Credit financing: checklist on adjusted EBITDA
In its simplest form, earnings before interest, taxes, depreciation, and amortization (EBITDA) forms the basis of some type of leverage ratio financial commitment, and these commitment levels are derived from historical financial information. of the operating entity as well as projections provided by the private equity sponsor, borrower, financial advisor or similar representative. EBITDA also performs many other functions in these types of facilities, for example, in loan pricing and exceptions to debt-based covenants.
The negotiation by borrowers and lenders regarding the definition of EBITDA in cash flow based credit facilities is fundamental to the size of the applicable loan default risk. Sponsors and borrowers, certainly, and even lenders, in many cases, have an interest in mitigating the risk of default by creating a leverage calculation that is a market-accepted approximation of constant operating cash flows. of the borrower. In addition, especially for highly leveraged transactions, regulated lenders have an interest in creating a thoughtful definition of EBITDA which, as part of the underwriting and risk policies of these lenders, avoids unnecessarily painting an image. too much leverage of the lender’s loan portfolio and other consequences of flag lending regulations.
This article is a brief reminder (to be taken into account by all market participants when negotiating the definition of EBITDA in credit facilities) of the general types of EBITDA adjustments that are often included in credit facilities. credit based on middle market cash flows, especially those with the influence of limited partners of shares. The general objective of the EBITDA of the credit facility is to add back to profit or loss interest, taxes, depreciation and amortization, as well as to add certain other non-cash, extraordinary and transaction-related items deducted from profit or loss on the determination of the net result.
Negotiating EBITDA add-ons often includes discussions of the following types of add-ons:
- Losses on interest rate hedging contracts.
- Financing costs and other amounts arising from indebtedness.
- Restructuring charges and projected savings / synergies as part of a restructuring.
- Management and consultancy costs and indemnities and expenses under the management contracts of the sponsors.
- Other extraordinary, one-time or unusual losses or expenses (for example, resulting from transactions, integrations, transitions, opening of facilities, consolidation, relocation and expansion costs).
- Costs of employee benefit plans or management and board of directors’ stock option plans, to the extent that such plans are funded by contributed capital or equity proceeds.
- Receipts for previously excluded non-cash gains.
- Losses on sales of securitization assets.
- The excess of GAAP rent expense over cash rent expense.
- Fees, costs and expenses arising from a transaction authorized by the financing documentation.
- Business interruption insurance proceeds for the applicable period.
- Litigation costs.
- All other non-monetary charges.
- Add-backs included in the borrower’s projections.
Each of these types of add-ons (and many others not listed) have their own nuances and level of market acceptance to consider. EBITDA is only a definition in agreements that often exceed 150 pages of very complex terms and arrangements, and lenders and borrowers / sponsors rely on a strong representation of outside lawyers to navigate the documentation of credit.