Corporate Finance Professional Interest Forum “Taking the Bull by the Horns: negotiating & restructuring corporate debt facilities” Chairman: Frank Moxon.

Corporate Finance Professional Interest Forum

“Taking the Bull by the Horns: negotiating & restructuring corporate debt facilities”

Chairman: Frank Moxon CF FSI

Stuart Faulkner, Strand Partners

Corporate Finance Professional Interest Forum

An investment banker’s perspective – Stuart Faulkner, Director

Presentation to The Securities & Investment Institute Corporate Finance Forum Negotiating and restructuring corporate debt facilities

7 April 2009

Table of Contents

1. Introduction

2. Key issues in the current environment

3. Negotiation and restructuring at healthy SMEs

4. Negotiation and restructuring at financially distressed SMEs

5. Capital market issues

6. Key pitfalls and mistakes

7. Where advisers add value (and where they don’t)

8. Conclusions

9. Questions and answers

10. Strand Partners Limited / Biography

1. Introduction

This presentation focuses upon the negotiation and restructuring of corporate debt facilities for public companies, particularly those listed on the UK AIM market

AIM saw a period of unprecedented growth in the period 2003 – 2006/7 resulting in:

A massive increase in the number of companies successfully seeking admission to AIM

A commensurate increase in AIM listed companies successfully raising equity through secondary offerings

Far earlier stage (often pre-profitable) companies successfully seeking admission to AIM

Strong institutional equity support for the AIM market and new admissions

Significantly increased lending support for AIM companies from banks

However, due to the equity market slow down in 2007, accelerating into 2008 and the credit crunch in 2008/9, the financing markets deteriorated rapidly

As a result, an ever increasing number of companies have been facing severe economic problems as a combined result of a deterioration of their underlying businesses and the most severe credit contraction since the 1930s

2. Key issues in the current environment

On the whole, whilst banks are making warm noises about corporate lending, particularly to SMEs, this is not borne out by the evidence:

A near 50 per cent. increase in company insolvencies in Q4 2008 (vs. Q4 2007)

The first net increase in company insolvencies vs. new company incorporation since 1989

Three consecutive quarters of lending decline to the UK SME market

Banks, particularly those now part owned by the government and managed by the Shareholder Executive, are exhibiting four key traits:

Significantly increased risk aversion;

A focus on protecting or, ideally, recovering capital...

...even at the expense of lending margin; and

utilising any rights, at the earliest opportunity, to restructure outstanding lending

Whilst this is clearly a major issue for any company with financial problems, it is worth noting that banks are increasingly seeking to restructure facilities even when a company is comfortably within its covenants and headrooms

Corporate debt restructuring is not just for companies facing financial distress

3. Negotiation and restructuring at healthy SMEs

Banks are increasingly using facility renewal dates as re-negotiation period, rather than simply rolling facilities forward A number of banks are even seeking to renegotiate facilities on an ad hoc basis between facility renewal

dates

Typical restructuring requirements from the bank include: Reduction in overall quantum Increase in security, particularly Personal Guarantees Decrease in duration of fixed term element of facilities Increase in “on demand” element of facilities Increase in financial and commercial information required by the bank Increase in costs, particularly charges

Key tactics for SME management when negotiating with banks Be thoroughly prepared

Have all your banking documents/terms reviewed and fully understand your legal position Have your financial forecasts, including underlying assumptions and sensitivities prepared and reviewed Have a clear and realistic sense of what your desired outcomes are before commencing the negotiations

3. Negotiation and restructuring at healthy SMEs (cont’d)

Focus the negotiation on the elements of the debt facilities that are important to your business Consider “giving up” unutilised committed financing in return for a longer fixed term on the remainder Pre-emptively offer greater financial information Seek a balanced trade-off between ongoing interest and one off facility charges

Attempt to keep your existing relationship manager involved, even if (s)he is no longer the decision maker

Understand the decision making processes within your bank

Do speak to other banks with regard to moving your facilities

Whilst it might not be achievable now, as the credit markets return to a semblance of normality, it will become easier

Focus on those banks with better capital ratios, expertise in your business sector, geographical links or a supportive local business centre

Be prepared to use aggressive tactics, if required:

Utilise all your facilities in full, whether needed or not, to prevent them being unilaterally removed by the bank

Formal legal letter from company’s solicitor if the bank breaches the terms and conditions of the facilities

