Since the financial crisis, there’s been a definite trend in both Canada and the US toward upfront negotiation of acquisition finance terms that were traditionally reserved for the definitive documentation stage.
But the trend has been decidedly less pronounced in Canada presently than it is in the US.
“So far, we’ve seen much more of the traditional approach, which is surprising because the debt market is said to be on the verge of constricting somewhat,” says Neill May of Goodmans LLP in Toronto. “What’s ironic is that the traditional approach is leading to friction at the end of some transactions because we are in fact beginning to see the first signs of lender caution.”
A primary reason for the divergence in approaches between Canada and the US is the difference in the players and the markets themselves.
“In Canada, if a bank’s not holding the loan, it’s an insurance company or the odd pension fund — and then acquirors can run out of room pretty quickly,” says Richard Higa of McCarthy Tétrault LLP in Toronto. “In the US, there are not only many more sources of financing, but also an institutional debt market.”
The existence of institutional debt markets allows US lenders to raise funds and then sell the debt. Canadian lenders tend to hold on to the debt. The upshot is that there’s more credit discipline here, much as there was in the securitization markets during the credit crisis.
“Goldman Sachs can raise $500 million and sell it all,” Higa says. “That doesn’t mean Goldman or J.P. Morgan aren’t good credit providers or irresponsible, but Canadian banks can’t and don’t take the same risks.”
Consequently, more US deals feature certainty of funding. In other words, because US lenders can take greater risks and have more competition, they are inclined to be more flexible in accepting broader deal terms at an early stage than early than Canadian banks that are inclined to tie things down in a more definitive manner in the traditional way.
“If an American lender doesn’t like the financial position of a company at some point, the lender’s going to be able to sell the debt because there’s a liquid market that trades at a discount,” Higa explains. “Canadian lenders can’t get away with that because they’re going to be holding the bag for the duration.”
Put another way, the more upfront negotiation there is, the more the risk leans to the bank side.
“Canadian banks need teeth in their deals,” Higa says.
Which is not to say that upfront negotiation doesn’t happen in Canada.
“I’m doing a deal right now where the financial covenants are in the deal sheet because sometimes the players like to lock down the definition of those covenants up front,” Higa says.
Indeed, Carol Pennycook of Davies Ward Phillips & Vineberg LLP in Toronto says that she does see upfront negotiation of acquisition finance terms in two very specific situations: M&A auctions involving more than one bidder and public-private partnership transactions.
“For both public and private auctions, the vendor is obviously looking for the best deal,” Pennycook explains. “But the best deal isn’t just predicated on price. It’s also predicated on the terms and conditions as well as the certainty of financing.”
In auction scenario acquisition financing, then, acquirors want to ensure committed funding as early as possible, which is to say in the deal terms. In these situations, the deal terms tend to contain a lot more detail except with regard to the fundamental representations.
To be sure, a surprising amount of negotiation can ensue even with detailed term sheets.
“What’s most important, though, is that regardless of the amount of negotiation, lenders and borrowers can be confident that the funding is committed,” Pennycook says.
For their part, P3 transactions — which almost always have more than one bidder and are predicated on detailed financial models — require certainty of funding to an even greater degree.
“A lot of P3 financing is done with institutional bondholders rather than a public prospectus,” Pennycook says. “But it’s important to the institutional holders that the bonds have ratings, and in order to get ratings the parties have to provide a very detailed term sheet — often as long as the credit documents themselves.”
Finally, there’s another kind of upfront acquisition funding that, oddly enough, involves an abbreviated deal sheet.
“That can happen where the key arranger and the borrower have had an existing relationship with an existing facility, so the term sheet ends up being shorter because it references the previous arrangements,” Pennycook says.