Private equity firms seek new terms to boost deal payouts

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Private equity firms have been actively seeking to include provisions in loan documents that would allow them to pay themselves larger dividends from companies they buy, a move that has been met with sharp criticism from lenders.

In the past, loan documents typically capped the exact amount of money a private equity firm could extract from one of its portfolio companies. Over time, those fixed amounts became flexible, based on a percentage of the company’s earnings.

But in recent weeks, private equity firms have been trying to go a step further by introducing a so-called high-EBITDA rule that allows a company to use its highest profits in any 12-month period for key tests that determine how much debt the company can take on or how much dividend it can pay to its owner, even if the company’s profits have fallen since reaching that peak.

KKR, Brookfield, Clayton, Dubilier & Rice and BDT & MSD Partners tried to insert the clause into loan documents, according to people briefed on the matter. All four firms declined to comment.

The terms have been met with stiff resistance from potential lenders, and in almost every case the provision has been ultimately removed from the loan documents. But the fact that private equity-backed companies continue to push for the provision has lenders on edge, with some fearing that competing creditors will cave and accept the provision.

The terms were included in interim loan documents supporting KKR’s buyouts of asset manager Janney Montgomery Scott, valued at about $3 billion in the deal, and its purchase of education technology company Instructure for $4.8 billion, as well as Brookfield’s $1.7 billion acquisition of nVent Electric, according to lenders who have seen drafts of the loan agreements. The clause was also included in interim refinancing documents by Wesco, which is owned by BDT & MSD Partners, and Focus Financial CD&R.

“It’s a really aggressive timeline,” said one creditor. “It’s hard to say, ‘I’m going to go one step further.’”

In one agreement, RBC, which was the lead guarantor on a $900 million term loan that Brookfield raised to invest in nVent, told the investor that the bank had strong demand and if the provision was an issue, he should “vote with his feet.”

Once enough investors left, the high-stakes language was removed from the loan document.

RBC did not immediately respond to a request for comment.

The fact that the language is being tested is one sign of potential imbalances in the loan market, a key source of funding for private equity buyouts. With buyout volumes still below their 2021 peak, investors have had fewer new deals to spread their funds across, leading to increased competition around some loans.

“When you’re in a strong market, it’s usually harder to resist” those conditions, said one banker involved in Instructure’s financing. But he added, “they won’t survive.”

That language was included in at least one deal, a $2.1 billion term loan for a commercial laundry company known as Alliance Laundry, according to two people briefed on the matter. The company planned to use the proceeds to refinance debt and pay an $890 million dividend to its owner, BDT & MSD, according to S&P Global and Moody’s.

The text, obtained by the Financial Times, states that “the borrower may consider EBITDA to be the highest amount of EBITDA achieved in any test period after the closing date… regardless of any subsequent decline in EBITDA after the date such highest amount was achieved.”

“If you didn’t ask for those terms in the negotiation, you didn’t do your job,” said one private equity executive. “You always want to give your companies maximum flexibility.”

The concept of high water is no stranger to creditors; it is much more prevalent in Europe’s leveraged financial markets. Some bankers and lawyers argue that the idea is rooted in common sense.

With some loans, the amount of future debt a company can borrow, or the amount it can pay back to its owner, is set as a percentage of profits. Companies like that flexibility because as they grow, they don’t have to keep changing loan documents if they want to borrow or deploy more cash. The investors said the experienced lawyers decided to take the concept a step further.

High-interest rate regulations pose risks to potential investors, especially if economic activity begins to slow before the loan becomes due.

“Over time, the protections built into commercial bank loan agreements have deteriorated,” said Tom Shandell, head of U.S. CLOs and broad syndicated loans at Investcorp Credit Management. “Private equity firms, which can afford the best and brightest lawyers, have gradually inserted provisions into loan agreements that weaken the protections.”