Introduction to Acquisition Financing & Recent Trends

By: Linda Curtis and Andrew Cheng, Gibson, Dunn & Crutcher LLP.

Business acquisitions vary widely in terms of size and structure, the parties involved, and the nature of the financing involved. The parties typically involve one or more buyers, one or more sellers, and one or more lenders.

A STANDARD ACQUISITION STRUCTURE IS THE PURCHASE of the target company’s equity, but acquisitions by merger are also common. An acquisition may also be structured as the purchase of all or substantially all of the target company’s assets. Even within each structure category there may be variations, and these variations may drive the structure and terms of the financing.

A leveraged buyout (or LBO) can be loosely defined as an acquisition that is funded all or in part with a material amount of debt, usually where the target’s assets and business are used as a source of potential repayment for the debt. Often, the buyer in an LBO is a private equity fund. A variant of the leveraged buyout is the management buyout (or MBO), where the target company’s management team, alone or with the help of a private equity partner, participates in the buyer side of the acquisition. A strategic acquisition typically refers to a transaction where the buyer is an operating company rather than a private equity firm. Given that the buyer in a strategic acquisition operates an independent business (unlike the buyer in an LBO, which is often a shell acquirer with no real assets or revenue formed by a private equity firm), the lender for the acquisition financing will often have a potential source of repayment from the old business as well as from the acquisition target. Although this article focuses primarily on debt acquisition financing for leveraged buyouts, a significant part of the discussion is relevant to strategic acquisitions, because many common LBO terms and conditions have crept into acquisition financings involving strategic buyers in the past few years.

Recent Trends in Acquisition Financing

A number of trends in acquisition financing have become evident since the 2008 financial crisis. First, the low interest rate environment since 2008 (that continues as of the date of this article) has made debt financing a very attractive source of funds for potential acquirors, both private equity funds and strategic buyers. Second, certain funds-type financing commitments (and acquisition agreements that do not contain financing conditions) have become standard in U.S. acquisition finance during this time period. Another general development since the financial crisis has been an increase in the sheer complexity of acquisition financing terms through the inclusion of incremental loan (also called accordion) and related provisions, amend and extend provisions, equity cures, and other innovations. For a sample incremental facility provision, see Sample Provisions: Incremental Facility (Credit Agreement). For a sample amend and extend provision, see Sample Provisions: Amendand Extend (Credit Agreement). For a sample equity cure provision, see Sample Provisions: Equity Cure Right (Credit Agreement).

A final general development is the increasing scrutiny of debt financings, including acquisition financings, by U.S. financial institution regulators—including, most importantly, the implementation of the interagency guidance on leveraged lending initially proposed by the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency in March 2013. 78 Fed. Reg. 17766 (Mar. 22, 2013). In November 2014, the agencies jointly published supplemental guidance on the issue of leveraged lending practices along with their answers to certain frequently asked questions by banks regarding the March 2013 guidance report, available at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20141107a3.pdf.

In effect, in the November 2014 guidance, the agencies confirmed and clarified their position on expected underwriting practices for regulated financial institutions and reiterated their position that they expect compliance with these standards. Since the 2014 supplemental guidance, both anecdotal evidence and league tables support the proposition that regulated lenders are now taking seriously the regulators’ concerns about excessive leverage; however, as of the date of this article, the full implications of such regulatory developments are yet to be determined. See also The Impact of Dodd-Frank and Capital Requirements on Commercial Lending.

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