Acquisition Strategy + “Main Street” Lending: Key Considerations
May 5, 2020
- The Main Street Lending Program brings favorable loan terms and is an attractive option for cash-strapped businesses or strategic buyers.
- Acquisitive companies should beware of the employee compensation restrictions that could seriously affect deal strategy.
- Main Street loan restrictions can potentially create misalignment between company strategy and employee performance.
In response to the COVID-19 pandemic, the Federal Reserve Bank ("Federal Reserve") has introduced a program to provide $2.3 trillion to support the U.S. economy. One part of this effort is the Main Street Lending Program ("Main Street Program") that dedicates $600 billion to provide eligible small- and medium-sized enterprises (“SMEs”) with new money in the form of four-year term loans. The Main Street Program may be a viable option for a low-interest infusion of capital into a portfolio company or subsidiary, but there are considerations to be taken into account before pursuing a Main Street Program loan.
The Main Street Program allows for new loans and the expansion of loans that existed prior to April 8, 2020, and there is no set allocation of the $600 billion between the two loan types. However, unlike the Paycheck Protection Program under the CARES Act (“PPP”), Main Street Program loans are not forgivable and come with restrictions related to the use of proceeds, employee compensation, capital distributions and stock repurchases.
Key Provisions of the Main Street Program
The Main Street Program is designed to enhance support for SMEs in the industrial, commercial and service industries that were in good financial standing before the crisis, and includes a number of key provisions:
- 4-year loans to companies employing up to 15,000 workers or with revenues of up to $5 billion
- Principal and interest payments will be deferred for one year
- Eligible banks may originate new Main Street Program loans or use Main Street Program loans to increase the size of existing loans to businesses
- Banks will retain a 5% share, selling the remaining 95% to the Main Street Program facility, which will purchase up to $600 billion of loans
- Firms seeking Main Street loans must commit to make reasonable efforts to maintain payroll and retain workers
- Borrowers must follow compensation, stock repurchase, and dividend restrictions that apply to direct loan programs under the CARES Act
- Firms that have taken advantage of the PPP are still eligible to take out Main Street Program loans
The Federal Reserve is also offering a different set of loans. The changes break these loans into three categories:
|New Loans||Priority Loans||Expanded Loans|
|Maximum Amount||Lesser of $25,000,000 or 4x 2019 adjusted EBITDA||Lesser of $25,000,000 or 6x 2019 adjusted EBITDA||Lesser of $200,000,000, 35% of undrawn or outstanding debt, or 6x 2019 EBITDA|
|Duration||2-4 Years||2-4 Years||2-4 Years|
|Rate||LIBOR + 3%||LIBOR + 3%||LIBOR + 3%|
Restrictions Related to Existing Debt and Other Debt
A borrower may not use the proceeds of a loan to repay or refinance pre-existing loans or lines of credit made by its lender. An until the loan is repaid, the borrower may not repay other debt of equal or lower priority, other than mandatory principal and interest payments.
Employee Compensation Limits
Highly compensated employees of Main Street Program loan holders are subject to certain restrictions on their total annual compensation, which includes salary, bonuses, awards of stock, and other financial benefits.
Compensation between $425,000 and $3,000,000
The borrower is required to freeze salaries for employees who earn between $425,000 and $3,000,000 in total annual compensation, and those highly compensated employees cannot receive, in any 12-month period, total compensation greater than their 2019 total compensation.
Compensation above $3,000,000
Compensation for these employees is capped at $3,000,000, plus 50% of their 2019 compensation over $3 million.
Implications for Borrowers
These compensation restrictions may seriously affect long-term strategies regarding retention of key employees both for private equity sponsors considering a Main Street Program loan for a portfolio company, or for a parent looking at it for a subsidiary.
First, the obvious is that any employee earning more than $425,000 will have his or her compensation frozen at the 2019 amount. Those close to the $425,000 limit would see a pay freeze, and depending on the size of the company, this could affect multiple levels of senior employees. The result could be that companies experience issues in retaining employees who might find other opportunities for work that do not involve the same restrictions.
Additionally, companies often incentivize key managers and employees with performance targets and/or equity awards. If employees know that compensation is capped for a period, it may eliminate that alignment among the employees and the sponsor or parent. This misalignment may impact the financial or strategic direction of the company, resulting in a sponsor’s (1) extending its hold period, (2) delaying an otherwise planned or more highly profitable exit, or (3) seeing a decline in financial performance.
Restrictions on Dividends and Capital Distributions
Certain restrictions on dividends and distributions will affect wholly or partially owned companies.
- From the date a loan is made until one year after it is repaid, a borrower is not permitted to pay dividends or make any other capital distributions with respect to its common stock.
- Any company structured as a pass-through entity (S-corp or LLC) that obtains a loan will be permitted to make tax distributions to its owners to the extent reasonably required to cover its owners’ tax obligations.
- If a company is part of a holding company structure, the borrower will not be able to make distributions to its parent for company overhead and expenses.
Implications of a Company Exit
As my colleagues have written about recently, there seems to be little doubt that the M+A market will rebound. This means there will be opportunities for private equity companies to exit an investment, or for a parent company to sell a subsidiary or division as part of a greater corporate development strategy.
If the selling company participated in the Main Street Program, the loan must be either repaid either on the date the company is sold or prior to a sale, but within a year of the loan date. Sellers should consider that restrictions related to employee compensation, dividends and capital distributions, and share repurchases will apply to the borrowing company for a year, even after the loan is repaid. Companies with equity incentive plans will need to consider this impact. If it is likely that a sale transaction will occur within the restricted period, there may be a change of control causing incentives to vest, and such vesting could run afoul on the employee compensation restrictions.
Companies Are Still Seeking Guidance
Though the Federal Reserve comment period has ended and changes were made on April 30, many questions and concerns related to the program still exist, including: the impact on existing credit agreements, exclusion of private lenders, the inability for borrowers to negotiate term sheets that might have preexisting definitions (such as EBITDA), and that the minimum loan amount may exclude certain small businesses, to name a few.
Private equity investors and strategic buyers considering the Main Street Program to inject needed working capital should be wary of the restrictions on these loans. With all the public, private and stimulus funding currently available to businesses right now, potential borrowers would be well-served to explore all the available options and balance both their short- and near-term strategies when evaluating the benefits and drawbacks of the Main Street Program.
Aaron Weir is a corporate M+A lawyer at Kegler Brown working with public and private companies on their comprehensive funding strategies. He can be reached directly at [email protected] or (614) 462-5419.