When it comes to cross-border deals, the lion’s share of buyers chasing transactions in Canada these days are American with private-equity firms snapping up both public and private businesses at a steady pace. And they are affecting Canadian financing practices.
Most of the cross-border private-equity acquisitions are being done with 10 to 20 percent equity and the rest is financed. The more a fund can lever up its acquisitions using cheap debt, obviously, the better the potential return.
“The US debt markets have been very frothy and borrower-friendly and the US PE funds making acquisitions – even when coming to Canada and dealing with Canadian banks – are really expecting to get comparable terms,” says Carol Pennycook,
a partner at Davies Ward Phillips and Vineberg LLP
in Toronto. “That slowly bubbles over into the non-cross-border market.
“So we’ve seen Canadian lenders a great deal of pressure over the last couple of years to relax covenants, allow greater leverage within their borrower company, far fewer restrictions in their covenants — even slightly relaxed events of default. But particularly we’ve seen quite a large increase with respect to the amount of debt they’ll permit their borrower to have. So we’re seeing greater leverage in the sense of what your financial covenants have to look like, how much debt you have to have compared to earnings.
“The Canadian market has traditionally been a bit more conservative than the American market, but with so much activity, those expectations, those differences, have significantly narrowed.”
Pennycook says US private-equity funds doing a transaction in Canada can access either US or Canadian lenders, and many doing cross-border transactions will divide it up and use a revolving credit facility with their primary US lenders, but bring some Canadian lenders into it as well. They’ll generally do a term facility, a single draw to be paid back on maturity if not before, with US lenders.
She says US Term Loan B – loans made by institutional investors whose primary goals are to maximize long-term total returns – traditionally have much more relaxed covenants and financial tests, and allow greater leverage. And Canadian lenders who want that business are coming under pressure to offer equivalent terms.
“But when you have two facilities with the same borrower you can ultimately expect that borrower is going to say, ‘Our US lenders let us use this, so we want you to make the same amendments, to make the same consents as well.’
“I foresee Canadian borrowers [on cross-border financing transactions] saying, ‘We’ve got that in our US debt facility so we want that in Canada as well.’ Good borrowers can exert that pressure very effectively, and they are.”
Pennycook says Canadian PE lenders – mainly banks and pension funds – aren’t losing significant market share to US lenders over more favorable terms so far, “but they’re certainly having their feet held to the fire.”
But forget the fire for a moment. There’s one sector where US lenders can’t hold a candle to Canadians: cannabis.
“Marijuana’s been a very hot commodity that’s caused a lot of lawyering and a lot of transactional work,” says Mitchell Gropper
, a partner at Farris, Vaughan, Wills & Murphy LLP
in Vancouver. “We’ve represented some US buyers who’ve come to Canada — US lenders and US banks won’t touch these transactions. They can’t.
“In those states in the US where marijuana’s legal they can’t even use the national banking system or the credit card system.”
In states where marijuana is legal, says Gropper, US companies that want to buy a Canadian marijuana company can presumably tap state chartered banks, “which are much like credit unions in Canada.” But they might not get the same favorable terms they would from a large national bank.
“Whenever you get into credit in a rationed market rates are high. But for a long time the marijuana producers couldn’t borrow anything at all, so for them anything below 35 percent for them is cheap.”
One group that is staying away from Canadian banks is Chinese buyers, he says.
The arrest of Huawei Technologies Co. Ltd. CFO Meng Wanzhou in December 2018 at the request of the US, which planned to extradite her, put a screeching halt to Canadian purchases. While Chinese entities generally did their own acquisition financing, the day-to-day operations of what became Canadian subsidiaries would have presumably been done through Canadian banks, which have seen that lending work dry up.
“Transactions from China are dead,” Gropper says. “It’s not just quiet. They’ve gone away.”
But other sectors are hopping and US buyers – especially freshly financed private-equity funds attracted by the low Canadian dollar and quality of young companies – are stepping in and keeping lenders busy.
, a corporate finance partner in the Montréal office of McCarthy Tétrault LLP
, says technology is especially hot. “Anything having to with artificial intelligence, payment systems, fintech generally. That’s an area where there’s a lot of activity and interest.”
Mining plays, industrials, mid-stream oil and gas assets that provide a steady yield, and even strategic companies in fields where a PE fund can leverage the acquisition by expanding geographical reach or market share of another, similar, acquisition are also hot commodities — and they all require financing.
Mayr says there are a couple of things US buyers coming into Canada need to know about the Canadian debt market.
“If you look at private debt in Canada, what’s particular, and very different from the US, for example, is our banking system is quite unique. It’s surprising but US and other foreign buyers don’t always know this: we have five or six very large banks and that’s it. So the commercial lending space is really occupied by a small number of large players.
“This can sometimes lead to challenges. If you’re really trying to get a competitive process going to raise private debt and price it, you can run into the issue that everybody’s putting the same terms on the table because of the limited sources of capital more quickly than in other jurisdictions.”
But banks aren’t the only ones offering private financing, he notes.
“It’s important not to underestimate the pension funds, which again is something unique to Canada,” he says. “The OMERS [Ontario Municipal Employees Retirement System] and Teachers [Ontario Teachers’ Pension Plan Board] and the Caisses [Caisse de dépôt et placement du Québec] are really unique in having become significant direct investors — both in the private-equity funds but also in the debt markets.
“They are important players in the ecosystem of the debt market in Canada, so it’s important to develop those relationships, and reach out to them. If you really want to get a process going where you competitively price a financing, you need to put these guys in the mix as well.”
The cost of capital for pension funds and life insurance companies is quite different from the banks, Mayr says, so they can price deals differently — although generally they take a longer-term view of assets they invest in.
“You can get them to do less traditional instruments such as debentures, quasi-equity — even though it’s debt. They’ll do a hybrid between the traditional loan and typical private-equity investments. If you just want debt capital there’s a whole myriad of ways they invest in companies which is very different from the traditional bank loan.”
Publicly traded US buyers who aren’t getting terms that they like from Canadian lenders are going around them in ways that are more difficult for private-equity firms, Mayr says.
“Public companies have access to US public debt markets and can access public debt faster and easier than accessing traditional private of bank debt here in Canada. What would really drive the decision is the pricing, and the public debt markets in Canada certainly aren’t as liquid or deep as in the US.”
But he too warns there are potential risks going forward to bypassing Canadian lenders on a purchase if the acquisition is going to remain in Canada, even as a subsidiary. “If I raise debt at the US parent level for the acquisition, structuring the debt efficiently operationally so it actually works from an operational and a tax point of view going forward can be more difficult to do by accessing a facility that’s outside of Canada. You typically need both.”
, co-chair of the tax group at Bennett Jones LLP
in Calgary, says Canada used to practically force US buyers to use US banks by charging foreign banks Canadian withholding tax on interest payments.
But the government realized Canada’s Big Six chartered banks didn’t have the financial capacity to loan as much money as was required, so in 2007 the government announced it was changing the policy to do away with withholding tax on interest payments to arm’s-length foreign lenders.
“There have been a number of productive changes to allow for inbound investment in Canada to be more effective. This change to withholding tax has absolutely freed up the ability to put more debt into Canada for foreign corporate acquisitions.”