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Private equity firms are aggressively pushing to include language in loan documents that could give them room to pay themselves larger dividends from the companies they have bought, drawing a sharp rebuke from lenders.
In the past, loan documents usually capped exactly how much money a private equity firm could extract from one of its portfolio companies. Over time, those fixed amounts became malleable and were based on a percentage of a company’s earnings.
But in recent weeks, private equity firms have been attempting to take things one step further with the so-called high-water ebitda provision, which allows a company to use the highest earnings it generates over any 12-month period for critical tests that govern how much debt the company can borrow or the size of dividends it can pay to its owner, even if the business’s earnings have slid since reaching that high point.
KKR, Brookfield, Clayton, Dubilier & Rice and BDT & MSD Partners have all attempted to work the clause into loan documents, according to people briefed on the matter. All four firms declined to comment.
The terms have received intense pushback from would-be lenders, and in almost every case the language has ultimately been stripped out of the loan documents. But the fact that private equity-backed companies continue to push for the inclusion of the language has lenders on edge, with some fearful rival creditors will buckle and accept the provision.
According to lenders who saw drafts of the loan agreements, the terms were included in provisional loan documents backing KKR’s buyouts of asset manager Janney Montgomery Scott, valued at roughly $3bn in the deal, and $4.8bn purchase of education technology company Instructure, as well as Brookfield’s $1.7bn acquisition of a unit of nVent Electric. The clause was also put in provisional documents for refinancings by Wesco, which is owned by BDT & MSD Partners, and CD&R’s Focus Financial.
“It’s a really aggressive term,” one creditor said. “It’s a tough time to say, ‘I’m going to push the envelope further.’”
In one deal, RBC, which was lead underwriter on the $900mn term loan Brookfield was raising for its investment in nVent, told an investor that the bank had strong demand and if the language was an issue they should “vote with [their] feet”.
When enough investors passed, the high-water language got pulled from the loan document.
RBC did not immediately respond to a request for comment.
The fact the language is being tested is one sign of a potential imbalance in the loan market, a critical source of funding for private equity buyouts. With buyout volumes still down from the 2021 peak, investors have had fewer new deals to spread their funds across, leading to heightened competition around some loans.
“When you’re in a strong market, it’s usually harder to push back against” these terms, one banker involved in the Instructure financing said. But, he added, “they’re not surviving.”
The language has made it into at least one deal, a $2.1bn term loan for a commercial laundry operation known as Alliance Laundry, according to two people briefed on the matter. The company planned to use the proceeds to refinance debt and pay a $890mn dividend to its owner, BDT & MSD, according to S&P Global and Moody’s.
The provision reads that “the borrower may deem Ebitda to be the highest amount of Ebitda achieved for any test period after the closing date . . . regardless of any subsequent decrease in Ebitda after the date of such highest amount”, text seen by the Financial Times showed.
“If you didn’t ask for those terms in a negotiation you didn’t do your job,” one private equity executive said. “You always want to give maximum flexibility to your businesses.”
The high-water concept is not foreign to creditors; it is far more prevalent in European leveraged finance markets. And some bankers and lawyers argue the idea is rooted in common sense.
In certain loans, the amount of future debt a company can borrow or the sums it can dividend out to its owner is set as a percentage of earnings. Companies like that flexibility, because if they are growing they do not have to keep amending their loan documents if they would like to borrow or distribute more cash. Investors said savvy lawyers decided to push that concept one step further.
The high-water provision creates a threat for would-be investors, particularly if a business begins to slow before a loan matures.
“Over time the protections that were built into credit agreements by commercial banks have deteriorated,” said Tom Shandell, Investcorp Credit Management’s head of US CLOs and broadly syndicated loans. “Private equity [firms], which can afford the best and brightest attorneys, have little by little put terms into credit agreements that weaken the protections.”