Unitranche Debt

Introduction

What is Unitranche Debt?

• A hybrid financing structure that combines senior and subordinated debt into a single loan facility
• Features blended pricing between senior and junior debt

Introduction

What is Unitranche Debt?

• Emerged prominently in the mid-2000s, gaining significant market share following the financial crisis
• Simplifies documentation, accelerates execution
• Provides borrowers with a single lender relationship
• Particularly popular in the middle market

Key Characteristics

Single Facility:

• Combines what would traditionally be separate senior secured and second lien or mezzanine tranches
• Into one integrated loan with unified documentation
• A single interest rate and coordinated terms

Key Characteristics

Blended Pricing:

• Interest rates reflect a weighted average of senior and subordinated debt pricing
• Typically ranging from 500 to 900 basis points over benchmark rates
• Depending on credit quality, leverage, and market conditions

Key Characteristics

Simplified Structure:

• Borrowers deal with one administrative agent and one set of loan documents
• Rather than coordinating multiple facilities with different lenders
• Different documentation and covenant packages

Key Characteristics

Split Lien or Pari Passu Security:

• Split lien: Senior and junior portions have different lien priorities on collateral
• Pari passu: All lenders share equal lien priority but different payment priorities

Key Characteristics

Direct Lending Dominance:

• Primarily provided by direct lending funds, BDCs, and credit funds
• Rather than traditional banks
• Reflects these lenders' ability to hold both senior and subordinated risk

Key Characteristics

Middle Market Focus:

• Most prevalent in middle-market transactions
• With enterprise values between $50 million and $1 billion
• Though some larger deals utilize unitranche structures

Structure and Components

Facility Size:

• Typically ranges from $25 million to $500 million
• Vast majority falling between $50 million and $250 million
• For core middle-market transactions

Structure and Components

First Out/Last Out Mechanics:

• In split lien structures, facility divides into "first out" (senior portion) and "last out" (junior portion)
• With different recovery priorities
• First out typically represents 50-70% of total facility

Structure and Components

Amortization Profile:

• Generally features modest amortization of 5-15% annually
• Higher than Term Loan B but lower than Term Loan A
• Balancing cash flow preservation with gradual deleveraging

Structure and Components

Maturity:

• Standard tenors range from five to seven years
• Providing medium-term financing
• Bridges working capital facilities and permanent capital

Structure and Components

Interest Rate:

• Floating rate structure based on SOFR plus a fixed spread
• Total pricing typically 200-400 basis points higher than senior-only financing
• But lower than weighted cost of separate senior and subordinated facilities

Structure and Components

Covenants:

• Usually includes maintenance covenants tested quarterly
• Though lighter than traditional bank facilities
• Common metrics: maximum total leverage (4.0x to 6.0x), minimum fixed charge coverage (1.1x to 1.3x)

Comparison with Traditional Structures

Unitranche vs. Senior/Subordinated Structure:

• Traditional structures require separate negotiations, documentation, intercreditor agreements
• And lender relationships for senior and junior tranches
• Unitranche simplifies this into one facility, reducing complexity and execution time

Comparison with Traditional Structures

Unitranche vs. Term Loan B:

• TLB requires additional facilities (revolver, possibly Term Loan A, mezzanine or equity)
• To complete the capital structure
• Unitranche can provide the entire debt component in one facility
• Though often paired with revolving credit

Comparison with Traditional Structures

Unitranche vs. Bank Financing:

• Traditional bank financing may offer lower pricing
• But requires higher equity contributions
• Includes more restrictive covenants
• Provides less structural flexibility than unitranche options

Comparison with Traditional Structures

Pricing Comparison:

• While unitranche carries higher all-in rates than senior-only debt
• The blended cost is typically lower than maintaining separate senior and mezzanine facilities
• With associated fees and documentation costs

Role in Capital Structure

Leveraged Buyouts:

• Private equity sponsors use unitranche to finance acquisitions
• Benefiting from streamlined execution, single lender relationship
• And higher leverage than traditional bank financing permits

Role in Capital Structure

Management Buyouts:

• Unitranche provides necessary leverage for management teams to acquire their companies
• Without the complexity of coordinating multiple debt providers

Role in Capital Structure

Recapitalizations:

• Companies seeking to refinance existing debt, fund distributions, or restructure capital
• Can execute more quickly through unitranche
• Than traditional multi-lender processes

Role in Capital Structure

Growth Capital:

• Businesses requiring significant capital for expansion, acquisitions, or strategic initiatives
• Can access flexible financing
• Without maintaining multiple lender relationships

Role in Capital Structure

Acquisition Financing:

• Unitranche facilitates platform acquisitions and add-on transactions
• For private equity-backed companies
• Executing buy-and-build strategies

