August 18, 2023

Debt Download

Welcome to Debt Download, Goodwin’s monthly newsletter covering what you need to know in the leveraged finance market. As summer winds down, read on to find out whether the debt markets have perked up.

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Goodwin Insights

Equity cures – often overlooked as “boilerplate” in credit agreement negotiations – are getting increased attention as businesses contend with more frequent financial maintenance covenant breaches and market volatility. Sponsors and other equity investors (“Investors”) and lenders are learning that robust equity cure rights allow Investors to buy time to protect their investment by addressing underperformance and avoiding renegotiating existing credit agreement terms and pricing in a lender-friendly market. Recent trends and points of negotiation on equity cures include:

  • Back-to-Back Cures: Among other conditions applicable to equity cures, credit documents typically limit Investors and borrowers from exercising equity cure rights more than twice in any period of four fiscal quarters. Some credit documents will additionally prohibit Investors and borrowers from exercising equity cure rights in any two consecutive fiscal quarters (meaning that they would have to skip a quarter after exercising the cure right before exercising it again). In today’s environment, companies will often require more than one quarter to turn around performance and, accordingly, Investors have been prioritizing the right to make equity cures in back-to-back quarters. The right to cure in consecutive quarters may be key to providing companies sufficient time to recover (and could prevent Investors from putting in capital in one quarter only to have a default the following quarter that cannot be cured with additional investments). To that end, in some larger cap credits, the cap on cures is flipped such that the borrower is prohibited from having more than two consecutive cure quarters in any four quarter period (i.e., the cap is three cures in a four quarter period).
  • Timing for Q4 Cures: Credit documents include deadlines by which Investors must make an equity cure for a particular fiscal quarter, and such deadlines are typically on (or within 10-15 days after) the date on which financial statements are required to be delivered for such fiscal quarter. As such, in transactions where borrowers are required to deliver quarterly financials only for the first three fiscal quarters of a fiscal year and an audit after year-end, such borrowers have significantly more time to make an equity cure in Q4 than they do in Q1, Q2 and Q3. In transactions where borrowers must deliver quarterly unaudited financials for all four fiscal quarters, as well as an audit for the full fiscal year, there is a question as to whether the cure deadline for Q4 should be tied to the delivery of the quarterly unaudited financials or the audited annual financial statements. Investors and borrowers have been pushing to tie the deadline for Investors to make an equity cure to the delivery of the audit instead of such Q4 financials. Successfully bargaining for this flexibility can give Investors an extra 2-3 months to evaluate the company’s performance and whether to make an equity cure. Also, borrowers should be cognizant if they are required under the loan documents to test their financial maintenance covenant at the end of each of the Q4 test period and the annual test period. If so, the borrower should consider how year-end audit adjustments may affect the required equity cure amount if the borrower needs to cure the Q4 financial covenant and then re-test the financial covenant when the audit is due.
  • Source of Capital: In order to exercise an equity cure, credit documents typically require only that there is an equity investment in the borrower (or the direct parent company of the borrower, to the extent it is a party to the credit documents). Credit documents do not, however, control the source of such equity investment. As such, Investors are regularly funding or arranging from third parties PIK holdco notes and other debt and hybrid debt and equity investments at a parent company outside of the credit group (which, in turn, uses the proceeds of such debt or other instrument to make a qualifying equity investment in the borrower or its direct parent) to finance, in whole or in part, equity cures in lieu of funding solely with traditional equity. PIK holdco notes funded or arranged by Investors can be more attractive than a traditional equity raise, because, among other things, they are not dilutive to existing equity owners, the cost of capital is lower, they are quicker to implement and may avoid triggering preemptive or other investor rights and they are a good option for Investors that do not have sufficient capital or the appetite to call capital to fund additional investments.
  • Lender Reactions: Some lenders are increasingly looking to identify additional defaults to force borrowers and their Investors to the table to negotiate a full amendment now instead of allowing them to delay or avoid those negotiations by exercising cure rights. Frequent targets for other defaults include late financial reporting or material event notices, missing certificates and challenges to the accuracy of EBITDA adjustments. Sponsors can significantly minimize the risk of surprise defaults by training management to rigidly adhere to all credit agreement requirements, whether big or small.

In Case You Missed It – Check out these recent Goodwin publications: Use of EBITDA in Earnouts Increased 22% in Two Years; Redemption Rights, Minus the Redemption; Be Mindful of Phantom Equity; Phantom Equity to the Rescue; Navigating the SEC’s Focus on Private Fund Fees: Understanding the Trends and Mitigating Risk; US Antitrust Agencies Release Revised Draft Merger Guidelines; and How Much Do Fund Managers Have to Contribute to Their Own Funds?


For inquiries regarding Goodwin’s Debt Download or our Debt Finance practice, please contact Dylan S. Brown, Nikolaus J. Caro, and Robert J. Stein.

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