USA Law and Practice Contributed by: Stelios G Saffos, Dan Seale, Peter Sluka and Alfred Xue, Latham & Watkins LLP
lenders for a variety of creative hybrid financing pack - ages including holdco facilities, mezzanine debt and junior capital positions to provide additional liquidity to support acquisitions in the United States without sacrificing leverage levels. Private equity sponsors in the United States have been increasingly taking advantage of debt-like, non-convertible preferred equity in order to supplement the liquidity of the operating company within the corporate structure, with such preferred equity allowing sponsors to incur additional leverage without the burden of cash interest payments (as these products often have a payment- in-kind feature). 3.8 Payment in Kind/Amortisation Increasingly, private credit transactions are including paid-in-kind (PIK) components. • Availability of PIK option: In the context of a typical private credit transaction with an opco (as opposed to holdco debt), a PIK option is limited to the first two or three years following the closing date. In other words, after year two (or, in some cases, year three), all payments of interest must be made fully in cash. • Amount of PIK: When available, a PIK option will allow for some portion of the “applicable margin” due on a term loan facility to be paid in kind. The amount of “applicable margin” that may be paid in kind is typically capped at 50%, though this is a negotiated point. Moreover, where a term loan facility includes a pricing step-down (or series of step-downs), private credit providers may expect a “minimum cash pay” construct which prevents the amount of cash margin paid from dipping below a certain level (eg, 2.50% minimum cash pay). • PIK premium: Where a PIK option is available, pri - vate credit providers expect to be paid a premium when the PIK option is exercised. This premium may be hardwired at 50 bps such that any usage of the PIK option produces a 50 bps premium. Alter - natively, some formulations will allow the borrower to use only a portion of the PIK option and only pay a portion of the PIK premium (eg, only convert half of the allowable 50% of the margin into PIK (ie, 25% PIK) and only pay half of the premium (ie, 25 bps).
• Amortisation: Private credit transactions that include a PIK option often include some level of amortisation holiday. A common formulation would be to forgo amortisation in any quarter in which a PIK election is made. That said, there are some pri - vate credit deals in the market without any amorti - sation at all for the life of the loan. 3.9 Call Protection Private credit providers continue to seek broader call protection than that typically offered in the syndicated market. But while private credit providers continue to seek 103/102/101 or 102/101 “hard call” formulations, these protections have been diluted by various carve- outs not historically included in “hard call” formula - tions. • Exclusions: Recent private credit transactions generally include some combination of the follow - ing exclusions: (i) internally generated cash, (ii) a qualified initial public offering (IPO), (iii) sale of all or substantially all of the applicable borrower’s assets, (iv) change of control, (v) dividend recapitalisations and/or (vi) some sort of “transformative transac - tion” or “enterprise transformative event” (typi - cally defined as (a) an acquisition or disposition of significant size, (b) a transaction that is not permit - ted by the existing debt documents and/or (c) a transaction that if consummated would not leave the borrower sufficient flexibility under the existing debt documents). Of course, many transactions will include some subset of this list, and there is certainly room for negotiation regarding underlying definitions such as “internally generated cash” and “transformative transaction”. • Step-downs: In a traditional 102/101 “hard call” formulation, any prepayment made in year one (if not eligible for an exclusion/carve-out) would be accompanied by a 2.00% premium. In the most recent matters, sponsors have sought interim step- downs such that the prepayment premium would decline by 25 bps per quarter (ie, a prepayment in the third full fiscal quarter following the closing date would only garner a 1.50% premium).
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