Advantages for Borrowers

Simplified Execution:

• Single negotiation process, one set of documents, one closing
• Reduce transaction complexity, legal costs, and time to funding
• Compared to coordinating multiple facilities

Advantages for Borrowers

Speed to Market:

• Direct lenders can typically commit and close within four to six weeks
• Significantly faster than syndicated multi-tranche structures
• Requiring broader market distribution

Advantages for Borrowers

Relationship Simplicity:

• One lender relationship eliminates coordination challenges
• Conflicting interests between senior and junior lenders
• And complicated intercreditor dynamics

Advantages for Borrowers

Amendment Flexibility:

• Changes to terms, waivers, or modifications require consent from one lender group
• Rather than coordinating multiple constituencies
• With potentially conflicting interests

Advantages for Borrowers

Higher Leverage:

• Unitranche often permits higher total debt levels than traditional bank financing
• Reducing required equity contributions in sponsored transactions

Advantages for Borrowers

Covenant Flexibility:

• While including maintenance covenants
• Unitranche packages are typically more flexible than traditional bank facilities
• Providing greater operational latitude

Advantages for Lenders

Enhanced Returns:

• Blended pricing provides returns higher than senior-only lending
• While maintaining significant downside protection
• Through senior security and structural features

Advantages for Lenders

Portfolio Diversification:

• Enables lenders to deploy capital across the capital structure
• In single relationships
• Rather than competing for senior-only opportunities

Advantages for Lenders

Control and Influence:

• As sole or lead debt providers
• Unitranche lenders maintain significant influence over borrowers
• Without coordinating with other lender groups

Advantages for Lenders

Hold Strategy:

• Direct lenders typically hold loans to maturity rather than syndicating
• Eliminating secondary market risk
• Enabling relationship-focused investing

Advantages for Lenders

Flexible Structuring:

• Lenders can tailor structures to specific transactions
• Adjusting first out/last out ratios, amortization, and covenants
• To match risk appetites and borrower needs

Common Terms and Conditions

Financial Covenants:

• Typical packages include maximum total leverage (4.5x to 6.0x stepping down over time)
• Minimum fixed charge coverage (1.1x to 1.3x)
• Potentially minimum EBITDA or liquidity requirements

Common Terms and Conditions

Reporting Requirements:

• Quarterly and annual financial statements
• Compliance certificates, annual budgets
• Notification of material events
• Provide ongoing visibility into borrower performance

Common Terms and Conditions

Mandatory Prepayments:

• Excess cash flow sweeps (typically 25% to 75% depending on leverage)
• Asset sale proceeds, debt issuance proceeds
• Insurance recoveries may trigger required prepayments

Common Terms and Conditions

Prepayment Flexibility:

• Many facilities allow voluntary prepayments
• Subject to minimum amounts and advance notice
• Some structures include prepayment premiums in early years

Common Terms and Conditions

Permitted Acquisitions:

• Documentation typically includes baskets for add-on acquisitions
• Subject to pro forma leverage tests
• Minimum liquidity requirements and lender approval thresholds

Common Terms and Conditions

Restricted Payments:

• Limitations on dividends and distributions to equity holders
• Often tied to leverage levels, minimum EBITDA thresholds
• Or available cash flow baskets

First Out/Last Out Mechanics

Payment Waterfall:

• In split lien structures, first out lenders receive all principal and interest payments
• Until fully repaid
• After which last out lenders receive remaining amounts

First Out/Last Out Mechanics

Collateral Priority:

• First out receives first-priority liens on assets
• Last out receives second-priority liens
• Creating differentiated recovery profiles in default scenarios

First Out/Last Out Mechanics

Recovery Expectations:

• First out typically targets 80-90% recovery in default scenarios
• Last out accepts 40-60% recovery expectations
• Reflected in different economic returns

First Out/Last Out Mechanics

Participation Arrangements:

• First out lenders (often banks) and last out lenders (often credit funds)
• Participate in the facility through intercreditor agreements
• Defining rights and priorities

First Out/Last Out Mechanics

Economic Split:

• First out typically receives SOFR + 300-450 basis points
• Last out receives SOFR + 700-1000 basis points
• Creating blended pricing for the borrower

Intercreditor Dynamics

Intercreditor Agreements:

• When unitranche includes multiple lender groups (first out/last out)
• Intercreditor agreements govern payment priorities, enforcement rights
• And amendment procedures

Intercreditor Dynamics

Standstill Provisions:

• Last out lenders typically agree to standstill periods (often 90-180 days)
• Before exercising remedies
• Allowing first out lenders to control initial enforcement actions

Intercreditor Dynamics

Amendment Rights:

