The Debt Connection – November 2015

In the latest Debt Advisory newsletter from Clearwater International, we look at debt funded shareholder transactions.

2015 has been a year where we have seen a material increase in the level of liquidity. Banks have been actively lending in the mid-market and supporting transactions with more borrower-friendly terms and lower or no amortisation in the debt to support buy-outs. We have also seen alternative lenders raise ever larger funds to deploy in the mid-market space, competing with both each other and traditional Banks via providing more flexible structures.

This high level of liquidity has meant 2015 has also been a year with a number of shareholder transactions funded via “debt-only” structures – a trend that we expect to continue going forward, as lenders look for innovative ways to deploy their capital.

A debt funded shareholder transaction has similar elements to an MBO, but the only external capital being provided to fund the transaction is in the form of debt. There is no external equity being contributed. This means the only equity contributions to the transaction will come from the management team buying into or increasing their stake and existing shareholders rolling some of their stake.

The companies that fit these types of transactions typically operate in sectors where the businesses are sold for comparatively low profitability multiples, may have limited growth and they often have relatively high asset bases. Similarly, these transactions normally carry the characteristic of the transaction being “friendly” – where the outgoing shareholder is keen to work alongside the existing Management team and may prove to be accommodating around cash actually leaving the business.

The asset heavy nature of a number of these businesses means debt funding can come in the form of Asset Based Lending (ABL), along with top up funding coming from debt funds as a direct substitute for equity. It is not uncommon to see a combination of funding types as part of a transaction.

Does this mean the end for private equity backed MBOs? Absolutely not! Many transactions simply do not work on a debt-only basis, as it is not possible to raise or secure enough debt against the business value or asset base to fund the transaction. Therefore, an external equity injection is required. What’s more, it is very unlikely for existing shareholders to be able to realise a full exit from a business in a debt-only funded transaction – this would most likely require new equity. In addition, private equity will add intellectual value to a business as well as capital, in the form of sector expertise, experience, network of contacts and market knowledge.

I think we will continue to see an increasing number of debt funded shareholder transactions in the market whilst liquidity levels remain high. They will, however, predominantly continue to be undertaken in areas which Private Equity firms do not find attractive and where business performance is solid.

Deal Example

Clearwater International recently advised the management team at leading print supplier York Mailing Group (YMG) on its MBO, which was backed by Pricoa Capital Group.

YMG is the UK market leader in the specialist production of retail flyers, media inserts and quality catalogues. In the past two years, the business has seen revenues grow from €94m to more than €136m through acquisitive and organic growth as well as significant investment in new machinery. This has also resulted in 275 new jobs and more than a 50% increase in earnings to €16m EBITDA.

Mark Taylor, Debt Advisory partner at Clearwater International, said: “We arranged bespoke debt capital facilities and follow on funding capabilities with Pricoa Capital Group, which will support the ongoing growth of the business whilst meeting both shareholder and management aspirations. The transaction highlights the strong interest being shown by alternative funders in quality UK assets.”