As a last resort, the Banking Ombudsman

3. Negotiation and restructuring at healthy SMEs (cont’d)

Remember that any material change to an AIM listed company’s debt facilities position is likely to be considered price sensitive information

Accordingly, this will need to be communicated to the market via a Regulatory News Service announcement (“RNS”) in a level of detail sufficient for the market to be able to form a judgement

Early consultation with your Nomad and Broker is always the best approach

Verification by lawyers

Craft message for external and internal audiences with public relations advisers

4. Negotiation and restructuring at financially distressed SMEs

Clearly, when a company is either approaching or is in financial distress, then it is in a far weaker negotiating position than one in rude financial health

However, even in this current environment, banks prefer to work with management and equity holders to find a solution, rather than immediately move to administration

Obviously, a number of common elements with negotiations by healthy SMEs: Have financial forecasts prepared with base case and sensitised scenarios Fully understand your legal position/debt documents

In addition there are some other key elements to have in place before approaching the bank A detailed explanation of how and why the current situation arose A proposed solution, including what you require from the bank, e.g. standstill/interest freeze/covenant

breach waiver/commitment not to pull facilities A summary of actions already taken, e.g.:

Cost reduction programs Tightened working capital Potential non-core disposals of business/assets IP advice/discussions with auditors, particularly with regard to “going concern” statement

Proposed RNS announcement, particularly if it references the debt provider Banks remain very sensitive to bad public relations

4. Negotiation and restructuring at financially distressed SME (cont’d)

Probable bank requirements

Potential solutions Issues

1. Re-equitisation of the facilities

Sale of non core assets/business to raise funds Time consuming and no guarantee of success, especially if perceived to be a forced seller

Rights issue (including General Meeting) to raise new funds Longer timetable than a placing and likely to be at a considerable discount. Less certainty, unless underwritten (very difficult in the current markets) than a placing. Lack of investor appetite

Placing (including General Meeting) to raise new funds Greater certainty that a Rights Issue, but still an investor appetite issue. Potential Rule 9 issues

Normally, new equity will only be forthcoming as part of a wider refinancing, including the debt facility providers

Debt for equity swap to restructure the balance sheet Less common than might be expected as a result of banks constrained balance sheets

Increasingly combined with new external equity Potential Rule 9 issues. Related party / ownership level issues Shareholders agreement. Often achieves a higher return for the bank than on

administration, but longer term, less certain, exit for the bank

Take private, either by existing major shareholders or a third party

Likely to require bank to “share the pain” in the refinancing Bank has effective veto power, via change of control clauses Bank has to be supportive of new management team and equity

provider for transaction to work

2. Restructuring of covenants

Capitalisation of (an element of) future interest payments Deferment of capital repayments Extension of term Tighter covenants going forward

Often requires new equity injection More complex with a syndicate of banks Often significant up front arrangement fees Less flexibility in the medium term

4. Negotiation and restructuring at financially distressed SME (cont’d)

Probable bank requirements

Potential solutions Issues

3. Greater control / monitoring of the business

Appointing a board director Banks increasingly reluctant to take on this direct involvement, particularly in listed companies.

Clear indication to the equity market that a major potential problem

Right to receive all board papers/management strategy papers Difficult for a board to give unrestricted rights, particularly during debt negotiations

Appointment of a bank approved NED, normally with “turnaround” experience

Potential to disrupt board. Not seen as independent. Often takes executive role

Removal of (some) executive directors Often difficult to find replacements – should be resisted unless the bank has suitable new team. Potential conflict if executive director(s) are major shareholders

Active involvement in the financial forecasting process/working capital and capital expenditure control

Risk of bank representatives becoming shadow directors Lack of clarity over who is running the business

4. Restructuring of charges and fees

Upfront fees to be funded by new equity or capitalised as part of refinancing

Without new equity, increases the indebtedness of the company – fees for refinancing of distressed debt usually severe

Need to ensure that the new structure is capable of being sustained such that the bank is not merely improving its position at the expense of other creditors

5. Bank wants equity kicker to debt package

Warrants, options, redeemable preference shares May require General Meeting to approve issue Shareholders may be unhappy about level of dilution Potential future equity overhang

6. Seeking personal guarantees from management/major shareholders

Potential guarantees limited to defined assets Should only be considered as part of a wider refinancing where the bank is contributing to the solution

Important to take separate personal legal advice

7. Administration Ensure all other options have been exhausted Consider a pre-packaged administration if there is a core

business capable of survival

Impact on suitability for future directorships Fair treatment of creditors Impact on suppliers Impact on employees

5. Capital market issues

AIM requirement to update the market with any price sensitive information, particularly with regard to a company’s financial position (AIM Rule 11)

Announcing that a company is in refinancing talks with its lending banks usually results in:

A precipitous fall in the company’s share price; and/or

Suspension of the shares...

