1. Financing Structure
M&A for Entrepreneurs Elective
© 2008 Babson College

2. Major Components of the Deal
Senior Debt
Long Term Debt
Subordinated Debt or Mezzanine Debt
Seller “Takebacks”
Equity
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3. What drives the structure of Deals?
 Historical Cash Flow
 Predictability vs. Projections
 Industry
 Amount of Debt Financing Available
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4. Key Leveraged Financing Guidelines
Maximize lowest cost debt
Cash flow must support senior and junior debt
Cash flow must be adequate to cover
seasonality or blips
Leverage assets appropriately
Covenants must be flexible to allow debt pmts
and C/F problems
Avoid conflicts among lenders and equity
partners
© 2008 Babson College

5. Bank Loan Decision Criteria
 Quality and experience of mgmt. and capital providers
 Bank’s experience in the industry and with deal players
involved
 Credibility of projections and historical profits
 Cash flow
 Industry trends
 Quality of assets as collateral
 Amount of equity & subordinated debt/mezzanine debt
 Asset liquidation plan (future cash flow generation)
 Fees and equity participation attractiveness
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6. Senior Debt
Senior Debt
 Commercial Finance
(Asset-based) Loans
 Revolving Line of Credit
(Generally Secured)
• Revolver
• Revolver/Term
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7. Commercial Finance Loans
Commercial Finance Loans
Amount of the line of credit is based on bank’s
view of quality and liquidation value of the
collateral and EBITDA/FCF/Cash Flow
A/R: 70-80% of A/R within 60 days past due
Complications: Service Receivables
Foreign Receivables
Inv: 0-60% depending on bank’s view of inv.
Appraised Value
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8. Revolver/Revolver-Term Loans
Revolver/Revolver-Term Loans
 Collateralized in leveraged deals
 “Cash Flow is King” (EBITDA/FCF)
 Covenants and terms
• EBITDA/Cash Interest
• Bank Debt/EBITDA
• Total Debt/EBITDA
• CAPEX Limits
• Leverage Ratios
• Restrictions on other debt
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9. Subordinated Debt/Mezzanine Debt
Subordinated Debt or Mezzanine Debt
 Junior to bank debt in liquidation of co.
 High coupon with equity kicker
 Some covenants
 Objective is to maximize equity return
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10. Equity Kickers
Equity
 Set as a fee, warrant/option,
% of profit or cash flow
 Amount of kicker depends on the
percentage of the deal provided
by the sub debt/mezz lenders
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11. Inter-creditor Agreements
 Established who is ‘agent’
 Priority in bankruptcy established
 Covenant and default consistency
 Affirms asset sale flexibility & amount
 Orders principal & interest payments
 Defines rules around prepayment
 Sets voting rules in syndicates
 Defines refinancing rights
 Establishes consistent curing provisions
 Governs sale of obligations by various parties
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12. What can go Wrong?
 Failure to follow management plan
 Slow Reaction to off plan performance
 Failure to run the company to maximize cash
 Revenue declines vs. projections
 Overly optimistic projections
 Conflicts among the lenders
 Lack of understanding of how to manage leverage
 Loss of confidence in management by lenders
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13. Harris Seafood
LBO

14. 1986 (A) 1987 1988 1989
Revenue (MM) $97 $104 $116 $125
EBITDA 14 17 20 21
FCF 11.6 9.3 8.4 10.3
Int. Exp. 1.4 5.7 5.1 4.7
Debt + Int. 10.6 8.9 10.3
Int. Cover 1.6x 1.6x 1.5x
Unused Borr. (7.0) 0.4 8.6
Available ($)
© 2008 Babson College