Unlike a traditional first lien debt provided by banks, where lenders maintain a senior secured first lien on substantially all assets of a capital seeker, in a bifurcated term loan, the collateral pool is “bifurcated”, such that current assets are typically pledged towards a line of credit provided by a bank, and all non-current assets are pledged to bifurcated term loan providers, who are typically non-bank entities.
Capital Type: Bifurcated Term Loan or Split Lien Term Loan
Typical Use: Finance growth, mergers and acquisitions and dividends
Funding Mechanism: Fully funded at the close of transaction
Security: Typically, a senior secured first priority lien on specific assets and a senior secured second priority lien on assets securing other first lien debt
Collateral: Typically, all non-current assets of the company, including machinery and equipment, real estate and intangible assets, and pledge of equity
Payment Priority: Usually the first to be repaid from the proceeds of liquidation of its collateral
Who Should Consider a Bifurcated Loan?
A bifurcated loan is relevant to borrowers with the following attributes:
- Substantial amount of current assets that can be used to obtain an ABL, but the borrower does not have a sufficient amount of non-current assets to obtain a larger asset-backed financing from a bank to satisfy capital needs
- The nature of the non-current assets limits available debt capital through a typical ABL provided by a bank, but a direct lender would go beyond the valuation of the hard assets and provide a much larger ‘airball’ loan, or enterprise value loan.
- Stable, largely predictive cash flows and a demonstrable track record of consistent financial performance, along with reasonable liquidity or line of credit availability, and ownership by a party that can provide ongoing capital support during downturns.
- For bifurcated loans structured for cash flow or EV of the borrowers, total indebtedness should not exceed 65-70% of EV, while maintaining total debt to EBITDA under 6.0x in most cases.
Advantages of a Bifurcated Loan:
There are numerous advantages in obtaining a bifurcated loan:
- Full utilization of debt capacity–most non-bank institutions can lend up to the full value of collateral, or maximum possible loan-to-enterprise value of the company, resulting in the maximum possible capitalization within a single tranche of debt
- Low maintenance–reporting obligations limited to financials and covenant compliance certificates
- As no amortization is required, cash flow is available for other corporate needs
- Cost efficient–while more expensive by itself, when combined with a line of credit or a term loan provided by a bank, a bifurcated loan provides a cost efficient solution for full capitalization
Drawbacks of a Bifurcated Loan:
Despite the above benefits, there are considerations for borrowers looking to obtain a bifurcated loan:
- Periodic appraisals are required for asset-backed structures
- More involved legal documentation, as individual credit agreements and an intercreditor agreement among various secured debt instruments will be required
Underwriting Process for a Bifurcated Loan:
Capital Providers: Typically, non-bank credit funds and BDCs
- Recovery through ongoing cash flow generation of Capital Seeker or through refinancing. In distressed situations, recovery through sale of Capital seeker as an ongoing business
- For asset backed structures, recovery through liquidation of collateral in a distressed situation
- For recurring revenues based structure, recovery through collection of ongoing contractual payments
- Confirmation of business’ ability to generate cash flow and repay debt, ability of owner or sponsor to inject additional equity and liquidity
- For asset backed structures, liquidity and value of the collateral
- For businesses with recurring revenues, e.g. software companies, validation of company’s ability to generate recurring revenues and maintain healthy contract renewal rates
- Typical credit underwriting process focuses on the ability of the business to generate consistent cash flows and risks that may disrupt consistent cash flow generation. Underwriting involves analysis of business model, competitive dynamics, customer base and commercial terms, ownership history, historical financial performance as well as financial projections, operations and background of key stakeholders, including key executives.
- Quality of earnings report produced by an accounting firm to validate the EBITDA of the business as well as any adjustments and an industry study to validate the company’s competitive position, size of the market, customer feedback, etc.
- For asset backed loans, appraisal of collateral by a certified appraiser to establish Net Orderly Liquidation Value (“NOLV”), which will govern the amount of capital that can be borrowed against such assets.
Amortization: Typically, none
- Most commonly, leverage ratios (senior debt to EBITDA and total debt to EBITDA) and fixed charge coverage ratio.
- Covenants related to appraised value of the collateral for asset backed structures.
- Total debt to recurring revenues ratio for structures focused on recurring revenues.
- Company prepared unaudited monthly financials, audited annual financials, annual financial projections
- Periodic appraisals of collateral for asset backed structures
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