In 2012 we published our book on mergers and acquisitions ….it is called “Middle Market M&A: Handbook of Investment Banking & Business Consulting“. One of the topics we address is financing acquisitions and various ways to thinking about getting deals done. In the middle market, funding strategic deals is often a mix of senior debt coupled with mezzanine and some type of seller financing (i.e. seller note or earn-out). If your company, as the buyer, is a lower middle market business itself; a key to being credible in the negotiating process is having evidence of financing before you enter discussions. This essentially means building an acquisition strategy and plan, then obtaining buy-in from lenders and investors before going to market. An advantage of this approach is having the experience and support of your financing sources early-on and in due-diligence. Overall this helps improve the likelihood of a successful transaction.
In recent months, I’ve had clients ask about “unitranche financing” ….what is it, what is different, when would you use it and where do you get it? The definition that we use in the Handbook of Financing Growth is –
“A hybrid senior loan product that blends first and second lien debt, and in some instances mezzanine, into a single tranche.”
A tranche is a round or an installment of funding. A company typically seeks to maximize its borrowings with lower cost senior (or first lien) debt and then add debt that is increasingly more expensive as the lien position decreases. It is similar to the concept that a mortgage on a house is the cheapest because it has the deed of trust in first lien position in the event of default. If you then get a second mortgage or equity line of credit, it has a second lien on the property and is a bit more expensive. Lastly, if you obtain unsecured debt like a credit card …it is the most expensive. In business, the unsecured debt is usually called subordinated debt or mezzanine financing.
Historically, each type of debt comes from a different funding source. A business would get senior debt from the bank, junior debt from a hedge fund or specialty finance company, and subordinated debt from a mezzanine lender or growth equity investor (mezzanine is a hybrid debt and equity).
In the market now, there are lenders that have combined all of the levels of debt for a company into a single financing resource (and set of documents) call “unitranche financing”. This can make a lot of sense when a company needs to get a deal done quickly and with a single lender ….eliminating the negotiations and costs among multiple parties.
Quarterly we read about new private equity funds being formed, each with a market focus and sometimes a unique twist on the conventional model. In recent years we haven’t seen too many new debt funding sources, though a few. 2nd lien or Jr. debt became popular, funded by hedge funds, prior to the great recession. And we saw the advent of unitraunch credit facilities providing varying layers of debt in a single instrument surface early this decade. In addition, we have seen a some asset based lenders offer hybrid credit facilities; they operate like a line of credit, but have some of the legal mechanisms of factoring …one such firm is Federal National Payables – they have focus on government contractors.
A new financing source has emerged in the past year. Taking from the framework of the stock exchanges, The Receivables Exchange has created a trading platform for accounts receivables. It allows a company with revenues of at least $1.5 million (and that has been in business for at least 2 years) to sell their accounts receivables on an as-needed basis to an open market in a controlled and confidential way. I really like it because it may augment your existing line of credit and possibly increase overall availability. For example, you can sell foreign A/R, which is usually excluded from most domestic credit facilities. Because there is no long-term commitment to sell your A/R, a company can use this credit facility to support tight cash periods when needed and not use it without penalty when cash flow is strong. Since your company is selling invoices either in groups or individually, it may likely obtain a better rate for your financially stronger customers. I was skeptical at first, but after getting to know some of the folks and researching the business I’ve concluded that The Receivables Exchange is for real and will likely be a major player in the years ahead …it is funded by Redpoint Ventures and Bain Capital.