Stacking facilities, ranking and the intercreditor problem

Almost no acquisition is one facility

A typical purchase in these sectors is funded by several things at once: a main loan against the trading cash, the buyer's own money underneath it, some of the price left in by the seller, and usually one or two facilities doing specific jobs on the side. Equipment funded separately. A line covering the gap between paying staff and being paid. Sometimes property funded on its own.

Each of those is straightforward on its own. Put together, they interact, and the interaction is what decides whether the deal completes on time. Two facilities that are individually attractive can be flatly incompatible, because both need the same security, or because one forbids the other.

That is worth understanding before anyone starts applying, because the order in which facilities are agreed changes what is available. A buyer who signs the first facility offered has frequently just excluded the second one they needed.

The layers, and what each one is doing

Read from the bottom up, because that is the order the risk is taken in.

The buyer's contribution is the bottom layer. It ranks behind everything and absorbs the first losses, which is the whole reason lenders want it. Where it comes from and what counts is in equity contribution.
Seller money usually sits just above it, ranked behind the bank by deed. Whether a lender counts it as stake or as debt is a drafting question, covered in vendor finance.
Subordinated commercial debt, where it is used at all, sits above the seller and below the bank, at a considerably higher price. Whether it belongs in a deal this size is argued out in mezzanine in an SME context.
Senior term debt is the top of the debt stack and the largest single piece. It is first in the queue, which is what makes it the cheapest money in the structure and the most conditional. The detail is in senior term debt.

Alongside that vertical stack sit facilities that are not really layers at all. Asset finance against specific equipment, invoice finance against the debtor book, and working capital lines all attach to particular assets rather than sitting in the general queue. They are the pieces most often forgotten at the planning stage and most often needed by month three.

Ranking and security are two different things

This is the distinction that causes the most confusion, and getting it straight makes the rest of the subject easy.

Ranking is the order in which creditors are paid, and it is set by contract between the lenders. Security is what a particular lender can take hold of, and it is set by the charges registered over the assets. A lender can rank first and still have poor security. A lender can hold a charge over a valuable asset and still be behind somebody else in the queue.

In an SME acquisition the security package usually starts with a debenture in favour of the senior lender. That gives fixed charges over identifiable assets, property, book debts, plant and intellectual property, and a floating charge over everything else the business owns from time to time. It is comprehensive by design, and that is exactly what creates the conflicts described below.

Two clauses inside a senior facility matter more than their length suggests. The negative pledge prevents the borrower granting security to anyone else without consent. The restriction on additional borrowing prevents it taking on other debt at all. Between them they mean that every other facility in the stack exists at the senior lender's discretion, whether or not anyone told the buyer that.

Where the conflicts actually appear

The debtor book. This is the most common collision by a distance. An invoice finance or asset-based facility needs a first-ranking charge over the book debts, because the debts are the entire security. The senior lender's debenture has already taken a fixed charge over exactly the same debts. Both facilities are perfectly sensible; they cannot both have first claim on the same asset. The resolution is a waiver or a deed of priority carving the debtor book out of the senior charge, and it has to be agreed rather than assumed. A buyer who has already signed the senior facility has much less room to ask.

Equipment already charged. Asset finance against plant that is caught by an existing fixed charge needs the same treatment. Where the equipment is being bought new, it is cleaner, because the funder takes title from the outset.

Property inside a business purchase. Where the deal includes a freehold, a commercial mortgage against the property and a term loan against the trading business are usually two lenders with two charges over two different things, and they still have to agree what happens on a default. Where it is the same lender, it is simpler and the pricing is often worse.

Seller security. A seller who has been promised a charge over the company, by someone who never asked the bank, is the late-stage argument that stalls more SME acquisitions than any other single item.

The documents that hold it together

Where two or more funders share a deal, their relationship is written down, and there are three documents in common use.

A deed of priority is the simplest: it says which charge ranks ahead of which, and often that is all it says. A subordination deed ranks a specific creditor behind the senior lender and sets out when they may be paid. An intercreditor deed is the full version, used where a commercial subordinated lender is involved, and it covers payment blocks, standstill periods, enforcement rights, what each lender may do on a default and what happens to the proceeds.

