Moving (acquisition) financing to the target – interaction with the M&A process

If the strategic or institutional buyer plans to debt finance the transaction in whole or in part, the requirements set for the financing structure and by the debt capital providers must be taken into account and integrated into the process planning. Poor or missing coordination can cause disadvantages, especially in bidding procedures.

The planned financing should be taken into account already at the stage of preparing and then conducting due diligence. For example, the current structure of the target company's financing should be analysed in more detail, especially if a repayment or refinancing is contemplated. Here, for example, the existence of special rights of the principal banks to terminate agreements in the event of a change of a shareholder (the so-called change of control) or agreed early repayment penalties play an important role. If the assets of the target company serve as collateral for its own working capital facilities or even for loan liabilities of affiliated entities, the legal (technical) but also cost-related aspects of the repayment should be analysed at closing at the latest. From a business management perspective, topics such as cash flow planning and ratios such as the equity ratio are most important.

Because acquisition financing banks do not usually carry out their own due diligence through advisors, it should also be taken into consideration that reports prepared for the buyer have to forwarded to and checked by the banks.

When negotiating and drafting the acquisition agreement, the obtained findings should be taken into account. For example, informing the current principal financing banks of the target company and preparing the repayment of the financing, as well as releasing the established collaterals ideally should be scheduled in the period between signing and closing. The actual repayment is then made as a closing action or a closing condition upon closing.

In addition, transparency should be created for the sellers at an early stage so as to ensure that they can actively participate in the handling of financing-related matters (e.g. presentations for banks). If necessary, the management of the target company should also be involved in the process, as target companies are often expected to provide collateral prior to closing to the buyer’s financing banks which will assume risk already when the closing occurs and the loans are disbursed.

When financing banks and borrowing companies agree the financial fundamentals of a financing arrangement in a commitment letter and/or term sheet, the parties involved are often faced with a high workload related to preparing documentation that has to be managed in parallel to the negotiation of the acquisition agreement. However, a high degree of standardisation has developed on the market, enabling the parties to focus on the essentials.  For example, larger financing arrangements and those intended for international syndication are based on the standards of the Loan Market Association.

Key matters regulated in loan agreements include first of all the loan amount, maturities and the interest margins which are often linked not only to a reference interest rate (e.g. EURIBOR) but also to financial ratios (e.g. debt-equity ratio).

Negotiations also focus on agreeing the meeting of specific financial ratios in future (financial covenants) and other obligations (covenants). These covenants can significantly limit the future operational leeway of the target and the buyer and its associated enterprises if, for example, the planned M&A activities are restricted or made dependent on the approval of the banks. Therefore, realistic and already now foreseeable developments of the business should be considered as permitted actions. In the event of a breach of such covenants, the borrower generally has the right to remedy the breach, for example if certain financial covenants were breached by contributing own funds.

In our view, the interlocking between the largely parallel workstreams of the acquisition and the financing process is essential for the successful completion of the transaction. The early and sustained exchange of information can prevent delays and difficulties with producing proof of financing to the seller, especially in bidding procedures.