For borrowers, one of the most important aspects of a determination of the equity cure is how often the borrower can use the equity cure. Lenders prefer to limit the number of cures allowed throughout the duration of the contract and often limit the number of uses of the cure over consecutive periods. For example, a lender may limit a borrower`s exercise of an equity repair determination to no more than twice a year and no more than three times during the term of the agreement. Such restrictions allow the lender to prevent a scenario in which the borrower could potentially use the equity remedy as a hedge for their ongoing financial difficulties. When negotiating an equity remedy, borrowers should push to minimize the limits of their ability to use the remedy, which reduces the likelihood that a financial deal will default. One potential pitfall that lenders should look for when negotiating stock turnaround provisions is so-called «back and forth.» Round trip occurs when the healing amount is provided by the borrower`s sponsor and then immediately repaid to the promoter through dividends or the repayment of subordinated debt. This system creates the artificial advantage of an equity remedy to avoid a default event without providing capital permanently to the borrower. Lenders can minimize the likelihood of back and forth by requiring that the remedy on equity come from a person or company outside the group of parties to the credit, so that there is an actual injection of funds into the borrower instead of accounting entries that do not improve the borrower`s financial situation. (a) Type of equity – Some equity adjustment provisions go so far as to prescribe the exact type of equity that can be issued by the borrower to generate the equity proceeds. The most common is the use of common shares as applicable equity. If the borrower is able to trade the use of preferred shares, the lender will generally dictate the characteristics of those shares, including the provision that all the traded characteristics of those shares, e.B. Convertibility, preferential dividends, repayment, maturity, etc., can only be triggered within a certain period after the maturity of the loan.
This is to ensure that the lender`s priority payment is not inadvertently triggered by equity that contains the elements of the debt. Borrowers and lenders must consider equity compensation provisions, but they must be carefully considered and negotiated. Borrowers should try to include these provisions in the loan agreement with as few restrictions as possible. If lenders agree to their inclusion, they should try to limit the borrower`s ability to use the equity remedy in the manner described above. b) Source of capital – The proceeds of equity may come from equity issued directly by the borrower, or may be the proceeds of a call for capital made by the promoter, which is then contributed to the borrower. In the case of transactions where the borrower consists of a group of affiliated companies, the provision for the capital exchange rate could limit the proceeds of own funds to funds provided outside the loan group in order to avoid back and forth, in which, technically, no new cash injection is made, but only bookings that do not have a positive impact on the borrower`s financial situation. Injecting cash from the equity issuance allows the borrower to increase its cash flow or EBITDA to meet financial covenants such as the operating cash flow ratio, debt service coverage ratio or leverage ratio. These financial covenants, which are a key component of cash flow loans, provide the lender with regular snapshots of the borrower`s overall financial situation – a must where the lender reviews the borrower`s free cash flow for debt service and eventual debt repayment.
For the lender, the equity cure signals not only the liquidity the company needs so much, but also the sponsoring company`s commitment to the borrower`s growth. Nevertheless, the lender is also interested in ensuring that the remedy on equity is not abused by the borrower and the developer, and so strict conditions are imposed, including: For many borrowers backed by sponsors, including tech companies that have raised at least one round of financing, the equity cure provides a lifeline that is not necessarily available to traditional borrowers. The equity cure is a provision in loan documents that allows the borrower to receive equity in the company in most cases or, in other cases, intra-group subordinated debt and use the proceeds in a way that strengthens certain financial ratios so that the borrower is able to avoid default. The provision gives the borrower another alternative if he would otherwise have been forced to request a loan change, waiver, forbearance or, worse, debt acceleration. In addition to dictating how the proceeds of an equity cure are applied, lenders will often try to limit the overall scope of an equity cure. Lenders generally prefer that remedies on stocks are only used to heal certain financial clauses. Lenders with great bargaining power may even be able to limit the remedy to financial restrictive covenants related to cash flow, while borrowers generally want to be able to use the equity curative proceeds for any purpose under the loan agreement. In order to limit the scope of a determination of the trajectory of the shares, a lender may insert language that provides that all contributions to the share price will not be taken into account in the calculation of consolidated EBITDA for all other purposes of the agreement, including the calculation of excess cash flows and pricing and leverage provisions. .