Chapter 22 - Debt Types of Private Equity Flashcards

1
Q

How does the control of the underlying company in the case of an LBO typically compare to the control of the underlying company in the case of mezzanine financing?

A

Mezzanine financing typically does not necessarily involve control of the underlying company.

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2
Q

True or false: An exit strategy for mezzanine debt may occur when the underlying company obtains capital through a large equity issuance.

A

True

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3
Q

How liquid is mezzanine debt when compared to leveraged loans or high-yield bonds?

A

Liquidity of mezzanine debt is minimal

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4
Q

Who are typical investors in mezzanine funds?

A

Pension funds, endowments, and foundations

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5
Q

What is the typical size of mezzanine funds compared to LBO funds?

A

Mezzanine funds are typically considerably smaller than LBO funds

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6
Q

Describe common restrictions placed by a mezzanine lender on a borrower.

A

Lender may approve or disapprove the issuance of additional debt, may require that new debt be subordinated to the original mezzanine debt, and may enjoy final approval on dividend payments by the borrowing firm.

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7
Q

What characteristic of mezzanine investing allows an investor to purchase the senior debt once it has been repaid to a particular level?

A

Takeout provision

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8
Q

Company XYZ has a simple capital structure where assets are financed 70% by bank loans (cost of debt 10%)and 30% by equity (cost of equity 27%). Suppose now that half of the equity capital is replaced with mezzanine debt at a coupon rate of 16% and that, as a result of equity capital being now more risky, the cost of equity capital rises to 31% Calculate the WACC when there was no mezzanine debt and when mezzanine debt was contracted (assume corporate tax rate is 0).

A

WAAC (without Mezzanine debt) = (70% x 10%) + (30%x27%)=15.1% WACC (with Mezzanine debt) = (70%x10%)+(15%x16%)+)15%x31%)=14.05%

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9
Q

ABC’s assets are currently being financed 70% by bank loans at an IRR of 9% and 30% by equity. ABC’s beta is 1.5, the risk-free rate is 3% and the expected return on the market portfolio is 12%%. Calculate the WACC of ABC (the corporate tax rate is 0)

A

Calculating cost of equity using CAPM; Rf = B(E(Rm)-Rf) , 3% + 1.5(12%-3%) = 16.5%. WACC of ABC; (70%x9%) + (30% x 16.5%) =11.25%

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10
Q

In bankruptcy proceedings, what is the meaning of the term cramdown?

A

Cramdowns can occur when creditors and debtors cannot reach an agreement. According to the US bankruptcy code, a reorganization plan under Chapter 11 may be confirmed by the court over objections so long as the plan 1) does not unfairly discriminate against the members of any impaired class that may have voted against it. 2) Fair and equitable with respect to the members of that class.

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11
Q

Keyword ‘Absolute priority’

A

(Distressed debt) Concept of which claim ranking. Payments to employees, payments for taxes and accounts payable generally take priority over payments to security holders.

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12
Q

Keyword ‘Acceleration’

A

Requirement that debt be repaid sooner than originally scheduled, such as when the senior lender can declare the senior debt due and payable immediately. This typically forces a default and allows the senior lender to enforce the collateral security.

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13
Q

Keyword ‘Assignment’

A

(Mezzanine debt) Senior lenders typically restrict the rights of the mezzanine investor to assign, or sell, its interest to a third party. However, generally senior lenders allow an assignment, providing the assignee executes a new intercreditor agreement with the senior lender.

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14
Q

Keyword ‘Blanket subordination’

A

(Mezzanine debt) Prevents any payment of principal or interest to the mezzanine investor until after the senior debt has been fully repaid.

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15
Q

Keyword ‘Blocking position’

A

(Distressed debt) A single creditor can block a plan of reorganisation if it holds a third of the dollar amount of any class of claimants.

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16
Q

Keyword ‘Chapter 11 bankruptcy’

A

Attempts to maintain operations of a corporation that may be viable as a going concern. Affords a troubled company protection from its creditors while the company attempts to work through its operational and financial problems. Plan of reorganisation proposed.

17
Q

Keyword ‘Chapter 7 bankruptcy’

A

Company is no longer viewed as viable business, assets are liquidated (to claimants and creditors).

18
Q

Keyword ‘Classification of claims’

A

(Distressed debt) Under the bankruptcy code, a reorganisation plan may place a claim in a particular class only if such claim is substantially similar to the other claims in that class.

19
Q

Keyword ‘Cramdown’

A

(Distressed debt) Bankruptcy code provides that a reorganisation plan may be confirmed over the objection of any impaired class that votes against it so long as the plan 1) does not unfairly discriminate against the members of that class and 2) is fair and equitable with respect to the members of that class.

20
Q

Keyword ‘Debtor-in-possession financing’

A

(Distressed debt) Secured lenders may decide to extend credit to a debtor company.

21
Q

Keyword ‘Fulcrum securities’

A

(Distressed debt) More junior debt securities that are most likely to be converted into the equity of the reorganized company.

22
Q

Keyword ‘Intercreditor agreement’

A

(Mezzanine debt) Subordination of mezzanine debt is typically accomplished in an agreement with the company’s existing creditors called an intercreditor agreement. This agreement places restrictions on both the senior creditor and the mezzanine investor.

23
Q

Keyword ‘Loan-to-EBITDA multiple’

A

(Mezzanine debt) Bank loans and other senior loans generally require a loan-to-EBITDA multiple of no more than 2 to 2.5. Mezzanine has a multiple of 4 to 4.5.

24
Q

Keyword ‘Mezzanine funds’

A

(Mezzanine debt) Organized like HF, VC, LBO. Investors in mezzanine funds are generally pension funds, endowments, and foundations. These institutional investors do not have the internal infrastructure or expertise to invest directly in the mezzanine market.

25
Q

Keyword ‘PIK toggle’

A

(Mezzanine debt) Allows the underlying company to choose whether it will make required coupon payments in the form of cash or in kind, meaning more mezzanine bonds. Leveraged loans do not have such a provision.

26
Q

Keyword ‘Plan of reorganisation’

A

(Distressed debt) Business plan for emerging from bankruptcy protection as a viable concern, including operation changes. The plan includes how creditors and shareholders are to be treated under the new business plan.

27
Q

Keyword ‘Prepackaged bankruptcy filing’

A

(Distressed debt) Sometimes a debtor company agrees in advance with its creditors on a plan of organisation before it formally files for protection under Chapter 11. Creditors usually agree to make concessions upfront in return for equity in the reorganized company.

28
Q

Keyword ‘Springing subordination’

A

(Mezzanine debt) Allows the mezzanine investor to receive interest payments while the senior debt is still outstanding.

29
Q

Keyword ‘Stretch financing’

A

(Mezzanine debt) Banks and other providers of senior secured debt often participate in mezzanine financing. This financing takes the form of stretch financing, where a bank lends more money than it believes would be prudent with traditional lending standards and traditional lending terms. This excess of debt beyond the collateral value of a company’s business asset is the stretch part of financing.

30
Q

Keyword ‘Takeout provision’

A

(Mezzanine debt) Allows the mezzanine investor to purchase the senior debt once it has been repaid to a specified level (one of the most important provisions in an intercreditor agreement and goes to the heart of mezzanine financing).

31
Q

Keyword ‘Weighted average cost of capital (WACC)’

A

Sum of the products of the percentages of each type of capital used to finance a firm times its annual cost to the firm.