…both of which are clearly undesirable and typically lead to damage to the underlying trading of the company

Therefore there is a significant inherent conflict between an early update being provided to the market and the ability to conclude a refinancing on the best terms for the company, with the least damage to the business model and trading

The company should consult at as an early stage as possible with its Nomad and its lawyers and rely on the advice received

AIM Rules are not prescriptive on when the AIM Team should be approached – whilst, for most issues, an early approach is usually the best option, the conservative nature of AIM with regard to potential financial distress makes it a harder judgement

Each case should be considered on the basis of its own particular circumstances and close attention should be paid to press, research comment and the company’s share price – ultimately it is for the Nomad, based on all pertinent information to make the call

5. Capital market issues (cont’d)

Debt for Equity swaps or a significant injection of new equity from a third party typically require:

Shareholder approval (dis-application of pre-emption rights/headroom) at General Meeting

Circular setting out the rationale for the debt/equity swap

If the bank is going to hold >29.9% of the equity, a Rule 9 whitewash (assuming the company is under the Takeover Code)

New directors appointed to the company, with resultant disclosures

Shareholder agreement

Existing shareholders, who are typically heavily diluted in these situations, are particularly focused on:

What alternative mechanisms were discussed to raise the required equity, particularly sale of the company/assets or rights issue / placing

What protection, as minority shareholders (particularly if the new equity has +->75% of the voting rights) will the current shareholders have, especially with regard to de-listing

Whether management is “sharing the pain” via dilution, loss of options/warrants, reduction in future compensation, return of bonuses etc.

Key message is that in a debt refinancing, whilst negotiating with the bank is of prime importance, the equity providers need to be involved at the appropriate time, even if it is only to provide them with apposite information – role of the Nomad and Broker will be key

6. Key pitfalls and mistakes

Not recognising a potential financial distress situation at an early enough stage Critical to monitor trading, working capital and financial forecasts in order to monitor compliance with

covenants and other key debt terms

Not approaching the bank early enough or approaching the bank without a proposed solution

Not approaching key advisers (Nomad, accountants and lawyers) prior to approaching the bank

Not taking formal solvency advice from an Insolvency Practitioner Key to protecting both the company and its directors (individually) and ensuring creditors are treated fairly

Preparing financial forecasts that are not realistic or defensible when analysed by the bank Important to have a solid base case, based on recent trading patterns

Treating creditors in an unequal manner in a financial distress situation, particularly staff payroll All creditors must be treated equally This does not, however, prohibit a company seeking to amend payment terms/freezing balances etc. – it is

important a company is clear in its communication with creditors (n.b. confidentiality issues for listed companies and timing of public RNS announcements)

Loss of focus on the core business

6. Key pitfalls and mistakes (cont’d)

Failure to take remedial action on costs

Failure to remove staff, particularly in the finance function, who are not fulfilling their roles

Not sharing all pertinent information with advisers

Not setting realistic deadlines to reach agreement and not having an agreed defined work program

Not being realistic in discussions with the bank

7. Where advisers add value (and where they don’t)

adviser Key strengths Issues

Nominated Adviser / Financial Adviser

Liaising with AIM team to best position company to complete restructuring

Project management of all advisers Point of contact for the bank Overall financial advice, including review of company’s

financial models Dealing with the public equity markets Sourcing external third party equity providers

Not a substitute for Insolvency Practitioner/legal advice Can only advise and negotiate within parameters set by the

company – not an alternative director/finance department

Legal advisers Providing analysis of existing debt documentation Liaising with bank’s (in house or external) lawyers Providing formal insolvency advice Preparing all required debt and equity documentation Assisting in preparing board minutes/ancillary documentation

Can only advise – not an alternative director/legal department Not financial advisers and can only negotiate debt terms, not

wider commercial terms

Accountants Provide formal review of forecasts/cashflow models “Going concern” review Any required financial information for a circular

Limited input on company’s financial forecasts, especially assumptions

Public Relations Useful for crafting message both externally (equity market, suppliers, customers) and internally (staff, unions etc.)

