European Union: The Rise Of Recurring Revenue Loans In Europe

As companies in the growth stage quickly expand, there is often an urgent need for additional capital to sustain growth, despite that the business may not yet producing (or only producing) an positive EBITDA. More and more, these companies are turning to borrowing as well as equity raises in order to meet their financing needs. This article examines the characteristics and unique characteristics of recurring loan, which is a service which has come into existence as a way to fund such firms.

In urgent need of cash there are also plenty of recurring revenue loan that are being offered in the market to public or later stage businesses. They are typically working capital revolving loans and the amount of debt that is available could be based on borrowing base idea. Revolving facilities like these aren’t the subject on this report, but they do share some features with recurring term loans.

What’s a recurring income loan?

A Recurring revenue loan is a type of loan that is available and sized in accordance with the nature of the income stream of a business and the nature of the revenue stream. The person who is borrowing an regular revenue loan is expected to present a record of anticipated revenues, usually arising out of contracts made with their customers. This makes the product a hit within the context of growing software companies and other businesses which have significant revenue streams committed to customer contracts.

For smaller amounts of debt, lenders will take into consideration how they will use the recurring revenue stream as well as its durability in their credit assessment and then decide to provide a loan according to their evaluation of the capacity of the borrower to pay back the loan using this revenue stream. The terms of the documents vary however in some instances might not contain a regular revenue covenant or liquidity covenant, whereas others include the concept of borrowing. The loans are usually rather short-term (up to about three years) they are available in modest principal amount and are granted with the expectation that they can be refinanced over the short period as the business expands.

With regard to debt, the terms have evolved to be more sophisticated. The first significant regular revenue loans were made within the US markets. More recently, many special lenders have agreed to provide loans with the terms of borrowers in Europe. European market.

What’s the reason they can’t take out a unitranche loan under typical leverage financial terms from one of the numerous directly-funded lenders?

The ideal market of recurring revenues loans are businesses that haven’t reached the point at which they have made a profit on EBITDA (or even if they have, their EBITDA isn’t enough to warrant the leveraged-based loan). Most of the time, the companies have been operating for only a few years, are dependent on shareholder financing rounds up to now and exhibit an excessive percentage of cash burn since they go through the midst of rapid expansion and growth. This means that traditional ratios for leveraged unitranche loans cannot be achieved, at most in the beginning of an regular revenue loan.

What are the main characteristics of a more Recurring revenue loan?

As previously mentioned the terms and conditions of regular revenue loans are different in the marketplace based on the amount of debt that is available as well as the level of development of the borrower, as well as whether the loan is intended to serve as an interim bridge to an EBITDA facility based on EBITDA or as a intermediary into an IPO or refinancing exit.

The terms and conditions of less frequent recurring income loans can vary greatly and aren’t discussed further in this alert. When it comes to loans with larger amounts There are a variety of characteristics that have been added to distinguish these loans from leveraged EBITDA loans based on EBITDA. The list of features below is based on the common features and is not meant to be a complete list but rather to identify a variety of the features available in the marketplace. The significance of these features in a particular loan contract will obviously depend on the specific nature of the borrower as well as the specific business being funded since there is no uniform product.

Purpose:

Recurring revenue loans are available for a variety of purposes for capital expenditure as well as some recent transactions, for the financing of specific acquisitions as well as refinancing existing debt.

Conversion Date:

These loans usually granted on the basis that the business willbe able to repay the loan at some date in the future (commonly three years after the signing of the loan agreement, although there are variations based on the particular business plan) commence generating EBITDA and, as a result be able to borrow according to EBITDA in conditions. The loan agreements for regular revenue loans are constructed on the assumption that the initial liquidity and the recurring revenue covenants will go out at this point and replaced with the unitranche-like leverage covenant. Certain loan agreements stipulate that the flip can be made at the discretion of the business (subject to a specific leverage limit being met). This guarantees that the company is not faced with a refinancing requirement at the time when it isn’t yet making enough EBITDA and can switch earlier if it exceeds the business plan that it is expected to follow.

