Corporate and acquisition finance innovations: US, UK and Spain

September 2024 | SPOTLIGHT | BANKING & FINANCE

Financier Worldwide Magazine

September 2024 Issue

The financial world has long looked to the US and the UK as pioneers in developing sophisticated instruments for corporate and acquisition financing. These developments have significantly influenced global markets, including Spain. Understanding the trajectory of these financial innovations from their inception in the US and UK to their integration and adaptation in Spain provides valuable insights into the future of corporate and acquisition finance.

Junk bonds and the rise of leveraged buyouts

In the 1980s, Michael Milken at Drexel Burnham Lambert revolutionised corporate finance with high-yield bonds, commonly known as junk bonds. These bonds enabled companies deemed too risky by traditional banks to secure funding, providing critical capital for substantial acquisitions. A landmark example is the financing of KKR’s leveraged buyout of RJR Nabisco in 1988, which used substantial junk bond financing. This deal catalysed the growth of the high-yield bond market.

As this innovation crossed the Atlantic, European markets, including Spain, began to embrace the concept. The Spanish high-yield market began to take shape in the early 2000s, with companies like Cirsa and Codere issuing high-yield bonds to finance their expansions. These early adopters paved the way for other prominent Spanish companies like Abengoa, OHL and Ono. Although the high-yield bond market in Spain has grown significantly since then, it still presents promising opportunities for further expansion.

Private equity and mezzanine financing

Mezzanine financing gained popularity in the US during the 1980s as private equity (PE) firms and corporate financiers sought innovative ways to support leveraged buyouts (LBOs) and expansion projects. This hybrid of debt and equity, including subordinated debt, convertible debt or preference shares, bridged the gap between senior debt and equity, allowing companies to secure additional funding without significantly diluting existing shareholders. The UK quickly adopted mezzanine financing, integrating it into its corporate finance landscape. Firms like 3i and Intermediate Capital Group played significant roles, facilitating numerous mid-market and large-scale transactions.

The adoption of mezzanine financing in continental Europe began in the early 1990s, spurred by successful implementation in the UK. Countries like France and Germany saw early adoption, with financial institutions and PE firms incorporating mezzanine layers into their financing structures. Despite less favourable legal frameworks, the influence of US and UK PE firms led to notable transactions in Spain in the late 1990s and early 2000s. The use of mezzanine financing provided Spanish companies and sponsors with tailored solutions for complex financing needs.

Although Spain remains a borrower-friendly jurisdiction, the market has evolved to incorporate more sophisticated structures, for example the use of double LuxCo structures became common, which helps to mitigate enforcement risks and enhances the efficiency and security of mezzanine financing arrangements.

The era of borrower-friendly financing solutions and the rise of direct lenders

More recently, innovative financing structures have emerged, significantly impacting markets worldwide, including Spain. The rise of debt funds and other alternative debt providers after the financial crisis developed into the hot market of direct lending today. Debt is provided by non-bank creditors, without intermediaries, through instruments like unitranche financing, term loan B (TLB) or covenant-lite loans.

Although these instruments first emerged in the early 2000s, they gained popularity in the wake of the global credit crisis, initially targeting the middle-market segment. Liquidity became the driving force, leading to more flexible investment criteria for capital. Non-bank lenders, particularly debt funds, rapidly expanded their presence. Borrowers and PE firms capitalised on their strengthened positions, negotiating more favourable loan terms.

Unitranche financing, first introduced in the US in the early 2000s, combines senior and subordinated debt into a single instrument, offering a streamlined, flexible alternative to traditional multilayered financing structures. It has gained traction in Spain in the last 10 years, initially through US and UK sponsors in their LBO transactions, now popularised by local alternative debt providers.

The US also introduced TLB structures, characterised by longer terms and minimal amortisation payments until maturity, offering more flexible repayment terms and either loose maintenance covenants (cov-loose) or none (cov-lite). Primarily targeted at well-performing companies of substantial size, this has limited the number of Spanish companies accessing this product. These financings are usually available to companies backed by large sponsors.

Emerging trends and future outlook

The integration of environmental, social and governance (ESG) criteria into financial instruments is gaining momentum. Sustainability-linked loans (SLLs) are rapidly becoming a cornerstone of sustainable finance, influencing the Spanish market significantly. These loans adjust interest rates based on a borrower’s ability to meet predetermined sustainability performance targets (SPTs), aligning financial incentives with environmental and social goals. Companies that meet their SPTs benefit from reduced interest rates, promoting sustainability and enhancing transparency and accountability.

