Recurring Revenue Financing: Structuring, Documentation, and Financial Covenants

Description

Emerging companies with positive revenue growth but high growth expenses, such as development costs, are often unable to achieve positive EBITDA and cannot obtain debt financing based on traditional working capital borrowing base or cash flow underwriting. For those companies and their prospective lenders, RRF is a possible solution. Private equity sponsors may also utilize recurring revenue of target companies to finance acquisitions. Finance counsel should have a thorough understanding of the structure, risks, and nuances associated with RRF.

The essence of RRF is that borrowing base criteria can be based on recurring revenue that meets tailored eligibility criteria. Typical financial covenants are based on maintaining recurring revenue growth and liquidity levels rather than EBITDA-based ratios. Financial covenants may also convert after time to more customary financial covenants in the form of EBITDA-based ratios (e.g., leverage ratio or fixed charge coverage ratio), along with the possibility for a reduction in the interest rate. Although RRF facilities may be used to finance acquisitions, they are not often highly leveraged, so significantly higher equity contributions may be required from a private equity sponsor seeking RRF than with traditional leveraged financing in the acquisition context.

Equity cure rights may be available, with proceeds generally applied to pay down existing loans to achieve required financial covenants outlined in the documents. Incremental facilities may also be included.

Listen as our authoritative panel discusses the key deal points and structuring nuances of RRF.