• Decisions affecting all lenders require specified percentages
• Of both first out and last out groups
• Protecting each class from adverse modifications

Intercreditor Dynamics

Voting Mechanics:

• Typical structures require majority consent from the combined facility for most amendments
• With certain changes requiring super-majority or class-specific approval

Risk Considerations

Refinancing Risk:

• Five to seven-year maturities require eventual refinancing
• Middle-market companies may face limited options
• If credit quality deteriorates or markets tighten

Risk Considerations

Interest Rate Risk:

• Floating rate structure exposes borrowers to rising benchmark rates
• Potentially stressing cash flow if SOFR increases significantly

Risk Considerations

Lender Concentration:

• Reliance on single or small groups of lenders creates dependency risk
• Relationship challenges or lender distress
• Can complicate future amendments or refinancings

Risk Considerations

Covenant Breach Risk:

• Quarterly maintenance covenants create ongoing compliance obligations
• Breaches can trigger defaults, fee payments, or forced deleveraging
• Even when the business remains fundamentally healthy

Risk Considerations

Limited Competition:

• Smaller lender universes in middle markets
• May limit refinancing options
• Or result in less favorable terms compared to broadly syndicated markets

Risk Considerations

Portability Constraints:

• Unlike syndicated facilities, unitranche may be less portable in sponsor-to-sponsor sales
• Potentially complicating exit transactions

Pricing and Economic Terms

Spread Determination:

• Pricing reflects credit quality, leverage levels, sponsor reputation
• Industry sector and market conditions
• Middle-market credits typically pay 500-700 basis points over SOFR

Pricing and Economic Terms

Upfront Fees:

• Original issue discounts of 1-3% and/or closing fees of 1-2% are common
• Providing additional lender returns and reducing borrower proceeds

Pricing and Economic Terms

Unutilized Fees:

• If facility includes delayed draw or revolving features
• Commitment fees of 0.5-1.0% on undrawn amounts
• Compensate lenders for capital availability

Pricing and Economic Terms

Prepayment Premiums:

• Some facilities include soft call provisions or prepayment penalties
• In years one and two
• Protecting lender returns from early refinancing

Pricing and Economic Terms

Success Fees:

• Occasionally, lenders receive additional fees upon specified events
• Like successful exits, IPOs
• Or achievement of performance milestones

Market Position and Usage

Private Equity Preference:

• Sponsors appreciate simplified execution, relationship focus
• And higher leverage availability
• Making unitranche increasingly standard for middle-market buyouts

Market Position and Usage

Bank Participation:

• Some structures involve banks taking first out portions
• And credit funds taking last out
• Combining bank pricing and credit fund return requirements

Market Position and Usage

Direct Lender Dominance:

• Non-bank direct lenders now dominate unitranche provision
• With dedicated funds raising capital specifically for this strategy

Market Position and Usage

Competitive Alternative:

• Unitranche competes directly with traditional bank club deals
• And broadly syndicated facilities in the middle market
• Often winning on execution certainty and speed

Market Position and Usage

Cross-Border Applications:

• Increasingly used in European and other international markets
• Though documentation and structural conventions vary by jurisdiction

Default and Enforcement

Events of Default:

• Standard triggers include payment defaults, covenant breaches
• Material misrepresentations, bankruptcy filings
• Cross-defaults and change of control events

Default and Enforcement

Remedies:

• Lenders can accelerate obligations, foreclose on collateral
• Exercise credit bid rights in sales
• Or negotiate consensual restructurings depending on circumstances

Default and Enforcement

Workout Flexibility:

• Single lender relationships often facilitate faster, more flexible workouts
• Compared to multi-lender situations
• Requiring complex negotiations and inter-creditor coordination

Default and Enforcement

Enforcement Coordination:

• In first out/last out structures, intercreditor agreements govern which lender class controls enforcement
• Typically granting first out lenders initial control rights

Conclusion

• Unitranche debt has become a fundamental financing tool in middle-market leveraged finance
• Offering borrowers simplified execution, flexible structures, and efficient capital deployment

Conclusion

• While providing lenders with attractive risk-adjusted returns across the capital structure
• Its single-facility structure eliminates coordination challenges inherent in traditional multi-tranche financings

Conclusion

• For private equity sponsors and growing companies, unitranche provides reliable access to leverage
• With relationship-focused lenders capable of providing ongoing support through business cycles

Conclusion

• While carrying higher all-in pricing than senior-only alternatives
• The blended cost typically proves competitive with traditional structures
• When considering total fees, execution certainty, and relationship benefits

Conclusion

• Understanding unitranche mechanics, pricing dynamics, and structural variations is essential
• For participants in modern middle-market finance
• Where this product continues gaining market share as both borrowers and lenders recognize its strategic advantages