Staple financing is a financing package arranged by a seller for potential purchasers as part of an auction process. It is organized by the seller and their financial advisors, and it comprises the principal, fees, and the loan covenants. The term “staple” is derived from the fact that the commitment letter and term sheets are stapled at the back of the acquisition term sheet provided by the seller and its investment advisors.
Staple financing helps to quicken the auction process since the buyers do not need to find last-minute, outside financing but can instead use the pre-arranged financing. Also, the potential buyers/bidders do not have the opportunity to negotiate the details of this financing until one of them has been announced as the auction winner.
In mergers and acquisitions, the investment bank advising the seller organizes the financing for the potential buyer and stands to earn fees from both parties in the transaction. This practice brings about concerns of ethical conduct on the part of the investment bank for providing advice to the seller and organizing acquisition financing for the buyer and earning fees from both parties in one transaction.
How does staple financing work?
An investment bank initiates the financing packages for the buyers, and also acts as the financial advisors to the sellers. The information contained in the acquisition term sheet includes the structure of the financing, pricing, and fees charged by the bank. Potential purchasers use the acquisition term sheet to evaluate the terms of the debt financing and decide if they will take up the financing offered by the investment bank or find alternative sources of funding.
Where several banks offer to finance multiple potential purchasers, the banks are expected to create financing “trees.” In such cases, there are separate teams within the bank that prepare debt financing packages for particular bidders and are separated by information barriers. The offers are then presented to each of the bidders for consideration.
Uses of staple financing
The following are some of the uses of staple financing:
Expedite sales process
In an M&A transaction, some of the potential buyers that are participating in the transaction may not have ready capital to complete the transaction within the allowed duration. This means that they will spend additional time looking for financing from various financial institutions to allow them to close the deal. However, when the seller and its advisors make financing available to the bidders, it becomes easier to expedite the process, leading to a successful transaction.
Maximize sales price
Staple financing is provided to all potential purchasers who have shown interest in completing the transaction. It guarantees them some form of funding, even when the amount of cash they can raise on their own falls below the threshold. Since the financing is provided to all potential buyers, it increases the overall competition and, thus, usually forces the buyers to raise their offering price in a bid to emerge the overall auction winner. Even when the seller has raised the selling price, the bidders will compete to outdo each other since the seller guarantees financing to supplement the buyer’s available financial resources.
Price signaling mechanism
Savvy buyers use staple financing to get an idea of the seller’s price expectations. It can be achieved by reverse-engineering the financing package to get the debt to EBITDA ratio. When the seller has knowledge of the price range that the seller expects, they can put forward a bid that has a high probability of being accepted by the seller. Knowing the price also helps encourage transparency of the transaction by providing balanced information to all buyers.
Guarantee financing to firms
Staple financing provides a guarantee of financing to firms that have difficulty sourcing funding from lenders. It reduces the possibility that some purchasers with a high potential of winning the bid may fall out of the auction process because they could not raise adequate capital to facilitate the transaction.
In the absence of financing from the seller and its advisors, many purchasers might be unable to complete the transaction, and the seller may end up accepting a lower purchase price due to lack of competition.
Conflicts of interest in staple financing
Even though staple financing is a useful tool in a buyer-seller relationship, certain risks cast doubt on its propriety. One of these risks revolves around the investment bank’s potential conflicts of interest. During an auction, the advisory department of the investment bank provides advisory services to the seller to help them get the best offer possible from the list of interested purchasers. On the other hand, the bank’s lending department organizes financing packages for the potential buyers interested in closing the deal.
As both an advisor and financing provider, the bank finds itself at crossroads because it collects two sets of fees. One fee is earned for their advisory services to the seller while the other is earned by providing financing to the potential buyer. Conflicts of interests arise when the bank helps the seller structure a transaction and goes ahead to offer financing to buyers to facilitate the same transaction they helped design, and earns fees from both parties in the transaction.
Examples of recent deals offering staple financing
Here are some of the transactions that have been completed through staple financing:
In 2010, Thomas H. Lee Partners sold Michael Foods, a producer and distributor of refrigerated potatoes, specialty eggs, cheese, and other dairy products, to GS Capital Partners for $1.7 billion. BofA Merrill Lynch acted as the sole financial advisor to Michael Foods and Thomas H. Lee. Affiliates of BofA provided debt financing to facilitate the transaction.
Also in 2010, Hillman Group, a company owned by Code Hennessy & Simmons and others, was acquired by Oak Hill Capital Partners, a New York-based private equity firm. The company was purchased for a total of $815 million. Barclays Capital acted as the financial advisor to Hillman Group, while at the same time offering debt financing to Oak Hill Capital Partners to close the deal.
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