Join Cascade Partners Director Arjun Murthy as he and Michael Romaya, Attorney with Varnum LLP, discuss the state of financings for middle-market business in today’s economic climate and the impact of supply chain issues and the ongoing pandemic.


Video Transcript

Welcome to Cascade Conversations. Join the team at Cascade Partners and their network of trusted advisers as they work to demystify details, terminology and strategies in the world of acquisitions, divestitures and financings.


Arjun Murthy – Director at Cascade Partners:
Thanks, Mike, for joining us. So, we have Mike Romaya here, who leads the corporate finance practice at Varnum Law Firm. Thanks for joining. I’m Arjun Murthy, a director at Cascade Partners in the Investment Banking Group.

So, Mike, today we wanted to talk about some financings and considerations for middle-market business owners and kind of your perspective on the legal front. So, hopefully we’ll answer some interesting questions that some people have asked us over the last couple of years or so.

But there’s been a lot of interesting things happening in the world as of late via the pandemic or supply chain issues, but also just a great market. Have you seen any type of tightening or any type of restrictions given some of the global issues happening or have things have remained pretty robust from your perspective?


Michael Romaya: Well, thank you for having me. And from what I’ve seen, things have remained robust. I mean, the markets remain strong. There’s a bunch of lenders out there, various different categories of lenders that are looking to deploy capital and really be a growth partner for companies doing acquisitions or to finance recapitalizations or LBOs.

So, despite the things that have gone on over the years with respect to COVID and now the war, the markets here, at least in the middle market, definitely have remained strong and sort of remain borrower friendly.


Arjun Murthy: And we’re thinking about some of these agreements that the borrowers are looking at because I know you represent both lenders as well as borrower. Is that correct?


Michael Romaya: Correct. Yeah. Our group, we represent lenders, a lot of regional banks, non-traditional lenders and a lot of borrowers across the various spectrums from ABL-base facilities, cash flow-based facilities, as well as real estate and construction financing.


Arjun Murthy: So, it gives you a pretty good perspective of kind of how both parties across the table are thinking here, kind of what these agreements really entail. So, from a borrower’s perspective, what are some things that they can proactively do to prepare if they want to undertake a growth financing, acquisition financing, etc., that can make things go a bit more smoother?


Michael Romaya: One of the first things that they should do is make sure their house is in order, make sure they’re covering documents, other material contracts—like leases accurately reflect the relationships that are that are currently in place—that will help streamline the process. And you also want to do a lot of your financial modeling with your advisors.

If you’re a financial buyer or you expect to do a lot of other add-on acquisitions, you really want to spend the time making sure you model out the right projections and as best you can. And then also make sure your credit agreements reflect that; making sure your financial covenants have the right ramp-up period, have the right add-backs because you really want to avoid defaulting on covenants out the gate because that can send the wrong message to the lending group.

So, more time spent on that in the front end as well worth it as a relationship goes out with your lenders.


Arjun Murthy: So, it sounds like that was a little bit of an indirect plug for having Cascade involved as well as Varnum.


Michael Romaya: (laughts) Yeah, correct.


Arjun Murthy: So, having a good team of advisors ahead of time.

So, ideally we’re thinking about it from the legal context. You know, what would be the ideal time frame to bring someone like you in from a borrower’s perspective?


Michael Romaya: I would say we want to start even before you start gathering your term sheets and going to market, if we can get in there maybe a few weeks or a month ahead of time to review your corporate documents again, your material contracts and just spend some time getting an understanding of what you’re looking to get out of the financing as well as we can—if there are already errors or things that need to be fixed in those documents, we can make the corrective changes.

We don’t need too much, too long of a time to get that done. But, you know, a few weeks up to a month is really advantageous because, if we start trying to address those concerns during the process, frankly, it just becomes more expensive and can distract from the overall timeline of getting the deal closed.


Arjun Murthy: Now, that makes sense. Oftentimes we see—and we’re guilty of it, too—people are trying to bring us in at the last minute, and you’re kind of playing a little reactive basketball there. So, we try to not do that as much, but I know you still are able to have success in those situations.

There’s a lot of different types of lenders out there right now in the universe, ranging from traditional large banks and institutions, and then other types of private credit funds, business development funds, unitranche players, SPACs, etc. What are you seeing in the middle-market and how do structures vary by different types of lenders?


Michael Romaya: Yeah. So, you have your traditional bank lenders that are going to be more relationship-driven. They’re going to have tighter leverage constraints and maybe a little bit of a tighter box to fit in. But you generally going to get—as long as you fit in that box—you’re going to get some more favorable terms.

