Financial implications & restructuring and acquisition financing

Financial implications & restructuring

Reduced cash flow, but also uncertainty about ability to retain assets locally, may trigger financial covenant breaches or have other implications under financing documents. We have identified also the less obvious triggers.

Acquisition financing

Capital markets, both equity issuances and new debt instruments, have closed for both new and pending deals. Syndicated bank financing projects that were not entirely committed as certain funds, have in many cases also been terminated, or stalled.

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Broader considerations for financial implications and restructuring

Sanctions, supply chain disruptions and market volatility may unexpectedly impact the company's financial position. Even if the company is able to absorb financial losses and limit the damage, the shock itself may trigger financial covenant breaches or other, less obvious concerns in the company's financing arrangements. And sometimes, that shock comes with a short-term spike in funding need, requiring some additional liquidity headroom. Either way, it is prudent to look beyond the immediate issue to the potential dominos behind it, and assess whether funding lines will remain stable, reliable (open) and legally committed. Financial implications tend to result in either of two issues: a covenant breach or a liquidity shortfall. The covenants most likely to be breached relate to the following:​

  • A material drop in EBITDA. ​
  • Most companies, however, use a definition of EBITDA in their financial covenants that deviates from the reported EBITDA number. The covenant EBITDA typically allows the borrower or issuer to normalize reported EBITDA by adding back certain exceptional items. This carve-out allows normalization of the negative financial effect of one-off, unexpected, non-recurring and to the​ company unrelated events on EBITDA. These add-backs were quite common at the onset of the COVID-19 pandemic as well as in other circumstances where there was a sudden shock event. ​
    • Important breathing space comes from the less-known fact that covenants are tested against quarter-end but lead to a default only once the compliance certificate has to be delivered. This is typically 30 to 45 days after the last day of the quarter. This allows for a period of 30 to 45 days to negotiate a waiver with the banks. This period tends to be sufficiently long, provided the company can show the various scenarios most likely to occur as well as plan A, plan B etc. ​
    • An event of default triggered by a cessation of business in Russia, Belarus, or Ukraine, is the cessation of business covenant applies directly to the subsidiaries or guarantors in those countries. Another check that is useful to perform as banks will ask to see the assessment, is whether the company indeed remains complaint with the now expanded sanctions laws in the EU, the US, and the UK.​
    • The supply chain issues, war or market volatility may be so disruptive to the company's business, that it constitutes a Material Adverse Change (MAC) or Material Adverse Event (MAE). After initial doubts, the COVID-19 pandemic was not considered to a MAC or MAE in any financing arrangements save for exceptional conditions. Our expectation is that lenders will also not qualify the situation in Russia, Belarus or Ukraine as a MAC or MAE per se, but only if these hit a certain borrower exceptionally hard, leading almost or actually to a bankruptcy.​
    • In case of borrowing base financing or factoring, the company needs to make sure the underlaying receivables do not concern any sanctioned persons as that would make collection of the receivables illegal.​
    • It goes without saying that, where the company is part of a group of entities, a default under one or more facilities of one group entity could have a knock-on effect on other facilities. Consequently, a check on any cross-default or cross-acceleration has to be performed.​

To assess whether a liquidity shortfall is likely to occur, bank will in almost all cases ask for a 13-week liquidity forecast showing the liquidity headroom of the company or the group. This chart shows the expected development of liquidity (including committed revolvers or overdraft facilities but excluding uncommitted lines) in each of the next 13 weeks (by week-end). It allows the board to decide whether or not to postpone certain payments or to accelerate collection of receivables. More importantly however, this chart allows the management board to initiate discussions with banks as it is one of the first things banks request when asked to provide additional headroom.

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Broader considerations for acquisition financing

Capital markets, both equity issuances and new debt instruments, have closed for both new and pending deals. Syndicated bank financing projects that were not entirely committed as certain funds, have in many cases also been terminated, or stalled. Only smaller bank financing deals, as well as direct lending (credit fund) deals, are continuing as before. We have not yet seen MAC (Material Adverse Change) or other clauses in drawn-financing being called. However, we do experience that financiers drag their feet in yet-to-close M&A deals, discretionary financing and capital expenditure financing. As for bonds, they typically require a credit rating. If the rating has not yet been obtained, the ratings processes are currently on hold or very slow. However, if a credit rating has already been obtained and is not up for renewal, we have not seen the rating agencies proactively reaching out (yet). . It is key to face this unwillingness of financiers head-on by preparing various scenarios and plan A, plan B, plan C etc. and to imitate discussions with financial and legal advisers. This allows the managing board to show the company's financiers that the board is in control. ​

Occasionally, the lenders may try to pressure the purchaser to terminate the SPA, or otherwise pull out, on the basis that a draw-down of funds to close the transaction would be unpermitted use of the facilities, or some comparable argument. If the company does want to seek a way out, it is key to stay in control of the narrative. Communication with the financier, the seller and the target company has to be coordinated from the new perspective. Several aspects, that were not in play before, are now of mounting importance. One of the main things to keep in mind is to prevent giving cause to liability claims by the seller or target towards the company (or its management board). Furthermore, the company has to prevent giving rise to the allegation that it is in default itself (creditor's default) and can therefore not rely on any default from the seller-side. To stay in the driver's seat, and control the narrative, requires advanced preparation prior to any communication with the seller or target on the topic of halting the deal.

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