Traditionally, banks have provided financing for rural estates in the form of loan facilities, often secured against property and other assets. Capital and regulatory restrictions on banks introduced in the wake of the financial crisis have resulted in many estates finding that banks are either less willing or unable to lend in the larger sums and on the longer maturities they desire. As a result, alternative sources of finance have emerged and one source which has proved attractive in recent years is the private placement market.
1. What is a private placement?
A private placement is a private debt arrangement between a borrower (issuer) and a non-bank lender (investor) or a small group of non-bank lenders. The investors on private placements are typically insurance companies and pension funds (historically US based but UK investors are increasingly active) who have long-term fixed liabilities for which they require long-term investments providing a fixed rate of return.
Depending on the financial strength and credit-worthiness of the estate, it is often possible to issue a private placement which is not secured. This is a clear advantage to the bank loan market where security over land and other assets will usually be a fundamental condition to the provision of any loan facilities.
2. What are the key commercial terms of a private placement?
Issuers usually appoint an experienced financial adviser at the outset of the process. Their role includes assisting with the selection of potential investors, preparing marketing materials, facilitating discussions between the issuer and the potential investors and providing guidance on the appropriate commercial terms for the private placement. The commercial terms will be crucial in ensuring both a positive uptake from the investor
community and managing the issuer’s risk over the life of the private placement.
Key commercial matters for issuers to consider upfront will include the following.
Generally, the private placement market will only be open to those issuers looking to raise a minimum of £10m. The amount that an issuer is able to raise in the private placement market will be linked to their asset base; on a recent transaction for a large landed estate client for whom the firm acted, the estate raised £105m.
Term and interest
One of the key attractions of a private placement is the combined effect of a long term and a fixed interest rate. Private placements tend to have a longer maturity than ordinary bank loans.
A term of between 10 and 35 years would be normal (although it is possible for maturities to extend further; we saw a term of 50 years on a recent transaction where we acted for a large landed estate). Interest rates in private placements will generally be fixed and rates of around 3% per annum are commonly obtained by estates. This type of long-term, fixed rate debt can be valuable in enabling finance to be procured for large-scale, long-term capital projects such as new developments, estate activities or visitor attractions.
Issuers will need to consider the repayment terms for the debt, both as to the ultimate repayment date and potential amortisations during the life of the debt and options for early redemption and prepayment.
The finances of the estate, both in terms of revenue streams (eg from rental properties, commercial activities, income-producing investments etc) and its balance sheet, will need to be robust enough to sustain payments of interest over the life of the debt as well as repayment of the principal amount of the debt at the end of the private placement’s life.
Private placements are attractive to issuers because of the length of maturity available. However, investors are also looking for long-term investment and interest revenue. To protect their position, investors will commonly require prepayment fees on an early repayment of the debt (make-whole provisions) to ensure they receive their initially expected rate of return. Make-whole provisions can make early repayment costly so
estates will need to consider carefully whether they are content for the debt to remain outstanding to scheduled maturity.
The appropriate level and types of financial covenants will need to be agreed. These will need to provide investors with comfort whilst protecting the issuer’s flexibility to manage its day-to-day operations.
Investors may expect to see both an interest cover financial covenant testing the issuer’s ability to raise enough operating profit to cover its interest costs and a leverage covenant testing the ratio of the issuer’s total debt to the value of its asset base. Other financial covenants might also be required depending on the particular issuer and will be a matter of commercial negotiation. It is key to ensure that financial covenants are set at the right level at the outset of the transaction, as it can be difficult to procure amendments and waivers of covenant breaches at a later stage.
Investors will require information as to the estate’s financial performance and activities. The frequency with which such information will need to be provided will commonly form part of the negotiations. Investors will expect to receive audited annual financial statements and possibly also unaudited semi-annual financial statements, both prepared using generally accepted accounting principles.
US investors are generally prepared to make sterling private placements available (usually by swapping US dollars for sterling over the period of the private placement). However, they will require an issuer to indemnify them for any losses that they may suffer from breaking or amending such currency swaps as a result of either the transaction not funding on the scheduled funding date or any unscheduled prepayment of the private placement.
3. Legal and practical considerations
Broad market acceptance of well-established model form documentation for private placements ensures that documentary negotiations between the issuer and the investor are minimised.
At the outset of any private placement, the issuer’s legal advisers will need to undertake an analysis of the issuer’s governing documents to ascertain whether the issuer has the power to borrow money (and, where relevant, grant security). If there is no such power, it may be necessary to amend the relevant governing document, which could take considerable time and have cost implications, depending on the structure of the issuer. This is a particularly significant point for estates constituted as charities or trusts (rather than companies) whose governing and constitutional documentation can often be bespoke and complex.
Many estates only conduct business at meetings of their directors or trustees. These meetings are often infrequent and it is often difficult or impossible to call short notice meetings when directors and trustees are travelling or involved in other projects. This can lead to delays or frustrate timings if not planned for properly.
If the structure is such that individual (and sometimes corporate) trustees are transacting on behalf of the estate, the transaction documentation will need to incorporate appropriate language to limit the recourse of the investor to the assets of the trust from time to time, and note that the trustees are entering into the documentation solely in their capacity as trustees and not in their personal capacity. If appropriate language is not
incorporated, there is a risk that the trustees could find themselves personally liable if the payments of interest/principal under the private placement are not paid when due.
Planning and launching a private placement can be an intensive process and estates wishing to make use of the pool of financing available in the private placement market will need to seek out and engage legal counsel and financial advisers who are familiar with market practice and the documentation requirements for private placements.
The use of private placements as a means of raising long-term finance has continued to increase exponentially and the UK market has developed momentum accordingly. Given the continued regulatory climate and imposition of capital controls facing banks, the use of private placements as a financing tool in the UK is likely to expand further. For those estates looking for sizeable long-term finance (whether for new capital projects or to match funding to long-term assets and investments they hold) private placements are likely to remain an attractive alternative option to the usual route of bank financing.
If you require further information about anything covered in this briefing, please contact Marc Glancy, or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, July 2019