If the company is able to meet the leverage EBITDA financial covenant there are numerous important advantages for the business as a result of the process. Particularly:

  • Margin Prior to the flip , the margin is typically fixed at a certain percentage. After the flip, the business will likely benefit from a leverage type margin grid.
  • Baskets If the loan agreement incorporates debt baskets, they could be eased upon the event of a reverse. The baskets could change from fixed-figure-based baskets, or baskets that allow the growth of a certain amount dependent on recurring revenue. These could include baskets based on larger of a fixed figure and an amount of EBITDA. The possibility of carrying forward and carry-back baskets may also be available after the turn.
  • Distributions A common goal of a recurring revenue loan would be to supply the company with the funds needed to grow (or as previously mentioned and in certain instances acquisitions) in a period when it’s not producing substantial or any EBITDA. So, up to the flip, there will typically be no ability to pay dividends or distributions to shareholders, though they are likely to be allowed in small amounts for the purpose of maintaining holding companies for the lender. After this, complete array of leverage facilities for unitranche authorizations, including a basket as well as EBITDA distributions based on leverage, usually are made accessible.
  • Prepayment Fees These loans typically include prepayment charges for prepayments until the third anniversary time of borrowing. Exclusions are likely to be considered in the same way like unitranche loans, however there is a general assumption that the loan is not likely to be refinanced within a short time.
  • Interest PIK: The company will usually be granted the option to PIK a percentage of the margin due in the form of a term loan. The option is usually limited to a specified time (e.g. between two and three years) following that date on the loan, and before the flip, and it will usually be coupled with the increase of percentage of the margin due in the PIK period. There is a possibility of an upper limit on the frequency and for how long the group is allowed to make use of this right. The possibility of a PIK could also end after a default.
  • Financial Covenants prior to turn, the company may be required to adhere to the minimum liquidity covenant as well as the regular revenue (or the variation that is equivalent to the recurring income) covenant. The definitions for these covenants are often scrutinized to ensure they offer a fair evaluation of the financial condition of the company in light of its particular attributes. Particularly, funders are determined to make sure that any cash that is counted in the interest of liquidity actually exists and not subject to the security of third parties, and in the event that other investments that are cash equivalent are part of the liquidity figure the funds are in a position to be converted into cash at a brief notice. The definitions used to determine the purpose in the determination of regular revenue (and in turn the regular revenue ratio, generally being a recurring revenue-based the leverage obligation) are subject to negotiations and can differ from agreement to agreement and agreements, but generally seeking to establish real recurring revenues that arise under, e.g. software licences. It is possible to be excluded from other revenues and adjust for customer turnover. After the flip the leverage ratio is usually based on the unitranche agreement which is based on net leverage and step-downs during the remaining period for the loan facility.
  • Equity Cure: While there is some variation among deals regarding how equity cures are treated ahead of the swap, the sums could be required to be used either in full or in part to the prepayment of the revenue loan, in contrast to the standard European single-ranche loans. After the flip, these equity cures will not have to be used for prepayment. In the past, there was no way to remedy any breach of the covenant on liquidity, however this is now a topic of debate based on the threshold where the covenant on liquidity is determined.

Security:

The lenders of recurring revenue loans typically expect a higher degree of security protection as well as the people in the group that provide security as well in the context of the actual security offered. Particularly, there is a particular focus on business assets that have value that, for companies with software will typically include Intellectual Property assets. Funders can also request for real-time diligence regarding intellectual property assets to determine the nature of security that should be granted, instead of using only general leverage style agreements on security guidelines and a post acquisition type evaluation of the security to be offered.

Financial Diligence:

Due to the rapid growth of the loan borrowers who take on recurring revenue and the increasing demand for them, lenders will demand the submission of current management accounts when making their decision on whether to lend audited annual accounts that might reflect the financial position of the company for a period prior to any loan decision, are less of significance to these companies. The increased degree of diligence can be evident in the continual obligations for providing financial information which are set by negotiation and can comprise monthly manager accounts as well as as well as the provision of performance commentary and comparisons with previous years and any updates regarding significant changes and important agreements of the group on an annual basis.

Warrants/Co-Invest

Funders can be provided with an equity gain as part of the return they receive on lending. It could take as a right to invest with equity, or the grant of warrants that can be exercised upon certain occasions, typically such as a listing, closing, refinancing or after the specified time period after when the loan was made. Be aware of whether the warrants will be used as a stand-alone item or be linked to the regular revenue loan to accommodate any possible future transfers. For some funders, it may be necessary that any warrants come with an exercise option for cash based on the conditions and terms of the fund that makes the funding available as well as their capacity to keep any equity that might be granted.

Conclusion:

The amount of debt that is lent under regular revenue loans has significantly increased in the last year. Due to the continuing trajectory of companies in the growth stage as well as their comparatively long time to going public as compared to a decade ago, and their continuing necessity for funding and financing for debt based on non-EBITDA metrics offers significant flexibility that allows these businesses to continue growing and not have to raise equity. The increase in financiers who are able and willing to fund this type of funding will make sure that this flexibility remain available for the foreseeable future. Of course, the particular terms of recurring revenue facility will remain in flux.