Bridge loan financing for mergers and acquisitions involves high stakes for borrowers and lenders. Understanding the timing, structure, terms and range of outcomes under a bridge loan commitment is key to a successful financing negotiation and to analyzing the overall transaction economics.
For corporations and private equity sponsors pursuing large acquisitions, securing a bridge loan commitment may be the final component to a winning acquisition bid. While in many cases the borrower and the committing bridge lenders view the bridge commitment as a backstop and share the goal of never actually having the bridge loan funded, the terms can be of critical importance to the overall economics of the acquisition and to the timing, structure and terms of a long-term financing. The complexity of bridge loan terms, and the broad range of potential outcomes that may follow a bridge loan commitment, make it imperative for an acquirer to promptly engage in careful negotiations with the bridge loan providers and to factor the bridge financing costs and terms into its economic analysis and projections for the acquisition.
The Financing Gap and a Bridge Loan to Cross It
In the current merger and acquisition environment, acquisition targets in middle market and large cap transactions will rarely accept a financing contingency in an acquisition agreement. Acquisition targets will closely analyze a bidder's financing sources to assess the likelihood that a bid, once accepted, will result in a consummated acquisition. This presents obvious difficulties for a potential acquirer that does not have an existing credit facility or cash sufficient to finance the subject acquisition. The challenges are particularly acute for transactions in which a bidder expects ultimately to finance the acquisition in whole or in part through new debt financing in the capital markets, through a high-yield debt offering or a broadly syndicated loan facility, where a number of factors, including confidentiality requirements, bid uncertainty, capital market conditions and transaction timing, may prohibit securing such financing in advance of announcing an acquisition.
Bridge loan financing offers a solution to fill the gap between the time a purchase agreement is signed and the time at which long-term financing can be obtained, and is sometimes the only practical option for an aspiring acquirer to secure a winning bid. Although the bridge loan, if it is actually funded, is necessary for purposes of financing the payment of the purchase price on the closing date, it is the bridge loan commitment, which is invariably provided by an investment bank (or its affiliates) regarded as highly creditworthy, that provides the critically needed assurance to the acquirer that financing will be available for the acquisition on the closing date regardless of whether a capital markets transaction can be completed by that time, and to the target that the transaction will not fail to close as a result of a lack of financing.
A unique aspect of bridge loan financing is that the investment banks (or their affiliates) providing the bridge loan commitment typically do not wish to participate in the long-term financing as debt holders, and seek to reduce or eliminate the significant risk associated with a funded bridge loan. Instead, investment banks commit to bridge financing so that they may be engaged to arrange the long-term financing and, in many cases, to facilitate the underlying acquisition for which they may also be involved, each of which offers significant fee income to the investment bank.
Structure of Bridge Loans
Bridge loans are typically short-term facilities used to bridge a financing gap until the borrower is able to obtain long-term financing from the capital markets or another takeout. Similar to other loans, interest rates for bridge loans vary depending upon the credit rating of the borrower or its debt. However, bridge loan interest rates tend to be higher than rates applicable to other forms of financing, and such rates typically increase periodically over the initial term of the loan. For example, a bridge loan with an initial term of one year likely will have an upward interest rate change on a quarterly basis. Interest rates will normally be subject to a cap, though the bridge lenders may also require a floor. Bridge lenders may also allow for non-cash or payment-in-kind interest payments, which also may be subject to a cap.
If the borrower does not pay off a bridge loan at the end of its initial term, the bridge loan will automatically convert into a long-term financing either in the form of a bond or a term loan with a longer maturity (e.g., five to 10 years) and a higher interest rate (typically the interest rate at the end of the initial term plus an additional premium). To facilitate conversion of the bridge loan into bonds, the bridge lenders may require the borrower to file a shelf registration with respect to these exchange securities prior to the end of the initial term. In addition, the bridge lenders may also require the borrower to pay liquidated damages equal to a percentage of the principal amount of the exchange securities if the exchange securities are not freely tradeable at the end of the initial term.
To compensate bridge lenders for the short-term nature of a bridge loan, commitments often include myriad fees, some of which have the potential to overlap. Fees may include the following:
- A commitment fee is a fee for the bridge lenders' commitment, payable whether or not the bridge loan is funded.
- A funding fee is a fee for funding the bridge loan, payable on the date that the bridge loan funds (typically on the closing date). If a bridge loan is refinanced before maturity, some bridge lenders may be willing to partially refund the funding fee depending upon the time between the funding and the repayment. These rebates range from 75 percent to 25 percent depending on the time period after which the refinancing of the bridge loan occurs. The shorter the period of refinancing after funding, typically the higher the discount. For example, the bridge lenders may be willing to refund 75 percent of the funding fee if it is refinanced within 30 days of funding, 50 percent if it is refinanced within 60 days of funding, or 25 percent if it is refinanced within 90 days of funding. Outside time frames for rebates vary and may be as long as 270 days.
