Is the price right? Handling bank debt in sale and purchase agreements.
September 14, 2016
Though seemingly straightforward, Bank Debt can be complex and can generate conflicting positions between Buyers and Sellers. Whilst it may seem obvious that “Bank Debt” should be deducted from Enterprise Value to calculate the final purchase price, there are a number of nuances that may make the consideration of Bank Debt more complex than at first assumed.
Generally, a Seller would prefer to minimise the bank debt deduction whilst a Buyer would prefer to maximise it. The key is to be aware of the difference between the book value of any debt and the full redemption value that a Buyer may have to refinance on Day 1 of its ownership. The amount of bank debt to be deducted may well be greater than the amount on the balance sheet that has been diligenced.
Some key considerations include:
Interest up to the date of completion will normally be included in the bank debt total.
Break fees and penalties
Any costs which will be incurred as a result of early repayment of debt should be reflected in the redemption value of debt.
Capitalised arrangement costs
Under both UK GAAP and IFRS, arrangement costs incurred by the company on entering into a debt arrangement may have been capitalised and netted against the debt amount on the balance sheet. For example, bank debt with redemption value of 100 may be shown on the balance sheet at 95, if 5 of debt arrangement fees have been capitalised Capitalised arrangement fees should be added back in arriving at the gross redemption value of debt to be refinanced.
When bank facilities are made available to a company but the company does not make use of all or part of the facilities, the bank will often make a charge for making this facility available. That cost will often be charged to finance costs, below the EBITDA line in the P&L and may not, therefore, be taken into account in arriving at Enterprise Value. To the extent that the facility cost relates to the operational activities of the company (for example it relates to a Revolving Credit Facility used to finance working capital), the Buyer may argue that the cost is an operating cost and should have been charged in arriving at EBITDA. The impact on price would be the facility cost x the multiple. Sellers are likely to disagree with such a deduction and may challenge the principles behind it.
In many instances, companies will take out hedging instruments to mitigate the risk of interest rate and/or exchange rate movements on the value of debt. In considering the redemption value of debt you should also be considering the redemption value of any related hedging instruments.
Find out more about this and other issues that arise during the sale & purchase agreement (SPA) at our forthcoming seminar on Thursday 6th October at 8:30am in London. Full details and registration can be found here.
What issues have arisen for you around Bank Debt on deals you’ve done? How did you get around them and what was the outcome? Share your thoughts below or schedule a meeting to discuss your situation in confidence.