Unitranche Loans in the Middle Market
In the first of this 2-part blog post series, we will review the unitranche loan market generally and discuss the key characteristics and advantages of unitranche loans with a focus on middle market private equity transactions. Part two of the series will focus on the agreement among lenders and its implications on borrowers and lenders post-close.
Growth in Unitranche Loans
The financing market for middle market private equity transactions has undergone significant changes over the past 5 years, driven in part by the increased availability of cheap credit. In this transaction environment, the ability to move quickly and efficiently can be a differentiating factor for private equity sponsors. In response, many lenders and borrowers have turned to unitranche loans as a preferred credit structure for private equity transactions in the middle market.
Unitranche Loans Generally
Unitranche loans combine what would traditionally be separate first lien and second lien credit facilities into a single secured credit facility. Under the unitranche debt structure, first lien lenders have payment priority over the second lien similar to a traditional first lien-second lien financing debt structure. This priority arrangement is accomplished through the agreement among lenders (AAL) that contractually establishes first out and last out credit tranches between the lenders. The AAL, among other things, lays out the payment waterfall, repurchase rights, voting rights and lender remedies.
Single Loan Agreement
Unitranche loans provide clear advantages for borrowers and sponsors over traditional loan structures. Chief among these is the use of a single loan agreement together with a single set of related loan documentation. In a traditional credit facility, a borrower with financing needs beyond the capacity or desire of one lender tranche would be required to negotiate separate credit agreements with different lenders. This increases the complexity associated with financings and often results in burdensome debt management processes both pre and post-close for the borrower due to the multiple financial covenants and consent requirements. The use of a single unitranche loan agreement and AAL results in a streamlined approach without the added complexities associated with executing separate credit facilities.
More Cost Efficient to Complete
In addition to the decreased complexity, unitranche loan financings are usually much more cost efficient than traditional loan financings where the borrower negotiates separate loan agreements with different lenders. This feature makes the unitranche structure particularly attractive to middle market borrowers who are often more cost conscious relative to large cap borrowers.
In our next blog post, we will review the agreement among lenders, its typical features and its potential impact on a borrower’s ability to respond to certain situations.