Pre-IPO Provisions and SPACs

Lenders may have noticed that sponsors are showing renewed interest in including pre-IPO provisions in loan agreements. These provisions are used in loan agreements for private companies so that if the borrower is subject to a listing or IPO certain changes occur automatically to make the loan appropriate for a listed borrower. Typically those changes will only occur if certain conditions are met, making the transaction a Qualifying IPO. However, these changes can be very significant to a lender, so it is worth understanding them thoroughly.

Pre-IPO provisions have been more common in recapitalisation transactions, particularly during periods when the IPO market has been strong and a sponsor intended to list or wants to retain the ability to list shortly after the refinancing. Sponsors would typically forego re-leveraging to the maximum extent which would have been possible in order to gain flexibility to IPO. Pre-IPO clauses have been less common in new acquisition financings, where maximising leverage was the priority.

Underlying the renewed interest in pre-IPO provision, most likely, is the emergence of special purpose acquisition companies (SPAC) as a force in the M&A market. During 2020 almost 250 SPACs were launched (a four fold increase on 2019) and already more than 130 have launched in 2021. A SPAC’s sole purpose is to find a target entity which is private and acquire that entity through a transaction where the resulting entity is listed. This means we are likely to see a wave of SPAC combination transactions in 2021 and beyond.

Anecdotally, intense competition for targets in the USA combined with currency movements, mean that SPAC sponsors are increasingly looking to Europe for potential targets.

Depending on the exact language in any given loan agreement, there is no reason why a SPAC combination could not, in principle, count as a Qualifying Listing under a Pre-IPO clause, subject to meeting any specified criteria to be a Qualifying IPO.  However, the structure of the transaction will need to be reviewed carefully against the actual drafting, since not all structures will actually be an “admission of shares of a member of the Group to Listing”.

How does a Pre-IPO provision work?

The provisions in a typical leverage financing which do not work for a listed borrower are, typically, the restriction on paying dividends and the change of control provision requiring the sponsor to retain control. When it lists, the company will also typically want to reduce its leverage out of some of the proceeds of the listing in order to meet expectations.

The typical pre-IPO clause therefore requires a repayment of the facility either down to a particular level or for a proportion of the proceeds down to a particular leverage level. There will often also be a requirement for the company to receive an appropriate rating following the IPO. Provided that these conditions are met, then:

• the change of control provision is amended to a more typical listed company alternative, where the original sponsor does not need to retain control;
• certain financial covenants (which will probably be obsolete after the de-leveraging) are replaced or removed, typically leaving leverage and interest cover tests at fixed levels;
• since the company will be public, the requirement to deliver financial forecasts (and some financial information) are typically modified;
• certain of the undertakings (especially the dividend provisions, indebtedness restrictions) are modified to remove any restrictions or allow more freedom; and
• the interest rate is set at an appropriate level or to include a modified ratchet, although this will obviously be controversial for lender who want to receive a more leveraged return.

Issues for leveraged lenders

We have seen continual erosion of the principle that a change of control or listing should require a prepayment, but this is a further attack on this principle which some lenders will be unwilling to accept.

For more pragmatic lenders, this provision may see them locked into a loan with a reduced risk profile but also significantly lower return and no guarantee that they can trade out of the loan. For debt funds this will be deeply unattractive.

With some of these provisions you find that the benefits of the Qualifying Listing are available even where a material reduction in the leverage level has not been achieved. Lenders should be satisfied that provisions only drop away if suitable levels are reached.

Lenders should also be careful to ensure that the combination of the provisions which are released does not allow the company to IPO and then recapitalise using borrowings as dividends. If both the financial indebtedness and dividend restrictions are completely removed there will be very little protection from this occurring.