Unitranche in a Time Crunch
In a business climate where merger and acquisition activity has been uneven, and political and economic uncertainty continues to grip the United States and Europe, any additional deal certainty and cost efficiency can give private equity firms a significant advantage. Whether your firm is seeking to buy a new portfolio company, refinancing an existing credit facility or planning to take a leveraged dividend, financial decision-makers should carefully evaluate the advantages and disadvantages of a unitranche loan facility when determining how best to protect and enhance the value of their investments.
What Is a Unitranche Loan?
Unitranche loan facilities feature a blended interest rate (calculated using the weighted average interest rates of the senior and junior debt facilities), single credit agreement, single set of security documents and their own pre-packaged version of the intercreditor agreement known as the “Agreement Among Lenders,” which specifies the priority of various lien components in a manner similar to traditional financing documents. The Agreement Among Lenders also addresses issues related to application of collateral proceeds after the exercise of remedies, control of the exercise of remedies, voting and consent rights with respect to waivers and amendments, and the rights of lenders to purchase debt of other lenders after certain triggering events.
One important characteristic that distinguishes a unitranche loan from traditional syndicated facilities is that the initial unitranche lender provides all of the financing on the closing date, thereby avoiding some of the uncertainty, delay and cost that may arise as a result of the negotiation of the intercreditor agreement between the senior and junior lenders. Following the consummation of the transaction, the unitranche lender has the option of splitting the loan into “first-out” and “last-out” tranches to be allocated among new lenders buying into the facility. The first-out tranche will have a lower effective interest rate than the last-out tranche to account for the different levels of risk. The blended interest rate paid by the borrower, however, remains the same.
Advantages of Unitranche Facilities
Speed and Certainty
A unitranche facility requires only one set of credit and collateral documents, which allows for a more cost-efficient, certain and timely closing. Given that only one initial lender usually commits to the unitranche facility, the borrower will be able to avoid the process of obtaining additional debt ratings and can circumvent the logistical difficulties of finalizing the syndication process. Furthermore, there is no need for an intercreditor agreement given that the Agreement Among Lenders does not need to be negotiated among various lenders prior to closing.
Predictability in Pricing
Since the syndication of a unitranche facility is generally not a condition precedent to closing, unitranche loans are not subject to provisions that allow arrangers to increase the pricing and modify the structural terms of a proposed facility in order to complete the syndication process. The absence of these terms, commonly referred to as “market flex provisions,” means that the cost of the facility agreed to in the unitranche term sheet is the cost that will be paid throughout the life of the loan.
Loan payments, financial reporting, notices, consents and modifications to the unitranche credit facility only involve a single agent, and the unitranche borrower must comply with only one package of financial covenants.
Weighing the Cost
The primary drawback to a unitranche facility is the higher pricing. However, the private equity fund should compare the cost of the pricing to the costs saved upfront in the documentation of the loan, the decrease in warrants (and ultimate dilution of its equity interest in the portfolio company), the long-term interest savings generated by an amortization of the entire facility (as opposed to just the senior debt) and the savings associated with completing a proposed transaction before a structural change in market conditions (such as an increase in federal tax rates) takes effect. The exact calculus will depend on the cash flow of the portfolio company and its strategy for paying down debt.