Private equity firms are looking for new terms to increase transaction payouts

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Private equity firms are pushing aggressively to include language in loan documents that could give them room to pay themselves higher dividends from companies they’ve bought, drawing sharp rebuke from lenders.

In the past, loan documents typically limited exactly how much money a private equity firm could extract from one of its portfolio companies. Over time, those fixed amounts became malleable and were based on a percentage of a company’s earnings.

But in recent weeks, private equity firms have tried to take things a step further with the so-called high ebitda provision, which allows a company to use the largest earnings it generates in any 12-month period to critical tests that govern how much debt the company can borrow or the size of dividends it can pay to its owner, even if the business’s earnings have declined since reaching that peak.

KKR, Brookfield, Clayton, Dubilier & Rice and BDT & MSD Partners have all tried to turn the clause into loan documents, according to people briefed on the matter. All four firms declined to comment.

The terms received intense pushback from potential lenders, and in almost all cases the language was eventually removed from the loan documents. But the fact that private equity-backed companies continue to push for the language’s inclusion puts lenders on edge, with some fearful rival lenders will cave in and accept the provision.

According to lenders who have seen drafts of the loan agreements, the conditions were included in the preliminary loan documents supporting KKR’s purchases of asset manager Janney Montgomery Scott, valued at about $3 billion in the deal, as well as the purchase of 4.8 billion dollar education technology company Instructure. like Brookfield’s $1.7 billion purchase of a unit of nVent Electric. The clause was also included in preliminary filings for the refinancing by Wesco, which is owned by BDT & MSD Partners, and CD&R’s Focus Financial.

“It’s a really aggressive term,” said one lender. “It’s a difficult time to say, ‘I’m going to push the envelope further.’

In one deal, RBC, which was the lead underwriter of the $900 million term loan that Brookfield was raising for its investment in nVent, told an investor that the bank had strong demand and, if language was an issue, they should “vote with (their) feet”. “.

When enough investors came through, the big language was removed from the loan document.

RBC did not immediately respond to a request for comment.

That the language is being tested is a sign of a potential imbalance in the credit market, a critical source of financing for private equity buyouts. With purchase volumes still down from their 2021 peak, investors have had fewer new deals to spread their funds around, leading to increased competition around some loans.

“When you’re in a strong market, it’s usually harder to push” those terms, said one banker involved in the Infrastructure financing. But, he added, “they don’t survive.”

The language has reached at least one deal, a $2.1 billion term loan for a commercial laundry operation known as Alliance Laundry, according to two people briefed on the matter. The company planned to use the proceeds to refinance debt and pay an $890 million dividend to its owner BDT & MSD, according to S&P Global and Moody’s.

The provision states that “the Borrower may consider Ebitda to be the highest amount of Ebitda realized for any Test Period after the Closing Date. . . regardless of any subsequent decline in Ebitda after the date of the highest amount,” the text seen by the Financial Times showed.

“If you haven’t asked for those terms in a negotiation, you haven’t done your job,” said one private equity executive. “You always want to give maximum flexibility to your businesses.”

The concept of high water is not foreign to lenders; it is much more prevalent in European leveraged finance markets. And some bankers and lawyers say the idea is rooted in common sense.

In certain loans, the amount of future debt a company can borrow or the amounts it can distribute to its owner is set as a percentage of earnings. Companies like this flexibility because if they grow, they don’t have to keep amending their loan documents if they want to borrow or distribute more money. Investors said savvy lawyers decided to take this concept a step further.

High water supply creates a threat to potential investors, especially if a business starts to slow down before a loan is due.

“Over time, the protections that were built into credit agreements by commercial banks have deteriorated,” said Tom Shandell, Investcorp Credit Management’s head of CLOs and syndicated loans in general. “Private equity (firms), which can afford the best and brightest lawyers, have slowly introduced terms into credit agreements that weaken protection.”