The chicken and the egg: using securitisation as part of the financing for an acquisition of a target entity

Following the global economic recovery post the global financial crisis, and more recently, the outbreak of COVID-19, companies have taken advantage of the turbulent market by expanding, acquiring or merging with competing companies through various and diverse funding structures. This article will seek to examine the considerations required for a share sale acquisition of a target entity (the Target) which includes securitisation in the purchaser entity's (the Purchaser) funding mix.

When acquiring a target entity, arguably one of the most important considerations is where the purchaser will source its funding for the proposed acquisition. As has always been the case, and perhaps more importantly today given the current global economic climate, companies will look to diversify their sources of funding across both debt and equity instruments and at a micro level, differing types of debt finance. Doing so provides not only better cost of funding but also reduced risk of borrowing by allocating the borrowings or debt raisings across different industries and instruments, each of which are subject to different external factors. The most common forms of raising funds for an acquisition include equity raising, leveraged finance and structured finance. Where the Target originates assets with a regular and contractual payment source, securitisation has proven to be a convenient and reliable source of funding, capitalising on the Target's existing book of receivables to raise funds.

Considerations relating to the existing funding structures in place at the Target and Purchaser levels

In almost all cases, the Purchaser will already have its own debt funding arrangements in place. In these circumstances, as well as in respect of any further amounts borrowed by the Purchaser to fund the proposed acquisition, consideration must be given to the loan and security documents to ensure that there are no restrictions on the Purchaser securitising its assets, including assigning its assets to a special purpose vehicle or granting security over its assets in favour of the SPV. In most cases, a consent will need to be obtained from the lenders of any existing debt, or a carve out will need to be included in any proposed financing documents, to expressly permit the above in the context of a securitisation.

Similarly, the Target will likely have its own funding debt arrangements in place which may include an existing securitisation programme. In these circumstances, the Purchaser will likely look to refinance any existing debt funding arrangements the Target has in place as part of the acquisition. As above, any new funding arrangements will need to accommodate the proposed securitisation and be structured accordingly. Where the Target has an existing securitisation in place, the Purchaser can either look to take over that securitisation programme by acquiring the relevant sponsor company and acceding to the securitisation documents as required (e.g. as Manager, Servicer and unitholder of the SPV) or refinancing that securitisation programme and winding up the relevant existing SPV. In making this determination the Purchaser will give consideration to the economics, costs and practicalities of either option, for example, if the Purchaser has no securitisation programme in place, it may look to piggy back of an existing structure and minimise the costs associated with establishing its own programme or if the outstanding securitisations are public term transactions it may not have the ability to refinance them and may just look to take them over as part of the acquisition.

Additional consideration may be required where the Target is a public or private company and where the funding will constitute financial assistance, being where a company (in this case, the Target) financially assists a person (in this case, the Purchaser) to acquire shares in that company or a holding company of that company. The financial assistance provisions of the Corporations Act (s260) are intended to protect shareholders and creditors of companies as well as to ensure that the resources of companies are used only for proper corporate purposes. To ensure no breach of the Corporations Act will occur, a number of steps must occur, and documents prepared to approve the financial assistance, including documents to be lodged with ASIC and shareholder approval. Where the Target will accede to a corporate debt facility in place to finance the acquisition and provide security as part of that accession, the financial assistance whitewashing (passing of the relevant resolution) can usually occur after the purchase transaction closes and as a condition to the Target becoming a party to those arrangements. Where a securitisation by the Target is part of the acquisition finance, the whitewashing needs to occur before the sale transaction can close. In some cases, shareholder approval may not be guaranteed, and this will need to be factored into any proposed timetable put in place. The parties will also need to consider in their negotiations on the sale and purchase agreement (SPA) whether the shareholder approval will be a condition precedent to the sale, i.e. which party is willing to take the risk on the shareholder approval being obtained. The Target and Purchaser will factor in the level of confidence they have that the shareholder resolution will be passed, including the support from any controlling shareholders of the Target.

Funds certainty

Depending on the competitive nature of the acquisition and where negotiations land in relation to the SPA, the Purchaser will likely want to ensure it obtains fund certainty from its securitisation (and other) funders in order to put its best foot forward by presenting to the Target a transaction that is likely to complete. This is particularly important where there is no funding condition precedent in the SPA for the Purchaser's benefit and the Purchaser will therefore look to obtain funds certainty to minimise any risk associated with failed settlement due to a lack of funds.

Where securitisation is going to form part of the funding mix, the Purchaser will proceed to set up its SPV vehicle (usually a trust) and arrange for investors to provide securitisation funding via a subscription of notes under the securitisation structure on the acquisition date. For the purposes of this article, we will assume that the underlying receivables to be securitised will be a blend of the Purchaser's own receivables and the receivables to be acquired from the Target on the acquisition date. The problem, however, is a classic chicken and egg scenario. The securitisation investors are not obliged to provide funding until a number of conditions precedent are satisfied, however many conditions precedent will not be able to be satisfied until the acquisition has actually occurred (which requires the securitisation funding). To manage this risk, the Purchaser and the funders will look to enter into commitment letters where they will commit (subject to certain conditions) to provide the funding on the acquisition date. Entry into the commitment letter will be dependent on several initial conditions precedent being satisfied, including satisfaction of all KYC and due diligence requirements, agreeing the form/terms of transaction documents (which can either be achieved by agreeing the forms of documents or agreeing to a long form term sheet which sets out all key terms) and obtaining an agreed upon procedures report in respect of the proposed pool of receivables. Once the commitment letters have been executed, the securitisation investors will have committed to provide the relevant funding amounts on the acquisition date subject to satisfaction of the underlying securitisation conditions precedent. These underlying securitisation conditions precedent are often heavily negotiated and the Purchaser will generally look to limit these to things within its control, such as its own solvency and performance of its contractual obligations.

