Certain Funds: What a Lender Can Still Refuse

A seller who signs a sale agreement takes the business off the market. If the buyer's finance then falls through, the seller has lost time, other bidders and sometimes staff and customers who heard the business was being sold. In a public takeover the stakes are wider: shareholders accept an offer, and the market prices the target on the assumption that the cash will arrive. A buyer whose loan can be withdrawn on a general deterioration cannot give that assurance.

The takeover rules in all three markets address this, in different ways. In the UK, the Takeover Code requires a cash offer document to include confirmation by an appropriate third party, such as the offeror's bank or financial adviser, that resources are available to satisfy full acceptance, and that party may have to produce the cash if it did not take reasonable steps to assure itself. In Australia, a person must not publicly propose a bid while reckless about whether it could pay if a substantial proportion accepts, and the bidder's statement must disclose its funding and any terms that could restrict it. In New Zealand, an offer under the Takeovers Code must confirm that resources will be available, and the Takeovers Panel expects firm financing to be in place when the offer is made, with very limited grounds on which it could be withdrawn.

Three things make funds certain. First, the conditions precedent are settled before signing: the finance documents are signed or agreed in final form, and what remains is within the buyer's control, such as the equity being paid in and the acquisition itself completing. Second, during the certain funds period the lender's drawstops are cut down to a short list of serious events about the buyer's group itself: failure to pay, insolvency, breach of a small set of core undertakings and representations, and illegality. The target's condition, which the buyer does not yet control, is not on the list. Third, unless one of those listed events has occurred, the lenders agree not to cancel, accelerate or exercise set-off during the period, whatever else they discover.

The period ends on the earlier of completion and a long-stop date, which follows the timetable of the deal: a private sale awaiting regulatory clearance, or a takeover offer running to its closing date and, commonly, the compulsory acquisition of the shares not accepted. In UK public bids, lenders often sign a short interim facilities agreement at announcement and negotiate the full facility afterwards. After completion the ordinary terms apply, softened for the acquired companies by the clean-up period.

A farm-machinery dealer group, constructed for this page like every figure in it, agrees to buy a rival dealership in another region in a private sale; the buyer has no other borrowing. Completion waits on competition clearance, with a long-stop four months away. The seller would sign only against certain funds.

Two months in, a poor harvest in the target's region cuts farmers' spending and the target's forecast EBITDA falls from US$8.0m to US$6.5m. Under an ordinary committed facility the bank might have argued that a material adverse change had occurred and declined to fund. Under certain funds it cannot. The buyer pays in its US$20m of equity, clearance arrives, and the bank advances US$30m into a deal that is a fifth of a turn more geared than the one it approved.

What would have stopped it is narrow: the buyer failing to pay the bank, entering insolvency, misstating its own legal status or authority, granting security to another lender in breach of a core undertaking, or the loan becoming unlawful. The equity condition was the buyer's to meet. Every other risk passed to the bank on the day it signed.

A committed facility outside acquisition finance is already a promise to lend, but a conditional one. Before each drawing, the lender usually requires that no default is continuing and that the repeating representations are still true. A covenant breach, an unpaid creditor elsewhere in the group or a material adverse change representation that has stopped being true can each stop a drawing. Certain funds removes those triggers for the period, and keeps only the ones that would make lending wrong rather than merely riskier.

It also differs from a commitment letter or term sheet, which usually remains subject to documentation and to the lender's further approval. Those are signs of intent. Certain funds is a contract that has already accepted the risk.

DEFINED IN ONE PARAGRAPH → · CORPORATE LENDING AND CREDIT RISK → · THE EQUITY CONTRIBUTION →

Because the bank cannot walk away after signing, the credit decision has to be complete before it. So the lender tests the loan against a downside case for the target rather than the seller's forecast, because, as the example shows, a weaker target is the bank's to fund; it finishes its diligence on the target; and it seeks a long-stop no later than the deal needs. It is paid for holding the commitment, often through a commitment fee running until completion or the long-stop.

For the buyer, certain funds is a negotiating asset. A bid backed by certain funds can beat a higher price that depends on finance still being arranged, and in a UK public takeover the cash confirmation makes it close to a precondition of a cash offer. The cost is that the buyer must have its documents, its equity and its lender's approval in place before it bids.