Need close monitoring by legal advisers and nominated adviser to ensure accuracy and regulatory compliance

Often seen by the banks as a disposable cost/adviser

8. Conclusions

Regardless of the underlying situation of a company, regular, full and honest dialogue with finance providers is critical

Should it look possible that a financial distress situation appears to be developing management should immediately seek advice from:

Legal advisers (including insolvency practitioner advice, if required)

Financial adviser (particularly the Nomad, if listed on AIM)

And then, as rapidly as possible, engage in dialogue with the key decision makers at the debt provider, ideally with a fully thought out proposal

In the current environment, banks are most focussed on protecting and recovering capital, particularly within the troubled loans teams

Troubled loan teams are over stretched and are likely to remain so for the short to medium term – assisting them to do their job will best position you and your company

Overall, the key message is communication – the quicker you engage with the bank, other stakeholders and relevant advisers the more likely it is a solution can be found

9. Questions and answers

10. Strand Partners Limited / Biography

Strand Partners Limited (“Strand Partners”) Established in 1993, Strand Partners is a focused and specialised corporate finance advisory and investment firm which concentrates on

providing financial advice to public and private UK corporates, private equity houses and qualified investors.

Strand Partners has advised on ca. £2 billion of equity raisings, restructurings and M&A transactions since January 2007.

Strand Partners' speciality lies in its ability to offer financial and intellectual resources and sound advice not usually available to the UK middle market, working in partnership with clients to craft creative solutions to their financial and strategic challenges.

The highly qualified executive team at Strand Partners have proven skills and experience across a wide range of financial disciplines, along with a total focus on client’s aims which enables clients to turn their proposals into actionable transactions.

Strand Partners is consistently rated as one of the market leading Nominated Advisers and holds the number one position in the AIM Oil & Gas sector, both by client market capitalisation and by number of clients.

Strand Partners’ has offices in London and Cape Town and is an approved Nominated Adviser and Financial Sponsor.

Stuart Faulkner – Executive Director Stuart Faulkner is a Director of Strand Partners Limited, one of London’s foremost, mid market, independent financial advisory firms.

Stuart read Modern History at St Anne’s College, Oxford University and then joined the investment banking division of Barclays de Zoete Wedd, which was acquired by Credit Suisse First Boston in 1997, before moving to Merrill Lynch in 1998 and Strand Partners in 2006.

Stuart has advised a wide variety of UK and international companies, including financial sponsors and international corporates, on mergers & acquisitions, defences, LBOs/MBOs and disposals and has extensive experience of Takeover Code transactions. Key transactions Stuart has worked on include the hostile bid for NatWest by RBS, the hostile bid for Carnival for P&O Princess, the flotation of Yell, the contested auction acquisition by TPG, CVC, MLGPE, Blackstone of Scottish & Newcastle’s pub estate, the acquisition of Abbey National by Banco Santander, the debt and equity restructuring of Watermark, the acquisitions by J O Hambro Capital of Sirvis IT and Bionostics, the MBO (backed by a Stanley Fink SPV) acquisition of Zenith Hygiene and the defence / auction of Celtic Resources against a hostile approach by Russian mining conglomerate OAO Severstal.

Corporate Finance Professional Interest Forum

Marc Isaacs, Nabarro

Taking the Bull by the Horns: Negotiating and restructuring corporate debt facilities

Marc Isaacs7th April 2009

Today’s talk will cover:

• The Credit Facility - understanding the problem • Lender rights following an Event of Default• What is the Borrower looking to achieve in a restructuring• What will the Lenders be looking for• Dealing with a Bank Syndicate• A couple of general issues• Key points to take away

The Credit Facility

• What is the current status of the credit facility?– At the outset you need to determine the borrower’s options and the

relative rights of the borrower and the lender.• Is there an outstanding Event of Default?

– If there has been an Event of Default which has subsequently been cured there may not be a problem. Depends on the detailed drafting.

• Potential Event of Default?– This does not always mean what you think it does!– If drafted correctly, it should not mean something that may become

an Event of Default in the future.– It should mean an event having occurred that but for the operation

of a grace period, the giving of notice or the making of a determination would be an Event of Default. Contrast this with an anticipated breach.

The Credit Facility (cont.)

• Anticipated breach?– What is lurking on the horizon – time to act now before a

Potential Event of Default or actual Event of Default exists.

