Debt funding and ARR lending: UK investment in the Nordics
In the last couple of years there has been a notable uptick in M&A private equity activity in the Nordic region
In the last couple of years there has been a notable uptick in M&A private equity (PE) activity in the Nordic region, with the TMT sector attracting particular attention. This has also expanded to inward investment from European PE firms, as domestic companies have become more internationally-minded and open to European PE investment in order to expand.
The widespread use of English in the region, with a large amount of corporate finance conducted in English, plays a significant role in foreign PE being able to execute transactions in the region. The technology and B2B focused economy has also increased its attractiveness for investment post COVID-19.
As a PE firm pursuing investment in the region, in particular raising debt facilities to support the investment, there are a few key considerations that should be kept in mind.
Norway previously had strict financial assistance and corporate benefit restrictions
1. Financial assistance and corporate benefit regime
Norway previously had strict financial assistance and corporate benefit restrictions, which had prevented Norwegian target companies from providing guarantees for acquisition financing facilities in connection with the acquisition of its shares. Norway also doesn’t recognise the shareholder ‘whitewash’ procedure which can be used to avert financial assistance restrictions.
In practice there was always a number of ways to partially workaround the prohibition against financial assistance, but these would be very unlikely to fully support the required acquisition debt to acquire the target (for reasons including the movement of monies not being able to exceed the target’s funds available for distribution of a dividend).
However, the financial assistance rules were eased in January 2020, with notable updates being:
- Allowance for financial assistance exceeding the target’s funds available for distribution of a dividend (provided the bidder is EEA domiciled and will form part of a group with the target)
- No security requirement from the bidder, so long as it can be argued that the acquisition is in the target company’s best interest and such financial assistance can be justified in the absence of any security
- Financial assistance must still be approved by a general meeting prior to this being granted by the board, including demonstrating the transaction is in the target’s best interests and the effect on its future liquidity and solvency
It must be noted that the financial assistance position varies across the Nordics:
- Denmark – financial assistance rules apply but can be worked around through a standard shareholder ‘whitewash’ procedure
- Sweden – no prohibition on direct financial assistance, but subject to demonstrating that the acquisition is in the best interests of the company
- Finland – financial assistance prohibition remains.
In any event, a share charge or pledge can be provided by the target (or Bidco) over its shares to the lender.
2. Existing bank or working capital facilities
If the target company has existing local bank or working capital facilities, then the existing security position should be clarified at the earliest opportunity. This security can be ‘all encompassing’ which may restrict the ability to move cash around the new group in order to service the acquisition debt.
It should be considered whether these facilities are required on day one and, therefore, if the existing security would provide restrictions on required security for the acquisition debt.
If these aren’t immediately required in the short term, then the transaction process can be expedited by putting this in place post-completion. The legal documents can be drafted with a ‘hollow’ tranche for a future working capital facility and intercreditor principles agreed in advance to minimise subsequent legal work.
In addition, a number of non-bank lenders in the current market can provide bridging liquidity facilities for a short period as an assurance.
a number of lenders can provide debt facilities which are linked to the ARR, rather than the earnings generation
3. ARR debt facilities
Given the prominence of tech-focused businesses in the region, a number of the investment opportunities will not be at the stage of generating earnings, given recent growth investment, but will be highly attractive through a base of Annual Recurring Revenues (ARR) and strong client retention.
From a traditional lending parameter perspective, this would make these target businesses challenging to lend to. However, in the continuingly evolving debt markets, a number of lenders can provide debt facilities which are linked to the ARR, rather than the earnings generation, of the target business. The ARR is typically determined based on the most recent month’s recurring revenue base and then annualised.
Key characteristics of these facilities include:
- Financial covenant linked to ARR – calculated based on total debt to ARR. Typically this will also include an agreed time frame where this will ‘convert’ (the ‘Conversion Date’) to a more standard leverage covenant. However, increasingly this conversion requirement can be negotiated away
- Conversion date – this can be defined as an agreed date, but the borrower should also negotiate the ability to elect for the conversion date to occur prior to this based on pre-determined metrics being met
- Single financial covenant given lower free cash generation of these businesses
- Extended PIK toggle periods – ability to continue to roll interest for longer periods than for standard debt facilities
- Margin ratchet linked to the ARR
- Monitoring KPIs agreed for each transaction, but can include details of recurring revenues associated with specific contracts to be provided each quarter
A wide range of lenders offer these facilities, from clearing banks to credit funds, each with varying appetites for ARR leverage and total quantum.
In addition, there are a number of UK based pan-European lenders with appetite and ability to support acquisitions in the fast-growing Nordic region.
Clearwater International’s UK Debt Advisory team has recent experience of raising both cashflow based and ARR linked debt facilities to support acquisitions in the Nordics. Clearwater International also has offices in Denmark and Sweden that can provide local, on the ground advice.
