“It’s the ultimate MBO capital structure,” says Stephen Greenwood of Deferred Finance Ltd, as he describes how his finance product is being used to keep mid-market deals moving
In times of tightened credit markets, with banks and other funders treading cautiously with lending, Stephen Greenwood may have the answer for ambitious management teams eager to buy the businesses for which they work.
As chairman of Deferred Finance Ltd, the only specialist underwriting consultancy for deferred consideration insurance, he has spent the last eight years researching and developing this funding source with strategic partner and shareholder Mitsui Sumitomo Insurance Group (MSIG).
In deals using a combination of asset-based finance and deferred finance, the deferred consideration insurance has been “designed”
by Greenwood to replace costly mezzanine and equity finance.
This useful option fills the gap between the vendor’s business price tag and the amount the acquirer is able to leverage.
Greenwood likens himself to a pioneer.
His concept guarantees that the vendor will be paid over a set period of time in the future should the acquirer fail to pay, as the seller is protected through a financial instrument which secures the vendor loan note that is underwritten and secured by a Standard & Poor’s double AA rated banking and insurance group.
“In the current economic climate, corporate financiers are facing tough times trying to source mezzanine in private equity markets, and this is where we can come into the equation.
“The idea of deferred consideration insurance was borne out of a need to assist corporate finance advisers and asset-based lenders to complete mergers and acquisitions in the most cost-effective way,” he explains.
“So far, we have written six mid-market deals, ranging between £20 million and £45 million.”
Like a scientist with a winning formula, Greenwood, who has been in insurance “design” for 20 years, is eager to explain the central premise of deferred consideration insurance.
“Take a buy-out worth £45 million: £30 million is paid in cash and £15 million through deferred finance. Let’s say the purchaser has to pay £5 million a year for three years. If the business fails to make any profit in the first year, we would have to step in and pay the vendor.
“When the purchaser has failed to make profit and hasn’t been able to pay the vendor, we have paid claims. The corporate finance advisers, who introduce transactions to us, can see that by paying claims the instrument actually works.”
Asset-based lending (ABL) is key to this funding option as deferred consideration insurance takes a second charge behind the asset-based lender. The “upside” is that the management team can take ownership of the business with a combination of debt and deferred finance, and in this way hold on to 100 per cent of the business, avoiding equity dilution.
“The MSIG underwriters Kevin Borrett, Ed le Feuvre and Fiona Willis dive in deep in the deal.
“The underwriting is quite vigorous and we only underwrite transactions that have good enough future flows that can service the asset finance and the deferred finance,” he explains.
The strategy has led to Greenwood typically insuring between £5 million and £25 million of deferred payments in mid-market transactions valued between £10 million and £150 million.
Greenwood says, “It’s great fun sitting on the fence between bank finance and insurance. It’s our job to bring the two together and use collateralised and securitised instruments to enable transactions.”
The team has worked with Warrington-based corporate finance adviser Dow Schofield Watts on two recent buy-outs where the additional funding was used by management teams in tandem with ABL as a substitute to equity finance.
James Dow, partner, says: “We have used deferred consideration insurance in mid-market deals where we have been able to put in place a large ABL facility. ABL doesn’t have a repayment profile, so is revolving in nature, which means it works really well with deferred finance, which ideally has a repayment profile of about five years.
“Deferred consideration insurance is unique to an ABL funding line because the nature of these asset-based facilities allows for something else to be repaid ahead of it.”
Banks and private equity lenders becoming more restrictive in their lending policies has widened the window available to asset-based lenders and the likes of Greenwood.
Statistics from the Asset Based Finance Association (ABFA) confirm that the industry is funding more deals and has advanced a record-breaking £16.2 billion from January to March this year, and this has opened up opportunities for Deferred Finance.
According to Greenwood, ABL is dominating the buy-outs market with cash lenders withdrawing their facilities. “In talks with the top two ABL providers in the country, we believe that ABL is currently making up around 55 per cent of the buy-out market.”
“In any ongoing merger and acquisition transaction, especially in MBOs, MBIs and BIMBOs, we simply remove the need for expensive mezzanine and private equity and replace it with secured deferred finance.”
Deferred Finance recently worked on an MBO of a public-listed transportation business for £9 million. A £5 million asset-based lending facility was used alongside £4 million of deferred finance insured through his finance product.
“The other option for the purchaser was to bring in the £4 million from a private equity house. The management was talking to a private equity group, but the terms of the agreement required 75 per cent equity.
“By converting the £4 million to deferred finance, the cash-rich Plc was able to accept the deferred finance option as it was securitised by MSIG, a double AA rated insurance company. “The £4 million was put on the balance sheet as a guaranteed long-term receivable asset – a positive balance sheet implication for the Plc and its shareholders,” observes Greenwood.