Financing for schools, universities and other educational establishments has traditionally taken the form of loan facilities provided by banks and often secured against property and other assets. New capital and regulatory restrictions on banks introduced in the wake of the financial crisis have resulted in many schools and universities 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, many schools and universities are increasingly looking to alternative sources of funding to meet their long-term financing requirements. One such alternative source of funding which has proved very attractive and popular in recent years is the private placement market.
1. What is a private placement?
A private placement is a private debt arrangement (often in the form of bonds or notes) between a borrower (in this context usually termed an “issuer”) and a non-bank lender (in this context usually termed an “investor”) or a small group of non-bank lenders.
The investors on private placements are typically insurance companies and pension funds, who have long-term fixed liabilities for which they require long-term investments providing a fixed rate of return.
Historically a form of financing much used in the United States, private placements are increasingly being used in Europe as a means of raising alternative finance and diversifying borrower capital structures. Whilst UK borrowers can, and do, look to US investors directly for this type of funding (particularly where very large sums of liquidity are being sought), many UK insurance companies and pension funds now also offer this type of finance as a means of bridging the funding gap created by the reduction in available long-term bank funding.
Depending on the financial strength and credit-worthiness of the school or university, 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 to assist with arranging the private placement. The role of a financial adviser includes assisting with the selection of potential investors, preparing marketing materials to be sent to those potential investors, 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:
How much is the school or university looking to raise? Generally, the private placement market will only be open to those issuers looking to raise a minimum of £10m.
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 anywhere between 10 and 35 years would be normal (although it is possible for maturities to extend beyond even 35 years). Interest rates in private placements will generally be fixed rather than floating and are usually fixed at a margin above gilt-rate yields corresponding to the length of maturity of the placement. Fixed rates of around 3% per annum are commonly obtained by schools and universities in this market. This type of long-term, fixed rate debt can be valuable in enabling finance to be procured for large-scale, long-term capital projects (eg student accommodation, teaching facilities and other “bricks and mortar” infrastructure etc.).
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, together with options for early redemption and prepayment.
Are the finances of the school or university, both in terms of revenue streams (eg from fees, commercial activities, income-producing investments etc.) and balance sheet, 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?
Are schools and universities willing to be locked into the private placement for its entire term?
Private placements are attractive to issuers because of the length of maturity available. However, investors are also looking for that long-term investment and interest revenue. In order to protect their position, investors will commonly require prepayment fees on an early repayment of the debt (termed “make-whole” provisions) which ensure they receive their expected rate of return on the full term of the debt.
A make-whole amount is typically calculated by reference to the discounted value of the interest which would otherwise have been payable on the prepaid amount. The inclusion of make-whole provisions can make early repayment of a private placement costly and so schools and universities 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 school or university’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. Any financials will need to be 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 (known as “Model X”) 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 schools and universities constituted as charities or trusts (rather than companies) whose governing and constitutional documentation can often be bespoke and complex.
Many schools and universities only conduct business at meetings of their governors or trustees. These meetings are often infrequent and it is often difficult or impossible to call short notice meetings when governors 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 school or university, 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.
The key documentation required for a private placement will generally comprise the following:
- Investor presentation: the issuer’s management will need to provide a thorough overview of the history, activities and principal assets of the school or university together with key financials (including details of investments and endowments). This usually takes the form of a set of slides presented to potential investors in roadshow meetings.
- Note purchase agreement: this is the equivalent of the loan agreement on a more traditional bank financing and will contain all the terms governing the placement. In general, the terms of the note purchase agreement will be less restrictive than the terms of a loan agreement. For issuers looking to diversify capital structures and have bank debt sitting alongside a private placement, it is usually possible to align the provisions of both to ensure consistency.
- Responsible officer’s certificate: a standard form certificate usually provided by a senior management figure (eg the Headmaster or Bursar). Provided at closing, it annexes copies of the issuer’s constitutional documents and resolutions and makes a number of confirmations (eg the representations and warranties in the note purchase agreement are correct and no default exists as at the time the certificate is delivered). Investors also require a responsible officer’s certificate to be delivered alongside copies of each set of financial statements during the term of the placement.
- Legal opinion: the investor will require the issuer’s legal counsel to provide a legal opinion to the investor in respect of the issuer’s capacity to enter into the transaction documents and due authorisation, due execution and enforceability of such documents.
- Planning and launching a private placement can be an intensive process and schools and universities 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.
5. Private placements: here to stay?
The use of private placements as a means of raising long-term finance has grown exponentially in the last few years 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 continue and grow further in the coming years. For those schools and universities 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.
This publication is a general summary. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, November 2018