UK Law and Practice Contributed by: Fergus Wheeler, Paul Yin, Tracy Liu and Medha Vikram, Latham & Watkins
Junior capital, which typically includes subordi - nated debt or mezzanine financing, supplements senior debt with flexible terms, such as interest deferral or PIK interest, aiding cash flow man - agement. Hybrid capital solutions, including convertible debt or preferred equity, offer tailored financing with potential capital appreciation and reduced cash outflows. Preferred equity is attractive in high interest rate or financial distress situations as it offers fixed dividends, priority in liquidation and provides more security than common equity as well as higher returns than debt. Preferred equity doesn’t impose the same repay - ment obligations as debt, preserving cash flow and reducing strain. It allows companies to raise capital without diluting common equity holders’ control, as it usually lacks voting rights. In high interest rate environments, it offers favourable terms compared to debt costs and aids recapitalisation or restructuring in financial distress situations. Common Junior/Hybrid Debt Structures The common junior/hybrid debt structures are as follows: • Holdco facility by private credit lenders with traditional Opco-level structures (eg, syndi - cated loans or high-yield bonds); • junior/second lien facility by private credit lenders with senior financing from syndicated loans or high-yield bonds; and • preferred equity.
Private credit lenders may also take equity shares (eg, common equity or warrants) along
with providing debt. Security Package
Typically, enforcement for Holdco instruments is above the Holdco borrower, with security over shares and receivables granted by its immedi - ate shareholder. Alternatively, enforcement may be below the Holdco borrower, with a holding company covenant to prevent leakage, involving a share and receivables pledge over the entity below and an account pledge from the Holdco borrower. 3.8 Payment in Kind/Amortisation In private credit transactions, PIK facilities are common, especially at the Holdco level, offer - ing a “pay-if-you-want” option. Borrowers can choose to pay interest in cash or capitalise it, with discounts for cash payments, enhancing cash flow flexibility during periods of financial constraint. Senior-level facilities are usually cash-pay, with an option to PIK interest for a set number of peri - ods, applying a premium for deferred payments to compensate for increased risk. Amortisation is not typically required, with lend - ers preferring bullet repayment at maturity. For incremental facilities, loan documents often require that additional debt should not be amor - tising unless existing lenders receive the same terms. 3.9 Call Protection Call protection is a key feature in private credit loans. Lenders will typically require a prepayment premium (“make-whole”) to compensate for the interest income lost due to early repayment. The structure of call protection varies and lenders
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