Unitranche Debt: A Closer Look

Designed to be a one stop or single tranche solution, a unitrache facility combines a small line of credit with a larger term loan, extended through an acceptable total leverage threshold.

Unitranche debt is secured by a senior secured first lien on all assets of a borrower. While governed by a single credit agreement, when the line of credit and term loan lenders are different, their mutual economic and administrative arrangements are governed through an Agreement Among Lenders, or AAL.

Quick Breakdown

Capital Type: Unitranche Facility or One Stop Loan
Typical Use: Finance growth, finance working capital needs, mergers and acquisitions and dividends
Funding Mechanism:  A line of credit portion of Unitranche can be funded and repaid at will, term loan portion of Unitranche is fully funded at close
Security:  Senior secured first priority lien
Collateral: Typically, all assets of the company and pledge of equity
Payment Priority: Usually the first to be repaid from the proceeds of liquidation of its collateral

Unique Features of Unitranche Debt

Unitranche typically has a small line of credit facility supplemented by a much larger and fully funded term loan. As both of these facilities are within a single loan, documented under a single document, and often provided by a single non-bank lender, it is called a Unitranche Term Loan. 

Lenders that do not provide the line of credit portion of a unitranche, often partner with banks that do. However, for the borrower, there will only be one unitranche credit agreement and one rate of interest. Under such arrangements, the line of credit lender will maintain first lien on all assets of the company with first payment priority, while the term loan portion of the unitranche will be last out, effectively making it a FILO. 

Line of credit and term loan lenders within a unitranche will document their agreement regarding economics and other issues through an Agreement Among Lenders (the “AAL”), which a borrower won’t be a party to. 

Who Should Consider a Unitranche Facility?

Businesses with the following characteristics should consider unitranche financing: 

• Stable, largely predictive cash flows and a demonstrable track record of consistent financial performance, along with ownership by a party (such as a PE firm, family office or independent sponsor) that can provide ongoing capital support during downturns
• Total indebtedness should not exceed 65%-70% of EV, while maintaining total debt to EBITDA under 6.0x in most cases

Advantages of Unitranche Loans:

Borrowers of unitranche debt enjoy the following benefits: 

• Simpler Legal Documentation: Single credit agreement with one lender or one lender group–no intercreditor documents, and no need for multiple credit agreements
• Full Utilization of Debt Capacity: Most non-bank institutions can lend up to the full value of collateral, or the maximum possible loan-to-enterprise value of the company, resulting in the maximum possible capitalization within a single tranche of debt
• Low Maintenance: Reporting obligations are limited to financials and covenant compliance certificates. Typically, no amortization is required, making cash flow available for other corporate needs
• Cost Efficient: Under most circumstances, cheaper than obtaining the same amount of debt capital through a combination of first lien bank loans and a Second Lien Term Loan, or a Mezzanine Term Loan

Drawbacks of Unitranche Loans:         

There are prominent considerations that borrowers of unitranche debt should take into account: 

• Cost: Unitranche is relatively more expensive than the first lien debt provided by banks
• Lack of Flexibility: Lenders typically require call premiums or prepayment penalties for allowing borrowers to repay the loan prior to scheduled maturity

Underwriting Process for Unitranche Debt

Below are the underwriting process and maintenance requirements for unitranche loans:

Capital Providers: Typically, non-bank credit funds, SBICs and Business Development Companies (BDCs)

Underwriting Thesis:  

1. Recovery through ongoing cash flow generation of Capital Seeker or through refinancing. In distressed situation, recovery through sale of Capital seeker as an ongoing business
2. For asset-backed structures, recovery through liquidation of collateral in a distressed situation
3. For recurring revenues based structure, recovery through collection of ongoing contractual payments

Underwriting Focus:  

1. Confirmation of business’ ability to generate cash flow and repay debt, ability of owner or sponsor to inject additional equity and liquidity.
2. For asset-backed structures, liquidity and value of the collateral
3. For businesses with recurring revenues, e.g. software companies, validation of company’s ability to generate recurring revenues and maintain healthy contract renewal rates

Underwriting Process:

1. Typical credit underwriting process focuses on the ability of the business to generate consistent cash flows and risks that may disrupt consistent cash flow generation. Underwriting involves analysis of the business model, competitive dynamics, customer base and commercial terms, ownership history, historical financial performance as well as financial projections, operations and background of key stakeholders, including key executives
2. Quality of earnings report produced by an accounting firm to validate the EBITDA of the business as well as any adjustments and an industry study to validate the company’s competitive position, size of the market, customer feedback, etc.
3. For asset backed loans where Unitranche is dependent on the value of fixed assets or intellectual property, such assets will be appraised by a certified appraiser to establish NOLV 
   

Amortization: Typically, none

Financial Covenants:   

1. Most commonly, leverage ratios (senior debt to EBITDA and total debt to EBITDA) and fixed charge coverage ratio.
2. Covenants related to appraised value of the collateral for asset backed structures
3. Total debt to recurring revenues ratio for structures focused on recurring revenues  

Ongoing Reporting:    

1. Company prepared unaudited monthly financials, audited annual financials, annual financial projections
2. Periodic appraisals of collateral for asset backed structures   

Learn More

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