In Spain, the adoption of SLLs is expected to grow as regulatory pressures and investor demand for sustainable finance increase. The integration of robust key performance indicators and third-party verification processes will be critical in ensuring the credibility and effectiveness of these instruments. As Spanish companies align with global ESG standards, SLLs will likely become a preferred financing option.

Although some indicators have shown signs of weakness, these may be temporary. Between 2018 and 2024, the market for sustainability-linked bonds and other sustainable debt instruments experienced notable evolution. Initially, there was rapid growth following the Paris Agreement of 2015, peaking in 2021. However, since 2022, issuance volumes have stabilised, with a slight decline expected in 2024. This deceleration may be due to regulatory, economic and credibility challenges. Companies have faced increased scrutiny and a higher standard of transparency, leading to more cautious bond issuance.

Nonetheless, sustainable finance is expected to become increasingly sophisticated, incorporating more ambitious sustainability targets, advanced monitoring, and tighter integration with corporate strategies. This evolution will enable businesses to comply with regulations, contribute to global sustainability efforts, and attract socially responsible investors.

Niche financing solutions for specific industries

In the ever-evolving landscape of business financing, there are numerous solutions tailored for particular cases. Among these, some of the most frequent and impactful are asset-based financing (ABF) and revenue-based financing (RBF). These instruments are well-established in the US, where the market maturity, size and average company scale are significantly larger than in Spain, making such transactions more substantial and frequent.

ABF involves securing a loan against the company’s assets, which can include inventory, accounts receivable, equipment or sole assets, such as vessels and aircraft. This type of financing is beneficial for companies with substantial physical or financial assets but which may lack the cash flow for traditional loans. ABF provides an alternative for businesses to leverage their existing assets to obtain necessary capital, often with more favourable terms than unsecured loans.

RBS is a flexible financing method where investors provide capital to businesses in exchange for a percentage of future revenues. This model is particularly prevalent among technology and software as a service companies due to their predictable and recurring revenue streams. The key advantages of RBF include its repayment flexibility, which aligns payments with the company’s revenue performance, and its non-dilutive nature, allowing companies to retain full ownership.

In the US, ABF and RBF are well-established financing instruments used by companies across various industries, from manufacturing to retail, for a broad range of borrowers and multiple purposes. However, in Spain, ABF and RBF are still relatively rare in most industries. ABF financings have long been established for vessels, aircraft and other unique assets. Beyond these purposes, it is uncommon to see this type of financing, except for Spanish affiliates participating as borrowers in cross-border asset-based loans. RBF is mostly seen in Spain in seed to venture capital transactions for relatively low amounts.

The Spanish financial market is less developed in terms of alternative financing methods compared to the US. Businesses are more accustomed to seeking funds from conventional banking institutions rather than exploring alternative funding sources like RBF and ABF. This reliance on traditional banks, along with a less sophisticated financial ecosystem, contributes to the lower prevalence of these innovative financing solutions in Spain. Nonetheless, Spanish companies and sponsors are closing the gap, becoming more sophisticated, and taking advantage of the options provided by more mature markets. The demand is increasing steadily, and the offer is improving.

Conclusion

The evolution of corporate and acquisition finance is marked by significant innovations originating from the US and UK. These innovations have gradually been adopted and adapted in Spain, enhancing the sophistication of its financial markets. As new trends emerge, Spain is poised to integrate these advanced financial instruments, benefitting from the pioneering developments in more mature markets. By staying attuned to global trends and tailoring them to local needs, Spanish companies can leverage innovative financing strategies to drive growth and competitiveness in the evolving economic landscape. The future of corporate and acquisition finance in Spain looks promising, with continued influence from the world’s leading financial innovators.

In a recent conversation with an institutional investor, a partner at one of Spain’s leading PE funds remarked: “There are always trends in the market, but I believe that almost everything has been invented in terms of distributing risk and return, although the names may change and the appetite for each type of risk and return fluctuates.” It will ultimately be the conditions and needs of the market that dictate these trends. By understanding, anticipating and adapting to these market dynamics, Spanish companies can effectively utilise these innovative financial instruments to achieve sustained growth and competitiveness in the evolving business environment.

Joaquín Fabré is a partner at Cases & Lacambra. He can be contacted on +34 91 061 2450 or by email: joaquin.fabre@caseslacambra.com.

Joaquín Fabré

Cases & Lacambra