Buyers read the facility letters closely and skim these. It is the wrong way round. The facility letter tells you what you owe. The intercreditor tells you what happens in the one scenario everybody is trying to avoid. Terms that appear in these documents and nowhere else are in the glossary.

Covenants across a stack, and why headroom disappears

Each facility brings its own covenants, and they are tested against the same business.

A debt service cover test in the senior facility will usually be defined to include everything the business has to pay, not just the senior loan. So adding a subordinated facility or a set of deferred instalments does not create a separate test; it consumes the headroom in the existing one. Two facilities that each looked comfortably serviceable in isolation can breach a covenant together in the first slow quarter.

Information covenants multiply as well. Three funders means three reporting timetables, often on different bases and different dates. Missing an information covenant is the cheapest possible way to lose a lender's confidence, and in a stack it is three times as easy to do.

Worked exampleTake a business whose rebuilt earnings comfortably cover a term loan on its own. Add an equipment facility, a deferred instalment to the seller falling in one month, and an invoice finance charge, and the same annual cash flow has four calls on it rather than one. On an annual view it still works. In the month all four coincide it does not, unless somebody has modelled the months rather than the year. These figures are invented to show the shape of the problem.

The order to settle things in

Sequence is most of the skill here, and it is not obvious.

Work out what the deal actually has to cover before approaching anyone. Purchase price, deferred payments, working capital from day one, professional fees, arrangement fees and the equipment that will need replacing in year one. Fees and working capital are the two routinely left out, and they are the two that cause the shortfall on completion day.
Settle the senior facility's shape first, including its position on additional borrowing and on carving out the debtor book. That facility is the largest and the most restrictive, so everything else has to fit around it.
Agree the seller's ranking next, and write it into the heads of terms rather than discovering it in the final fortnight. What belongs in that document is covered in heads of terms.
Then the asset-backed pieces, with the consents already understood.
Give the intercreditor documentation its own slot in the timetable. It is a multi-party negotiation and it does not compress.

What goes wrong

Nobody asked the senior lender first. A second facility agreed in good faith and then refused consent is wasted time, wasted fees and a hole in the funding a fortnight before completion.

The stack was built to reach a number rather than to work. Adding layers until the total equals the price is arithmetic. Whether the business can service the result is a different question and the only one that matters.

Legal cost was underestimated. Every additional funder adds its own legal fees, paid by the borrower, plus the cost of the intercreditor. A stack of four facilities on a modest deal can cost more in professional fees than the cheapest layer saves in interest.

The timetable ignored the multi-party documents. Two lenders and a seller agreeing a priority deed is not a task that happens in the last week, however willing everyone is.

The buyer never saw the whole picture. Facilities arranged separately by separate people, with nobody holding the complete structure, is how a deal ends up with two lenders expecting the same first charge.

Where stacks get complicated by sector

Stacking is at its most involved where a business holds real assets and real debtors at the same time. In electrical and M&E, where contracting businesses carry vehicles, plant, retentions and a substantial debtor book, most acquisitions involve at least three funders and the debtor book conflict comes up almost every time. The same is true across much of facilities management, where contract retentions and a heavy payroll cycle put pressure on working capital from the first week.

Where the value is in recurring fees and there is very little to charge, as in accountancy practices, the stack is usually simpler and the ranking conversation is mostly about the seller.

Getting a whole structure looked at as one thing

The difficulty with a stack is that each funder assesses its own piece, and nobody is responsible for whether the pieces fit. That gap is where deals get into trouble, and it is not filled by any of the individual lenders.

What we have is knowledge of this market and of specific people who fund each layer of it, which means we can tell you what the whole structure is likely to look like, and where the consents will be needed, before you commit to any single part of it.

Tell us what the deal has to cover and how the business trades. We go to the lenders and brokers who fund structures of that shape, and we come back to you with who can fund it and what they will want to see.

We introduce buyers who are acquiring through a limited company or a NewCo. If you are buying personally, as a sole trader or as a partnership, we will point you to an authorised firm directly instead.