Project Funding - Unitranche Debt/Loan

A hybrid loan structure that combines senior and subordinated debt into one debt instrument

What is Unitranche Debt?

A Unitranche Debt is a hybrid loan structure that combines senior and subordinated debt into one debt instrument.

This type of loan borrower pays a blended interest rate that falls between the senior debt rate and the subordinated debt rate. Unitranche debts started in the United States in 2005 and gained popularity as a financing option in the European leveraged loan market beginning in 2012.

The main goal of unitranche financing is to make debt-financing terms flexible and increase company capital access. Borrowers increase market liquidity and bring new energy to a traditional debt market.

The primary providers of unitranche debts are non-traditional lending entities such as debt funds and other institutional lenders. These lenders focus on acquisition finance and middle-market lending. This form of lending was popular during the financial crisis and the credit crunch that followed when troubled companies could not access loan facilities from the mainstream credit markets.

Usually, under unitranche financing, a single lender provides the entire credit with only a single set of documents.

Users of Unitranche Loans

The primary beneficiaries of unitranche debt are middle-market corporate borrowers with sales of less than $100 million and an EBITDA of less than $50 million. Unitranche debt is an alternative credit market for companies needing more access to ample credit facilities from traditional financial institutions.

The average size of a unitranche loan is $100 million, and it is often used to finance leveraged buyouts such as management buyouts and private equity acquisitions.

Characteristics of Unitranche Debts

The following are the critical characteristics of unitranche debts:

1. Single Loan Agreement

Unitranche financing involves a single credit agreement and requires one set of collateral documents. It reduces the documentation and paperwork borrowers must comply with before accessing funds.

Traditional leveraged financing like junior, mezzanine, and senior debt require separate documentation, and borrowers must comply with different covenant packages in each debt. This means that for a borrower to qualify for a single debt, they must fill out several documents, which takes time and effort.

The only instance when a borrower may be required to fill out more than one document in a unitranche debt is when a revolving credit facility needs a separate loan agreement.

2. Call Protection

A unitranche lender may seek non-call/early prepayment protection for the first 12 to 24 months of the loan’s life.

The prepayment fees and the length of the non-call period vary from market to market but are negotiated before reaching a final agreement.

Most lenders include a “make-whole” provision in the credit agreement for the first two years so that any interest and fees due during this period can be paid alongside the other prepayment amounts.

Without this provision, some lenders may charge an extra 1%-2% on top of the prepayment amount.

3. Maturity and Bullet Repayment

A unitranche debt comes with a single interest rate and maturity term, usually between five and seven years. Unitranche financing usually requires a one-time lump-sum repayment of the entire loan at maturity.

4. Benefits to the Borrower

One of the benefits of unitranche financing is its simplicity compared to traditional credit facilities. Borrowers only go through a single approval process and prepare one set of documents for the lenders.

Also, taking on a single debt instrument that combines two types of debts reduces the number of legal reports the borrower would be required to prepare. Due to this simplicity, borrowers are willing to pay a premium fee above what they would have paid to a traditional financial institution.

When dealing with a time-sensitive transaction, unitranche financing gives the borrower the advantage of dealing with a single lender, which helps close the transaction quickly. Unlike traditional credit loans, a borrower must deal with different lenders and provide several legal documents.

Since the borrower is dealing with a single lender, he can negotiate flexible covenant documentation, amortization rates, and repayment terms. Also, the borrower will incur lower administrative costs since only one administrative agent authorizes the debt instrument.

In addition, unitranche financing allows small and medium-sized companies to access funding that would be impossible to get from a bank. Most banks impose restrictive regulations that disadvantage small borrowers, who are less stable than large companies.

Unitranche financing gathers these lenders to negotiate and create favourable terms that do not restrict small borrowers. When these senior lenders agree to the deal, they can offer significant senior debt and earn high interest in the long run.

Disadvantages of?Unitranche Debt

Unitranche debts usually come with call protections that require the borrowers to make repayments for a certain predetermined period.

The call protection locks borrowers in debt for a minimum period, so they cannot use their excess cash reserves to pay the debt off in voluntary lump-sum amounts.

Similarities between Unitranche Debt and Equity

Due to some contractual features in a unitranche agreement, unitranche financing possesses a few characteristics similar to equity financing. One of the similarities between these two forms of financing is the comparability to shareholders.

Just like shareholders, unitranche funding aims to provide capital for long-term financing. It offers the benefit of ensuring efficient decision-making during the loan period and negotiating the debt agreement.

In equity financing, investors participate in decision-making and are entitled to be informed of the company’s future plans. If the company decides to liquidate, shareholders are entitled to receive a share of the company after secured creditors are paid.

Similarly, unitranche providers request shares in the borrower’s company to gain control over the company should an enforcement event occur. The lender also sends advisors to the borrower to provide market knowledge on strategic matters.