• Is the facility fully drawn? – Potential Event of Default likely to act as a drawstop (but

typically permits rollover of existing advances in a revolving credit facility).

– Consider drawing the facility in full.• Standstill required?

– Aim is to give the borrower some financial stability to agree a restructuring plan with its creditors.

– Gives the creditors time to obtain full and reliable information on the borrower.

Lenders rights following an Event of Default

• Acceleration of facility• Cancelling of commitments• Drawstop (potential Events of Default as well)• Placing the facility on demand (no longer a committed facility)• Borrower needs to consider whether it has sufficient working

capital• Will auditors sign off the company as a going concern without

committed facilities?• Wrongful Trading

Wrongful Trading

• Wrongful Trading– section 214 of the Insolvency Act 1986. – Once a director or directors conclude (or should have

concluded) that there is no reasonable prospect of the company avoiding an insolvent liquidation, directors have a duty to take every step which a reasonably diligent person would take to minimise potential loss to the company’s creditors.

– If, after the company has gone into insolvent liquidation, it appears to the court that a director has failed to comply with this duty, the court can order the director to make such contribution to the company’s assets as it thinks proper.

Borrower’s Objectives

• Re-setting of financial covenants • waiver of existing breaches• Capitalisation of interest (interest holiday)• Deferment of scheduled amortisation • Extension of maturity• New money required?

Lender Requirements

• Information, Information, Information– (Updated business plan and independent investigating

accountant’s report). Can the borrower convince the lenders that the business will be viable post-restructuring.

• Additional equity or subordinated debt to go into the Borrower– (consider a rescue rights issue and/or injection of mezzanine

finance)

• Security and/or additional guarantees• Dividend lock-up• Tighter operating covenants and more stringent reporting

covenants• Higher Margin and Fees (even if deferred)

The Bank Syndicate

• Consider level of lender consents required for each specific request. Understanding when all lender (as opposed to majority lender) consent is required is key to negotiating with a syndicate.

• Borrower may no longer know who its lenders are (watch out for

silent sub-participations)• Divergence of objectives among lenders (contrast original

lenders looking to recover 100% v. lenders who have bought at a discount in the secondary market who may only need to recover 80% in order to make a profit).

• Interaction between Senior and Mezzanine Debt (need to carefully check the intercreditor deed)

The Bank Syndicate (cont.)

• Appointment of Steering Committee• How to deal with minority lenders when all lender consent is

required.• Debt buy-backs • Yank the Bank – can work against the borrower when a facility is

trading below par.

General Issues

• Financial Assistance (still relevant?):– Prohibition repealed in relation to a private company giving

financial assistance for the purpose of the acquisition of shares in itself or another private company (still applies in relation to public companies)

– Despite repeal, proper consideration still required when giving financial assistance

– If there is any doubt as to a company’s solvency, the directors will need to consider the interests of the company’s creditors, and the company should not give financial assistance.

– Directors should consider the cash flow and net asset position of the company to ensure there are no solvency issues. Although there is no longer a strict requirement for a company to have positive net assets in order to give financial assistance, the existence of net assets is still relevant to the question of the company’s solvency.

General Issues (cont.)

• Set-aside of security– Security can be set aside where it is a transaction at an undervalue

(e.g. security taken but no new monies advances) (section 238, IA 1986).

– The security must have been created in the two years before the winding up or administration and must have been made when the company was insolvent or resulted in the company's insolvency.

– Security can also be set aside where it is a preference transaction (this is where a company intentionally benefits a creditor, surety or guarantor by enhancing its position in the event that the company becomes insolvent) (section 239, IA 1986). Relevant time period here is six months.

– A transaction is only a preference if the company is influenced by a desire to put the preferred person in a better position on winding up.

– Granting security to try and prolong the life of the company and ensure its survival is probably not a preference (Re MC Bacon Limited [1990] BCC 78) .

General Issues (cont.)

• Change of control – where fresh equity injection or debt for equity swap results

in a change of control– target debt facilities and key contracts

• Listing Rules and Takeover Code issues

Key Points to Take Away

• Borrowers need to take early advice (particularly with regard to wrongful trading and general insolvency concerns).

• Borrowers need to engage with their lenders but must talk to their advisers first.

Taking the Bull by the Horns: Negotiating and restructuring corporate debt facilities

Marc IsaacsPartnerTel. +44(0)20 7524 6924Email. [email protected]

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Corporate Finance Professional Interest Forum