UNITRANCHE LOANS FOR ACQUISITIONS
Unitranche loans offer a streamlined, flexible financing solution for acquisitions, especially for middle-market companies. They combine senior and subordinated debt into a single facility. However, this convenience comes with trade-offs in cost and potential complexity.
Advantages
- Speed and Certainty of Close – A primary advantage is the expedited transaction process. Dealing with a single lender (or a small club of lenders) and one set of documentation eliminates the lengthy and often difficult negotiations required for separate senior and mezzanine tranches, thus increasing the certainty of closing a deal quickly.
- Simplified Structure and Administration – Borrowers have a single credit agreement with one blended interest rate and one set of covenants and reporting requirements. This significantly reduces administrative and legal costs, and simplifies ongoing payment terms.
- Relationship-Based Lending – Direct lenders involved in unitranche financing often cultivate long-term relationships with private equity firms. This ongoing dialogue can be beneficial when seeking additional financing for growth or working through potential covenant issues.
Disadvantages
- Higher Overall Cost of Capital – The primary drawback is a higher headline interest rate compared to traditional senior bank debt alone. The blended rate reflects the higher risk of the “last out” portion of the loan.
- Prepayment Penalties/Call Premiums – Lenders typically require prepayment penalties or “call premiums” if the borrower wants to repay the loan before its scheduled maturity, which can limit refinancing flexibility.
- Risk Concentration – Relying on a single or small group of lenders creates concentration risk. Issues with a specific lender’s funding capacity or change in strategy can pose a greater risk than in a widely syndicated loan.
- Potential Restructuring Complexity – The initial structure is simple. The “agreement among lenders” (AAL) governs the rights between the senior (“first out”) and junior (”last out”) portions of the debt. However, complexities may arise during a bankruptcy proceeding, as there is limited case law on the matter.
- Limited Renegotiation Options – Once the loan agreement is in place, there may be limited flexibility to renegotiate terms.