Summer 2016 FINSights: Emerging trends in acquisition

The rise of Mezzanine and vendor finance KEY FEATURES • Ability to meet vendor headline price expectations when senior and In the present Australian market, senior lenders will usually advance up to 4x earnings but to mezzanine lenders have otherwise been 'tapped out'. win a bid sponsors may need to leverage up to 6x earnings or more. So where can a • More , less equity enhances the internal rate of return on a successful Sponsor look for extra leverage? Two sources of acquisition finance over and above senior exit (the converse is also true). debt are becoming increasingly popular – mezzanine (mezz) holdco and vendor finance. • Vendors will generally accept their debt being subordinate to senior and mezzanine debt. Mezzanine Holdco Senior debt is generally advanced to a member of the operating group (or a special purpose • Vendors may accept long dated maturities with little or no . finance company above it) and secured over the assets of the operating companies. On the other hand, a mezzanine holdco loan is advanced to a company above the senior obligor CONSIDERATIONS group and secured over just the shares in the holding company beneath it. If a vendor will not accept a deeply subordinated unsecured position, Mezzanine lenders are structurally subordinate to the senior lenders since on resulting complexities may include: any recovery of proceeds from the operating group will flow first to the senior lenders before being paid to the holding companies and the mezzanine lenders. There is therefore no need • Restrictions by the senior and mezzanine lenders on when periodic for the mezzanine lenders to enter into contractual subordination arrangements with the payments such as cash pay interest may be made to the vendor. senior lenders and this increases deal certainty as well as minimising negotiation time • If the vendor wants security, it will either need to be above where the senior and expense. and mezzanine lenders are secured or contractually subordinated and Interestingly, up until recently mezzanine loans in Australia were confined to a single lender, second ranking to the senior and mezzanine lenders. day one single advance. These days mezz loans are becoming more complex and • Issues to be resolved in any subordination and priority arrangements structurally more like senior loans, other than the subordination, security and pricing. include when (or whether) the vendor can enforce, such as when the senior Thus, we have recently documented multi-lender mezzanine loans involving multiple and mezzanine lenders have not been repaid within 6 months after their tranches and draws, long dated availability and even accordion facilities. maturity and have not accelerated the senior debt and/or mezzanine debt. Vendor Finance • The vendor may require protection around the conduct of any senior or Also known as deferred consideration, vendor finance is an agreement to pay some of the mezzanine enforcement, such as extending any duty under law to obtain acquisition consideration at a later date. the best price reasonably obtainable on enforcement to the vendor. A recent example of its growing use is the sale by Ardent Leisure of its Goodlife gymnasium In summary, there are several advantages to vendor finance but these can chain to Quadrant Private Equity which included vendor finance of $30m, payable within two sometimes be outweighed by disadvantages, depending on the structure of years with no interest and subordinated to bank debt. the transaction.

John Mosley T: +61 2 9921 4428 Caitlin Chiu T: +61 3 8608 2832 PARTNER M: +61 412 104 948 SPECIAL M: +61 417 322 423 COUNSEL E: [email protected] E: [email protected]