Timing and co-ordination of close

As flagged, one of the main considerations in an acquisition is timing. As many of the steps are interdependent it is critical that a steps plan is prepared which will ensure that all documents and consents are released and effective at the appropriate time on the acquisition date. From a securitisation perspective, this will involve, amongst other things:

• delivery of:
  • a written resolution (the first resolution) from the Target which permits entry into the share and purchase agreement and the retirement and appointment of new directors/company secretary; and
  • a second resolution (immediately following the completion of the acquisition) (the second resolution) which approves entry into the securitisation documents. We note there is practical question as to who approves the securitisation on behalf of the Target. The presumption is that the outgoing directors will not want to approve or be involved in entry to the relevant securitisation documentation which will need to be agreed and ideally signed before the acquisition date. The practical solution is to prepare a second resolution which is signed by the incoming directors authorising entry into the securitisation documents;
• release and accession of any relevant tax grouping documents; and
• execution and release of the securitisation documents.

In order to manage timing risk, all documents will be pre-agreed and pre-signed by the appropriate parties and held in escrow until their release. For example, the securitisation documents and the second resolution will be signed by the new directors who were appointed under the first resolution as if completion had already occurred. While the securitisation funding is required for completion to occur, technically speaking the securitisation is not yet authorised (as the second resolution signed by the new directors is not valid until completion has occurred as the new directors will not be appointed until completion) and the securitisation conditions precedent will not have been satisfied. In practice, all such documents are released at the same time on a closing call as the securitisation funding being provided so that the various steps and conditions precedent are satisfied simultaneously. This ensures that all processes run smoothly on the acquisition date as all documents and steps have been "notionally" satisfied prior to that date and are just contingent on a formal release in a particular pre-agreed order.

Issues related to the securitised pool of receivables

Where the Purchaser's securitisation involves a pool of receivables which have been originated by another entity, in this case the Target, the Purchaser will need to be satisfied that it is able to give all the required asset representations and that the receivables satisfy the agreed eligibility criteria (which include representation and criteria as to origination etc). This is on the assumption that the seller is not providing any comfort in relation to the receivables under the SPA. Under a usual securitisation arrangement where the Purchaser has originated all the receivables, the consequences of a receivable being found to be ineligible (ie. an asset representation made by the Purchaser has been found to be incorrect or the receivable does not comply with the eligibility criteria) are quite strict and these would usually be limited to an obligation on the Purchaser to either repurchase the ineligible receivable or to cash collateralise an amount equal to the aggregate outstanding balance of the ineligible receivable. In the context of an acquisition where the Purchaser is relying on the securitised pool of receivables to fund the acquisition, an appropriate alternate regime will need to be negotiated in respect of any receivables originated by the Target which are (or will be) ineligible for the purposes of the securitisation. Negotiations will largely be driven by the nature of any potential issues that have arisen during the asset due diligence process as well as what representations or criteria the securitisation investors see as fundamental in nature. This regime is often complex and can take many forms, including:

• certain eligibility criteria not being applicable to the acquisition receivables;
• an undertaking that the Seller use reasonable endeavours to work with the securitisation investors to resolve a number of identified issues that may have been identified during the asset due diligence process;
• the creation of a remediation reserve where excess income is trapped to indemnify the trustee for any costs and expenses incurred by it as a result of the acquisition receivables not complying with the eligibility criteria; and
• buyback obligations where the Seller undertakes to buy back those ineligible receivables if certain thresholds are breached.

Where the Target assets to be securitised sit within an existing Target securitisation programme, a payment direction deed may assist with streamlining the required funds flows on the acquisition date so that on the sale of the acquisition receivables to the new securitisation warehouse, the existing Target securitisation funders will be simultaneously paid out and consideration paid to the seller of the Target. Time differences on account of the location of any of the counterparties also need to be factored in and pre-funding arrangements may need to be put in place. A similar regime would also apply to any corporate finance facility in place. This ensures an efficient and clean movement of funds and the funds flows can be co-ordinated such that payment of the relevant amounts will result in an automatic release of any relevant securities/interests on the acquisition date.

While securitisation funding in the context of an acquisition presents some logistical and practical considerations, as outlined above, the numerous acquisitions which have contained a securitisation funding element have shown that securitisation funding remains a valid and convenient funding source for any potential acquisition that includes a pool of receivables with a regular and contractual payment source. It is imperative that all stakeholders at both the acquisition, corporate funding and securitisation levels communicate with each other to strike the right balance to achieve an efficient outcome which satisfies each stakeholder's requirements. Much planning and coordination is required along the way to ensure all the relevant streams of work required to achieve financial close are completed. While the process is not an easy one the success of a number of acquisitions in the last 12-18 months which have included securitisation as part of the funding mix demonstrates that it can be a successful one.