structure. For
example, say Lender A has a lien on current
assets and Lender B as a first lien on the
M&E. In the intercreditor agreement, Lend-
er A may seek a “use clause” from Lender B
to utilize the equipment to complete WIP
inventory or convert raw materials into
finished goods.
Another critical issue is when the
most risky piece can buy out the seem-
ingly least risky piece (senior first lien
debt). We don’t want someone holding
a buyout provision over our head on a
technicality.
Antosyzk (Moderator): So what becomes
tricky is negotiating triggers and what is
evergreen or expiring?
Tobin: Yes. Once again, this comes down
to the experience and character makeup
of the junior lender. On the ABL side, I also
want these agreements to give me the flex-
ibility to provide needed liquidity should
containing an asset-based loan plus a
high-yield tranche or a middle-market
cash-flow term loan plus mezzanine
debt, the borrower gets one facility.
Whether the unitranche is cash-flow
or asset-oriented, the benefits to the
borrower are one loan document, and
a simplified execution that generally
does not require a syndication. In addi-
tion, unitranches can often be more at-
tractive from a cost of capital perspec-
tive because amortization payments
are applied to the one tranche instead
of to the lower-priced term debt, while
the higher-priced mezzanine debt
remains in place.
Sheer: The groups that are leading uni-
tranche lending are doing large holds, and,
when combined with an asset-based loan,
the hold sizes are typically larger than
their commercial bank counterparts. You
can often team up and take down a fairly
substantial deal with two or three parties
raising their hands. A lot of these deals are
being won by groups that have worked
together; it’s a very small community.
Antosyzk (Moderator): Multitranche
financings necessarily involve close eco-
nomic relationships between providers of
debt capital. David and Tim: As the senior
lenders, what do you look for in a good
junior capital provider?
Gaito: Like everything in life, you want to
work with people whom you like and trust.
We can be fairly agnostic about the partner
for unsecured mezzanine in a sponsored
deal, because the sponsor is likely driving
that process. But as that junior piece gets
more active, our partner universe shrinks.
There are certain rights and agreements
near and dear to both parties’ hearts, and
you have to know that your partner is go-
ing to behave like you would if you were in
their position.
Tobin: I agree. Also, given that we are
sharing our collateral with another lender
whose interest may not always align with
ours, I want to see that the second lien
lender is providing appropriate additional
liquidity and flexibility. If it’s a cash-flow
“When we’re in a junior position, we’re very focused on our first lien partner as the steward or agent of the relationship, both in terms of dialoguing with senior management as well as monitoring the company’s collateral and finances.”
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our decision makers to hammer out a well-
defined structure. The next day we reached
an agreement and closed the deal in two
weeks. That never would have happened
if our communication had not been very
explicit and open.
Antosyzk (Moderator): Junior capital
providers had a boom year in 2011. While
this year started off less robustly relative
to the same time last year, things seem to
be picking up. What do each of you see for
the balance of 2012?
Sheer: While it’s true that overall debt
capital volume is down slightly year-to-
date 2012, 2011 was one of the most robust
years in a long time. And with interest
rates at 40-year lows and plenty of cash to
be deployed by all of the capital lenders,
on a year-to-date basis we’re still looking
at near-record volumes. Everyone wants
to put money to work, particularly when
you’re sitting on cash earning less than 50
basis points. Certainly for the foreseeable
future, say the next three to six months, we
anticipate a high level of transaction activ-
ity in the capital markets.
Tobin: We expect our retail lending
group will see more junior lending
opportunities for M&A in the middle
market for most of 2012.
Gaito: Absent a recession, I think the mar-
ket will be very robust in 2012, particularly
for junior capital or unitranche financing.
As Len mentioned, money is available for
the right deal. And because an election
year brings uncertainty, I think a lot of
groups will be going to market before year-
end to try to leverage up companies to a
reasonable level. Anecdotally, if you talk to
any kind of investment bank, many will say
their pipelines are stronger than ever.
Long-term unitranche financing also
can be a real growth area for us, as it
allows a bank to work with a junior
capital provider as a club participant. A
commercial bank can pick its leverage
entry point, price that amount of debt
at a lower cost and then allow the junior
capital provider, whose tranche carries
more risk, to layer in the more expensive
debt and earn its desired (higher) return.
This generally allows commercial banks
to stay in or enter a credit at what most
institutions would view as relatively
conservative leverage levels.
Carner: I, too, have a bullish outlook, and
would like to mention one other factor
that will create more opportunities for
junior capital providers. As the regulatory
climate becomes more restrictive and
requires higher levels of capital allocation
from traditional financial institutions,
bank debt will gravitate even more strong-
ly toward high-quality credits. Companies
having performance challenges or are in
the midst of a transition will find bank
capital less available and will therefore
seek out alternative financing solutions
that involve junior capital. I see this hap-
pening not just in 2012, but over the next
several years.
Antosyzk (Moderator): Thank you all for
participating and sharing your knowledge
and viewpoints. TSL
Roundtable participant contact information:
Cheryl Carner (ccarner@crystalfinco.com),
David Gaito (david.gaito@pnc.com),
Leonard Sheer (len.sheer@cowen.com),
Timothy Tobin (tim.tobin@ge.com),
Peter Antoszyk, (pantoszyk@proskauer.com).
the company get in trouble. It’s the com-
pany’s job to fight for flexibility in good
times, but we need to know that we have
the ability to provide funds which allow us
and the company to preserve and protect
our collateral, no matter what that does to
the borrowing base. Making sure we have
the ability to manage and fund a reason-
able sale process is going to be a priority.
Antosyzk (Moderator): We’ve talked about
the importance of clearly defining and
communicating the lien and collateral
positions and the challenges of inter-
creditor agreements. What are some of the
other potential pitfalls or hurdles that can
undermine multitranche deals?
Carner: The parties also need to have clear
understanding of the diligence process.
Who will be leading this? Is everyone satis-
fied with the resources or parties to be
utilized? On this point and the other issues
mentioned previously, the senior lender
and junior capital provider need to work
through the hot buttons upfront and nego-
tiate a path satisfactory to all parties.
Gaito: Intercreditors are very techni-
cal agreements, and it’s really hard to
understand where someone is coming
from unless you talk to them. For example,
PNC and Crystal were competing on a deal
last year for a 363-bankruptcy exit that had
to close in four weeks. Two weeks before
close, we concluded that we’d be better off
partnering and had an all-hands call with
“Long-term unitranche financing also can be a real growth area for us, as it allows a bank to work with a junior capital provider as a club participant.”