Originally published in the January 5th edition of Transacted.

Portability is effectively an exception to standard change of control requirements, which ordinarily force the selling sponsor to repay outstanding debt in full upon a portfolio company exit event.

Rather than returning cash to the existing lender, forcing the buyer to line up their own separate debt financing, portability instead allows the existing debt package to remain in place through the transaction.

Take It if You Can Get It

For financial sponsors, portability is an attractive option and can be a needle mover.

Standard credit agreements usually include prepayment penalties should a change of control occur early on in the term of the loan. A typical three-year stepdown would require the selling sponsor to repay 103% of initial principal for an exit within the first 12 months of a new facility, dropping to 102% and 101% in years two and three.

While it would be unusual for a sponsor to exit an investment that early in its hold, it’s often not the original debt financing that causes prepayment issues. Additional mid-hold financings for add-on acquisitions, dividend recapitalizations, or refinancings in advance of an upcoming maturity could all come relatively close to a potential exit event.

With portability, however, selling sponsors can sidestep these penalties altogether—the loan doesn’t need to be repaid. Most portability provisions included in loans are valid for 18 - 36 months post-close, which generally covers the timeline of the worst prepayment penalties.

Portability may also be beneficial to the buyer of the target company. In uncertain markets, when debt financing is relatively more challenging to obtain, the prospect of a pre-existing package could be quite attractive. That’s especially true if the terms on the existing debt are likely to be unattainable in the current environment.

Even if financing is readily available on favorable terms, portability would still allow the acquirer to avoid underwriting fees that they would otherwise incur from a new lender.

Isolated Cases or the Start of a Trend?

A concept that appears more frequently in infrastructure deals, with the lower risk profile of the asset class, portability has only ever seen sporadic use in mainstream buyout private equity.

In recent months, however, it has become marginally more commonplace—roughly mirroring a more general trend of erosion in terms and covenants, particularly for larger private credit financings.

A number of late 2023 deals included portability language, per Bloomberg and Pitchbook…

• Veritas Capital’s sale of consulting firm Guidehouse to Bain Capital, transferring a $3.1 billion facility

• BC Partners’ dividend recap for portfolio company NAVEX Global with a new $1.2 billion portable loan from Antares Capital

• Kohlberg & Co. requested and received portability on additional add-on financing for portfolio company AWP Safety

• In the syndicated market, Aquiline Capital Partners secured a portable $575 million cov-lite Term Loan B for its human resources business CoAdvantage, refinancing its existing debt and facilitating a dividend

Changing Market Dynamics

Sponsor-backed transaction volume has declined meaningfully over the past twelve months. For buyout firms, it’s become more difficult to secure favorable exits, and has meant fewer actionable opportunities as new process launches are pushed back.

That’s also a problem for private credit. Less activity means less origination, and there’s mounting pressure to boost deployment, ideally to levels closer to the heights hit in 2021 and 2022. At the same time, lenders now face increased competition from newly raised funds and investment banks that want to stem the market share loss of their traditional bank-led syndications.

With these dynamics at play, the opportunity for lenders to remain invested in an asset via portability has become relatively more attractive. And for those trying to win competitive lender processes, portability could be a reasonable concession to provide.

Any extra edge direct lenders can find may prove helpful as they compete in a private credit market that’s expected to hit $1.8 trillion by the end of this year, more than double its pre-pandemic size.