USA Law and Practice Contributed by: Nicholas A Dorsey, Ryan J Patrone, Kelly M Smercina and Margaret R M Rallings, Cravath, Swaine & Moore LLP
Senior Secured Debt In the USA, term loans and/or debt securities are commonly used to finance a portion of an acqui- sition. Acquirers who do not otherwise have a revolving credit facility (for example, a special purpose entity formed by a financial sponsor) will also establish such a facility at the time of securing the other financing, typically for work- ing capital purposes. The commitment size and availability under revolving credit facilities may be based on the cash flows of the business or with reference to particular asset classes, such as inventory and accounts receivable. Term loans, debt securities and revolving credit facili- ties may be secured. They may also be com- bined in different levels of lien priority; for exam- ple, it is relatively common for a financial sponsor acquirer to obtain a first-lien revolving credit facility, a first-lien term loan and a second-lien term loan. Revolving credit facilities are secured on a first-lien basis (although, in the case of an asset-based revolving facility, the first-lien col- lateral may be limited to the applicable assets while other assets may be pledged on a junior lien basis or remain unencumbered). In Europe, secured revolving credit facilities are often secured on “super-senior” basis, with pri- ority over other senior secured debt (usually NY law-governed debt securities) in receiving the proceeds of common security enforcement. Senior Unsecured Debt Unsecured term loans and/or debt securities may also be used to finance an acquisition. Investment grade facilities are normally unse- cured, while non-investment grade facilities will often include one or more secured debt instru- ments. In European acquisition financing, there will often be a tranche of secured debt instru- ments, with a tranche of unsecured debt instru- ments (usually issued by a parent company of
the secured debt issuer) also proposed to be issued. In European acquisition financing, “unse- cured” debt instruments are often still secured on a subordinated basis on minimal security (eg, share pledges) and are subject to the intercredi- tor agreement. Senior Subordinated Debt Debt that is contractually subordinated to other debt of the same obligor may be used to finance an acquisition. In European high-yield debt securities issuances, “senior subordinated” can mean that the issuer’s primary obligations are senior and the debt securities are guaranteed on a subordinated basis by entities that also guar- antee other group debt on a senior basis. Please see 2.1 Governing Law for further infor - mation on loans and debt securities. 3.2 Mezzanine/Payment-in-Kind (PIK) Loans Other less common US acquisition financing structures include mezzanine financings and pay-in-kind (PIK) instruments. Mezzanine Financing Financings that include both debt-like and equity-like components are commonly known as mezzanine financings. The reference to mez- zanine relates to the fact that the obligations are subordinate to some or all of the debt in the cap- ital structure yet prior to some or all of the equity in the capital structure. The issuance of preferred shares is an example of a relatively common US mezzanine financing. Preferred shareholders rank behind debt-holders and ahead of com- mon equity-holders. Preferred shareholders may also be entitled to the regular payment of dividends, which may accumulate in the event of non-payment.
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