Then you’ll see from the nontraditional lenders—obviously the nontraditional lenders are going to have a higher cost of capital. A lot of times there can be equity tickers or other things that are built into the deals to make sure that they get their certain returns that they’re expecting. And a lot of times, they work together. Depending on what the snapshot is of the business, you’ll have a senior bank relationship and then you’ll have a mezz relationship sort of in a subordinate position. And you really do want to make sure that your senior bank and your mezz lender have a good relationship. A lot of times, they’ve worked on deals together in the past.

So, I think it’s very beneficial if you do have that structure to make sure your senior and mezz lenders—it’d be nice if they’ve done deals together or at least are on the same page of where the growth is going to be and you feel that you have a good working relationship.


Arjun Murthy: And so, if you do have kind of that bifurcated structure with maybe a traditional lender or some type of mass or unitranche player behind them, what are some considerations from a documentation standpoint—inner creditor agreement I’m sure is something that comes to play—where does someone like you sit in terms of negotiating that, or is that really left to the two separate parties?


Michael Romaya:
Depending on what on what side that we’re on. Obviously, the inner creditor and the majority of that negotiation is taken on between the two lenders with some input and comments from the borrower side. But that’s really the document that’s going to govern the relationship and how things are going to occur between the various the one-all versus the two-all lender.

And then in a syndicated deal on the one-all side, you’re going to have the credit agreement and you also want to make sure the participants—if you do have a syndicated deal—are people that the borrower feels comfortable with, mainly the agent feels comfortable with. They’ve done deals with them because you want to have friendly lenders in the deal that all sort of see the company in the vision the same way.

So, a lot of times the agent bank is going to have various relationships and ideas to who to bring to the table for your bank group. And a lot of time based on what the industry is, they’ll try and find lenders that have experience in those markets. If you’re an agricultural company, you want to have some lenders that have some of that strong agricultural experience because you don’t want to have in the bank group is someone that gets uncomfortable or is in unfamiliar territory with the ups and downs that might happen in your industry.


Arjun Murthy: Now, that makes sense. Having someone with experience and kind of understands it and can get through some of those intricacies of each business definitely would be the path of least resistance, you’d think. But, oftentimes, it may not be, such as Cascade, who’s a generalist, where sometimes you can add value regardless.

Going back to the diligence front, quality of earnings is a big subject that we see on the sell-side and buy-side from an M&A perspective. But on the financing side, are you seeing lenders typically require quality of earnings as part of diligence or are there certain times in which it’s not necessarily needed?


Michael Romaya: Yeah, I mean, it’s very common, especially on the larger transactions. If you’re on a single bank, middle-market type deal, no, you don’t need them. But as you get into the various bank group type structures or you have some component of subordinated financing, you do see them and they are common. But you don’t see them commonly one bank sort of middle market transaction.


Arjun Murthy: Got it. Interesting. Then thinking through covenants, we’ve seen a lot of aggressive structures out there from all different types of lenders, and just given the rise and emergence of different types of lenders, things have become competitive. So, have you seen any of that change as of late? We’ve seen the Fed increase rates, we have seen a couple more coming down the pipe here, or have covenants pretty much stayed aggressive and—thinking about the traditional two or three from a financial standpoint—how have those changed?


Michael Romaya: I’ve seen them sort of remain consistent with some sort of total leverage ratio, senior leverage ratio, fixed charge coverage ratio or debt service. I think people have sort of been expecting the rate increases over the years and now they’re coming to fruition.

So, as the various progressions happen, we’ll see the credit agreements start tightening up or what considerations those bring, but so far it’s been the same sort of traditional covenant reporting package that you’ve seen.

As you get into sort of nontraditional bank financing, you have sort of board observer rights and you’ll have various sets of potential warrants and other options that come into play into the documents. But from the senior position, in general affirmative and negative covenants, they’ve remained consistent so far.


Arjun Murthy: Yeah, I think regardless of bringing out a partner, there’s going to be some sort of increase reporting requirements probably that a lot of standalone businesses haven’t been used to doing previously. But it can also be a good thing because it helps institutionalize that business as well.


Michael Romaya: That’s right.


Arjun Murthy: Yeah, thinking through the remainder of 2022, do you have any helpful predictions that people can have?


Michael Romaya: That I think things hopefully remain strong. I mean, so far deals—there seems to be a lot of capital available throughout the market and we continue to see a lot of deal flow and a lot of activity. We continue to see the growth in the financial buyers. So, I predict that’s going to continue and I think, from the lending side, the banks are ready as well as non-traditional lenders to sort of support that growth.

And there’s a big push to sort of partner up with the right management team and the right growth team to really see some of these returns that they’re looking for and really betting on the right management team that has a plan and a good prediction of where they can pick up value and want to support that.


Arjun Murthy: Well great. Appreciate the helpful insights and this is a great conversation. Thank you.


Michael Romaya: Thank you for having me. Thank you, Arjun.


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