- A deal-away fee is a fee to the bridge lenders on the closing date in the event another source of financing is used. Typically the fee is intended to compensate the bridge lenders for the fees that they would have otherwise received had the bridge loan funded.
- If the bridge loan is syndicated, the lead bank is usually appointed as the administrative agent and receives an additional administrative agent's fee when the bridge loan funds, then typically annually thereafter for as long as the bridge loan is outstanding.
- A duration fee is a periodic fee on the outstanding balance of the bridge loan, sometimes increasing the longer the bridge loan remains outstanding.
- If the bridge loan is not refinanced by the end of its initial term and converts into long-term financing as discussed previously, bridge lenders often will require an additional conversion/rollover fee to compensate them for continuing the bridge loan under the new financing structure. Fees are typically equal to an underwriting fee that would have been paid had the bridge loan been replaced in a bond offering. Similar to the funding fee, the conversion/rollover fee may also be subject to rebate depending on when the bridge loan is repaid after the end of the initial term of the bridge loan.
- A refinancing fee is a fee payable when the bridge loan is refinanced prior to its initial term. Typically, the refinancing fee is equal to the conversion/rollover fee.
- A bond underwriting fee is a fee for underwriting a bond offering to replace the bridge loan, typically documented separately from the bridge loan commitment.
Careful attention should be paid when negotiating bridge-loan-related fees to avoid potential overlap. For example, the refinancing fee could overlap with the bond underwriting fee in cases in which the bond offering is placed by the same investment bank that issued the bridge loan. Similarly, the refinancing fee may potentially overlap with the deal-away fee if the deal-away fee provision is worded broadly to extend beyond the initial funding of the bridge loan.
Often the most contentious provision when negotiating a bridge loan commitment is the securities demand, which provides the bridge lenders with the right to require the borrower to issue long-term debt securities into the capital markets to refinance the bridge loan. Once the conditions for the securities demand are met, the investment bank, rather than the borrower, controls the timing to take the long-term financing to market. Common points of negotiation include the following:
- Timing. A borrower may request to limit the bridge lenders' ability to make a securities demand until some period after the bridge loan funds (e.g., up to 180 days after funding) to allow for flexibility to fund the bridge in case the price of long-term debt is higher at closing. However, in recent years, borrowers have typically been unable to obtain such "holiday" periods from bridge lenders. More commonly, securities demands are exercisable at closing, although bridge lenders also may require that the securities demand be exercisable pre-closing with the securities issued into escrow.
- Number, frequency and minimum size of demands. To limit the costs of multiple securities demands, borrowers may try to limit the number, frequency and minimum size of each demand.
- Sale process requirements. Often, borrowers will seek to obtain an obligation from the bridge lenders that they will obtain the best price for the securities offering or at least make a bona fide attempt (e.g., at least one road show).
Securities Demand Failure
Borrowers and bridge lenders also typically negotiate the remedies in case the securities demand fails to raise funds sufficient to repay the bridge loan in full. In particular, bridge lenders will often request the ability to exercise any or all of the following remedies upon notice of a demand failure:
- Increase in the bridge loan interest rate to the highest rate chargeable under the facility
- Modification of bridge loan terms to include defeasance and call provisions customary in publicly traded high-yield debt so long as the failure continues
- Default under the bridge loan so long as the failure continues
- Payment of a conversion/rollover fee
Similarly, borrowers may seek to narrow the scope of the securities demand failure through a provision permitting the borrower to refuse a securities demand if it would result in potentially adverse tax consequences (e.g., cancellation of debt income or applicable high-yield discount obligations issues).
Terms of Long-Term Financing
Sponsors who have experience with negotiating fully underwritten commitment letters with one or more lead lenders and arrangers that intend to syndicate a significant part of an acquisition loan facility will be familiar with "market flex" provisions in fee letters that enable the committing lenders and arrangers to "flex" certain specified terms of the credit facility. Such "flex" provisions apply as well to bridge loan commitments, in which underwriters seek broad discretion to vary the terms of the long-term financing to facilitate the syndication of the long-term credit facility or the placement of the long-term debt securities. The scope of such flex rights can vary dramatically depending on conditions in the capital markets, sponsor relationship, leverage and issuer credit profile. Among the many terms that may be subject to flex are price, structure flex (senior debt, senior subordinated, second lien tranches), maturities, financial covenants and financial covenant calculations.
A corporation or private equity sponsor negotiating a commitment for a bridge loan will invariably seek the best economic terms for the bridge facility and for the anticipated long-term financings. However, as much or more focus is needed on limiting the downside risk by negotiating limits on the rights of underwriters to make securities demands and flex key economic and legal terms, and by understanding the impact of a downside case on financial projections for the acquisition.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.