© 2008 Babson College

Financing StructureM&A for Entrepreneurs Elective

© 2008 Babson College

Major Components of the Deal

Senior Debt

Long Term Debt

Subordinated Debt or Mezzanine Debt

Seller “Takebacks”

Equity

© 2008 Babson College

What drives the structure of Deals?

Historical Cash Flow

Predictability vs. Projections

Industry

Amount of Debt Financing Available

© 2008 Babson College

Key Leveraged Financing Guidelines

Maximize lowest cost debt

Cash flow must support senior and junior debt

Cash flow must be adequate to cover seasonality or blips

Leverage assets appropriately

Covenants must be flexible to allow debt pmts and C/F problems

Avoid conflicts among lenders and equity partners

© 2008 Babson College

Bank Loan Decision Criteria

Quality and experience of mgmt. and capital providers

Bank’s experience in the industry and with deal players involved

Credibility of projections and historical profits

Cash flow

Industry trends

Quality of assets as collateral

Amount of equity & subordinated debt/mezzanine debt

Asset liquidation plan (future cash flow generation)

Fees and equity participation attractiveness

© 2008 Babson College

Senior Debt

Commercial Finance (Asset-based) Loans

Revolving Line of Credit (Generally Secured)

• Revolver• Revolver/Term

Senior Debt

© 2008 Babson College

Commercial Finance Loans

Commercial Finance Loans

Amount of the line of credit is based on bank’s view of quality and liquidation value of the collateral and EBITDA/FCF/Cash Flow

A/R: 70-80% of A/R within 60 days past due

Complications: Service Receivables

Foreign Receivables

Inv: 0-60% depending on bank’s view of inv.

Appraised Value

© 2008 Babson College

Revolver/Revolver-Term Loans

Collateralized in leveraged deals

“Cash Flow is King” (EBITDA/FCF)

Covenants and terms

• EBITDA/Cash Interest

• Bank Debt/EBITDA

• Total Debt/EBITDA

• CAPEX Limits

• Leverage Ratios

• Restrictions on other debt

Revolver/Revolver-Term Loans

© 2008 Babson College

Subordinated Debt/Mezzanine Debt

Subordinated Debt or Mezzanine Debt

Junior to bank debt in liquidation of co.

High coupon with equity kicker

Some covenants

Objective is to maximize equity return

© 2008 Babson College

Equity Kickers

Set as a fee, warrant/option, % of profit or cash flow

Amount of kicker depends on the percentage of the deal provided by the sub debt/mezz lenders

Equity

© 2008 Babson College

Inter-creditor Agreements

Established who is ‘agent’

Priority in bankruptcy established

Covenant and default consistency

Affirms asset sale flexibility & amount

Orders principal & interest payments

Defines rules around prepayment

Sets voting rules in syndicates

Defines refinancing rights

Establishes consistent curing provisions

Governs sale of obligations by various parties

© 2008 Babson College

What can go Wrong?

Failure to follow management plan

Slow Reaction to off plan performance

Failure to run the company to maximize cash

Revenue declines vs. projections

Overly optimistic projections

Conflicts among the lenders

Lack of understanding of how to manage leverage

Loss of confidence in management by lenders

Harris Seafood LBO

© 2008 Babson College

1986 (A) 1987 1988 1989

Revenue (MM) $97 $104 $116 $125

EBITDA 14 17 20 21

FCF 11.6 9.3 8.4 10.3

Int. Exp. 1.4 5.7 5.1 4.7

Debt + Int. 10.6 8.9 10.3

Int. Cover 1.6x 1.6x 1.5x

Unused Borr. Available ($)

(7.0) 0.4 8.6