Presenting a live 90-minute webinar with interactive Q&A Financial Covenants, EBITDA, Events of Default and MAC Clauses in Commercial Lending Structuring Effective Credit Agreement Provisions to Maximize Borrower Protection and Lender Remedies THURSDAY, NOVEMBER 12, 2015 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Benjamin D. LaFrombois, Partner, Hinshaw & Culbertson, Appleton, Wis. Upneet S. Teji, Attorney, Greensfelder Hemker & Gale, Chicago The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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FINANCIAL COVENANTS, EBITDA, EVENTS OF DEFAULT AND MAC CLAUSES IN COMMERCIAL LENDING Structuring Effective Credit Agreement Provisions to Maximize Borrower Protection and Lender Remedies
Why Financial Covenants? Purpose • To monitor the strength of a business • To evaluate the ability to repay debt • Early warnings of financial issues and potential payment default What do they measure? • Cash flow • Leverage • Liquidity • Net Worth *Covenant-Lite Loans 6
When are Financial Covenants Relevant? Underwriting process • Loan application Commitment/term sheet stage • Covenant figures • Covenant definitions Loan document negotiation stage • Negotiation of covenant definitions • Grace periods • Cure rights • Flexibility, reporting obligations and reasonableness • Expenses 7
Where to find Financial Covenants Affirmative Covenants • Reporting requirements • Tax returns • Income statements/balance sheets (audited) • Rent rolls • Maintenance Covenants Negative Covenants • Incurrence-based Covenants • Maintenance Covenants 8
Types of Financial Covenants Maintenance Covenants • Periodically tested • Breach is generally an immediate default • Equity cure rights • Simple or Complex Incurrence-based Covenants • Triggered by specific events • Examples: • Incurring additional debt • Entering into acquisitions • Paying dividends • Selling assets 9
Maintenance Covenants Focus on Balance Sheet (measured as of a given date) • Net worth covenant (tangible) • Debt to capital ratio • Balance of accounts Focus on Cash Flow (measured for a given period) • Leverage ratio • Interest coverage ratio • Debt service coverage ratio • Fixed charge coverage ratio • Free cash flow 10
Covenant Periods Measurements as of a particular date: • “Total Debt as of the last day of each fiscal quarter” • “Net Worth as of last day of each fiscal year” Measurements for a specified period: • “Interest Expense for the twelve month period ending on the last day of each fiscal year” 11
Financial Covenant Definitions Definition: “ Net Worth” means, as of any date of determination , (i) the total of all assets appearing on the most recently delivered balance sheet of the Borrower, after deducting all proper reserves (including reserves for depreciation, obsolescence and amortization) less (b) the total liabilities of the Borrower appearing on the most recently delivered balance sheet of the Borrower, in each case, calculated in accordance with Generally Accepted Accounting Principles which excludes accounts receivables, work-in-progress, accounts payable and certain accrued liabilities as determined by Lender. Covenant: Borrower shall not permit Net Worth of the Borrower as of the last day of any fiscal quarter of to be less than the sum of $[________________] plus [___%] of positive Net Income for each fiscal year ending after December 31, 2015. 12
Financial Covenant Definitions DSCR: Borrower shall maintain as of March 31, June 30, September 30 and December 31 of each year, commencing December 31, 2015, a ratio of (i) Income Available for Debt Service to (ii) Debt Service Requirements of not less than 1.25 to 1.0, calculated for the immediately preceding twelve-month period. 13
EBITDA EBITDA means: Earnings before interest, taxes, depreciation and amortization. EBITDA is: • Reflective of operating cash flow available for debt service • Not "actual" cash flow • Useful for cash flow evaluation in connection with cash flow lending and business valuation • Useful in comparing businesses that are impacted by factors such as interest and tax 14
EBITDA means… “ EBITDA ” means, for any period, Net Income for such period plus (excluding any extraordinary gains and/or losses), to the extent deducted in determining such Net Income, Interest Expense, income tax expense, depreciation, amortization, and [***ADD- BACKS: any one-time, non-recurring charges/fees/transaction costs, or other expenses that do not have to be paid (such as management fees***] , transaction fees (including legal and other costs and expenses) incurred in connection with [acquisition/financing] or such other one-time, non-recurring non-cash charges and expenses approved by Bank, in its reasonable discretion, on a case-by-case basis. 15
EBITDA Add-Backs • Included in EBITDA definition – Interest, Tax, Depreciation and Amortization • Negotiation Points – Non-recurring loss items – Management fees to related parties – Internal, one-time restructuring charges – Anticipated cost savings (in connection with an acquisition) – Equipment lease payments – Future fees and expenses in connection with acquisitions and future debt 16
EBITDA Add-Back Considerations 1. Specific one-time charges: penalties and settlements 2. Current Transaction Expenses: “all non -recurring expenses, fees, costs and charges incurred within [6] months of Closing in connection with the Loan Agreement”. 3. Future Transactions Expenses: “all non -recurring expenses, fees, costs and charges incurred in connection with any Permitted Acquisition, any Permitted Issuance of debt, any Permitted Disposition or any proposed or actual amendment, modification or refinancing of any indebtedness”. 4. Non-Cash/Accounting Items: goodwill write-offs; non-cash equity compensation expense. 5. Management Fees: “the amount of management, consulting and advisory fees paid to [Guarantor/Manager] (or any accruals related to such fees) during the measurement period.” 6. Limitation on Add- Backs: “provided that such amount shall not exceed [% of EBITDA or amount] for such measurement period]”. 17
EBITDA in Financial Covenants • Use of EBITDA in Cash flow vs. Asset-based lending • Leverage Ratio: – Debt to EBITDA (Maximum) • Interest Coverage Ratio: – EBITDA to Interest Expense (Minimum) • Fixed Charge Coverage Ratio: – EBITDA to specific "Fixed Charges" (Minimum) – Fixed Charges may include senior debt charges, interest expenses, dividends/distributions, and capital expenditures • Measurement Periods: – monthly/quarterly/semi-annually/annually 18
EBITDA in Pricing Applicable Margin/Pricing Grids Example: "Debt" to EBITDA Ratio Applicable Margin for Revolving Credit Applicable Margin for Term Loan (in Loan (in basis points) basis points) Greater than 2.00x 400 425 Less than 2.00x but greater than or equal to 375 400 1.50x Less than 1.50x but greater than or equal to 325 350 1.00x Less than 1.00x 300 325 19
Increasing EBITDA • “Increasing” EBITDA – Acquisitions (pro forma financials) • Equity Cure Rights – Limitations • Opportunities to exercise cure rights (consecutive and/or non-consecutive) • Limits on size of cure amounts (individual and/or aggregate) 20
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