Middle-market companies and leveraged-buyout firms are returning to the recent past with a hybrid loan structure that simplifies the use of subordinated debt and offers companies a lower cost of capital.
First created in 2005, a unitranche facility is a faster way to borrow than the traditional structure for senior and mezzanine debt. The latter is often more complex, because it requires companies to use several lenders — often a bank, a mezzanine fund, and another capital provider — for each credit, according to Ted Koenig, chief executive of private investment firm Monroe Capital.
In a unitranche facility, a single lender, usually a specialist in business-development financing, provides the entire credit, works with the borrower, and slices up, or “tranches,” the loan for other investors. The advantages to the borrower: the convenience of a one-stop shop for financing and a reduced risk that the deal will fall apart. Also, because of the way the loan amortizes, unitranche borrowers often pay less interest than they would using traditional financing.
Borrowers typically use unitranche facilities for refinancings, recapitalizations, dividend transactions, and any financing where they want speed and minimal hassle. Because of its high success rate, unitranche lending is also particularly useful for companies financing a buyout in the currently anemic mergers-and-acquisitions climate, says Koenig.
To be sure, the number of unitranche deals is small compared with traditional loans. Still, unitranche financing has picked up in the last two years, according to S&P Capital IQ. Monroe Capital has done 12 unitranche transactions in the last eight months, including financing the acquisition of Fabco Automotive, a transportation parts supplier, by middle-market private-equity firm Wynnchurch Capital in October.
Wynnchurch settled on a unitranche facility for a couple of reasons, says vice president Neel Mayenkar. For one, it produced a lower cost of capital, because the entire loan amortized over time, unlike a typical hybrid loan deal, where only the senior debt amortizes, Mayenkar says. Using a unitranche structure also made the financing process easier, he says. The deal “didn’t require as much micromanagement as it would have had I dealt with two lenders the whole time,” Mayenkar says. “I was able to focus more on the deal and the diligence.”
As another benefit, the up-front interest rate on the deal was competitive, but the economics will pay off even more down the road, says Mayenkar. “By year three of the transaction, fewer dollars of interest are flowing out under this structure,” he says. Mayenkar cautions, however, that the payoff for other borrowers will depend on things like the cash-flow characteristics of their businesses and how they envision paying down the debt.
One potential drawback of unitranche facilities: a borrower is typically not aware of the intercreditor agreements that govern its loan or what portion of the loan is owned by the various lenders, according to a paper by Practical Law Co., an online publisher for attorneys. This setup could cause problems for borrowers if they need additional financing or covenant waivers, Practical Law added.