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Unitranche Debt

Guide to Understanding Unitranche Debt

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Unitranche Debt

In This Article
  • How does the unitranche debt arrangement process work?
  • What are the benefits to unitranche debt over traditional senior/subordinated debt financing?
  • What is the difference between “straight” unitranche and “bifurcated” unitranche debt?
  • How are “first-out” and “last-out” tranches different?

Unitranche Debt Financing Structure

Companies are increasingly opting for unitranche financing in lieu of traditional credit facilities as it presents a “one-stop-shop” to obtain necessary funds.

Unitranche debt is a distinct financing arrangement in which senior and junior tiers of debt tranches are blended into a single offering.

Governed by a single credit agreement, unitranche loans combine senior debt and subordinated debt into one credit facility.

Therefore, the separate first and second lien facilities function as a single secured loan facility.

So from the perspective of the borrower, unitranche debt is essentially an agreement with just one lender, with a single set of contractual terms.

Unitranche vs Traditional Term Loans

Traditionally, capital raising via traditional debt issuances entailed a time-consuming process:

  • Step 1: The borrower (or sponsor) negotiates with bank lenders – who tend to be more risk-averse – to raise the maximum amount of cheap senior debt.
  • Step 2: The subsequent step is to raise the remaining capital from other, often more expensive sources, e.g. corporate bonds, mezzanine financing.
  • Step 3: Depending on the circumstances, i.e. the terms set by the senior secured lenders with liens on collateral and covenants, raising the necessary funding can be a burdensome, drawn-out process, especially if attempting to manage disparate lenders.

Benefits of Unitranche Debt

So how does unitranche debt fix these issues?

Unitranche debt provides multiple benefits, not just to the borrower but the lenders, as well, namely:

The simplified negotiations and reduction in paperwork are among some of the prime appeals to unitranche financing.

While there is yet to be standardization in the structure of unitranche lending agreements, the following tend to be true generally:

  • Interest Rate (%): The interest rate on unitranche term loans is higher than traditional term loans, yet the ease of access to capital, flexibility in structuring the debt, and short time frames to close counteract the higher pricing.
  • Principal Amortization: Mandatory amortization is relatively very rare on unitranche debt.
  • Prepayment Premium: The prepayment penalty is either zero (or minimal), giving the borrower more flexibility for refinancing debt or taking out certain debt tranches.

Interest Rate Pricing on Unitranche Debt

The pricing on unitranche debt – i.e. the interest rate – sits right between the highest and lowest rates on the separate tranches.

The interest rate represents a “blended” rate that should reflect the spread of risk between senior and subordinated debt.

There are exceptions to the rule regarding interest rates, but as a generalization:

  • Unitranche Debt Interest Rate (>) or (=) Traditional Senior Debt Interest Rate
  • Unitranche Debt Interest Rate (<) 2nd lien or Subordinated Debt Interest Rate
Market Price Volatility

Since unitranche debt is typically held onto by lenders until maturity, price volatility in the secondary markets is much less of a concern.

Straight vs Bifurcated Unitranche Debt

Generally speaking, there are two types of unitranche loans:

  1. Stretch Unitranche
  2. Bifurcated Unitranche

In the former, stretch unitranche combines senior and subordinated debt into one financing package, typically for funding LBOs in the middle-market (i.e. it has a “stretch” leverage multiple to accommodate the buyout).

For example, 5.0x EBITDA of financing under the traditional senior/junior debt structure could instead be 6.0x EBITDA of financing under unitranche financing.

As for the latter, a bifurcated unitranche slices the loan into two distinct tranches:

  1. “First-Out” Tranche
  2. “Last-Out” Tranche

The first-out portion gets priority of payment if certain triggering events occur.

Agreement Among Lenders (AAL)

The agreement among lenders (AAL) underlies the financing terms of the unitranche debt and is an integral component to bifurcated unitranche debt.

Since the loan is split into first-out and last-out tranches, the AAL establishes the waterfall payment schedule and allocation of fees/interest to lenders.

Since payments are “blended,” the apportion and distribution of the funds must be done per the AAL, which is the unified document meant to maintain order among creditors, similar to an inter-creditor agreement.

Side Note: The details contained within the AAL are kept confidential from the borrower.

Unitranche Debt Financing Risks

Even before the COVID pandemic, concerns were mounting regarding unitranche financing and the direct lending market as a whole.

One drawback to unitranche debt, in particular, remains unsettled – which is how the Bankruptcy Court treats the agreement among lenders (AAL).

The unitranche arrangements have yet to truly be tested by a major contraction in the economy or recession – which could inevitability cause a rise in bankruptcies and financial restructuring, where the novelty of AALs could potentially cause complications.

The AAL functions like an inter-creditor agreement by governing the priority ranking, voting rights, and different economics among creditors.

Still, the enforceability of the agreement in Court remains questionable because the bifurcated unitranche debt still practically appears as a single tranche of lenders.

Unitranche Debt Trends + Market Outlook

The unitranche debt market was already in the midst of gradually picking up steam at the time, but the Financial Crisis in 2007/2008 was a major catalyst.

Since then, the growth in unitranche financing volume was due in part to the emergence of specialty lenders, such as:

  • Direct Lenders
  • Business Development Companies (BDCs)
  • Private Credit Funds

Historically, unitranche loans were a funding source utilized in middle-market transactions. In particular, middle-market private equity firms were the most active in their reliance on unitranche financing to fund leveraged buyouts (LBOs).

  • Average Deal Size ~ $100 million
  • EBITDA < $50 million
  • Revenue < $500 million

But even larger-sized deals now appear to have caught on to the trend. In 2021, the buyout of Stamps.com by Thoma Bravo for $6.6 billion was financed with $2.6 billion of unitranche debt provided by Blackstone, Ares Management, and PSP Investments.

Thoma Bravo Stamps Unitranche

Largest Unitranche Debt Financing – Thoma Bravo Acquisition of Stamps.com (Source: Paul Hastings)

Nowadays, unitranche debt seems to be headed in a direction beyond just combining first-lien/second-lien structures.

For instance, a senior/mezzanine financing blend with an “equity kicker” attached, “split collateral” unitranche debt, and other unique hybrid offerings appear to be on the horizon – resulting in a promising outlook for the market in the coming years.

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