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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Private equity firms are aggressively pushing to include language in loan documents that could give them room to pay themselves larger dividends from the companies they have bought, drawing a sharp rebuke from lenders.

In the past, loan documents usually capped exactly how much money a private equity firm could extract from one of its portfolio companies. Over time, those fixed amounts became malleable and were based on a percentage of a company’s earnings.

But in recent weeks, private equity firms have been attempting to take things one step further with the so-called high-water ebitda provision, which allows a company to use the highest earnings it generates over any 12-month period for critical tests that govern how much debt the company can borrow or the size of dividends it can pay to its owner, even if the business’s earnings have slid since reaching that high point.

KKR, Brookfield, Clayton, Dubilier & Rice and BDT & MSD Partners have all attempted to work the clause into loan documents, according to people briefed on the matter. All four firms declined to comment.

The terms have received intense pushback from would-be lenders, and in almost every case the language has ultimately been stripped out of the loan documents. But the fact that private equity-backed companies continue to push for the inclusion of the language has lenders on edge, with some fearful rival creditors will buckle and accept the provision.

According to lenders who saw drafts of the loan agreements, the terms were included in provisional loan documents backing KKR’s buyouts of asset manager Janney Montgomery Scott, valued at roughly $3bn in the deal, and $4.8bn purchase of education technology company Instructure, as well as Brookfield’s $1.7bn acquisition of a unit of nVent Electric. The clause was also put in provisional documents for refinancings by Wesco, which is owned by BDT & MSD Partners, and CD&R’s Focus Financial.

“It’s a really aggressive term,” one creditor said. “It’s a tough time to say, ‘I’m going to push the envelope further.’”

In one deal, RBC, which was lead underwriter on the $900mn term loan Brookfield was raising for its investment in nVent, told an investor that the bank had strong demand and if the language was an issue they should “vote with [their] feet”.

When enough investors passed, the high-water language got pulled from the loan document.

RBC did not immediately respond to a request for comment.

The fact the language is being tested is one sign of a potential imbalance in the loan market, a critical source of funding for private equity buyouts. With buyout volumes still down from the 2021 peak, investors have had fewer new deals to spread their funds across, leading to heightened competition around some loans.

“When you’re in a strong market, it’s usually harder to push back against” these terms, one banker involved in the Instructure financing said. But, he added, “they’re not surviving.”

The language has made it into at least one deal, a $2.1bn term loan for a commercial laundry operation known as Alliance Laundry, according to two people briefed on the matter. The company planned to use the proceeds to refinance debt and pay a $890mn dividend to its owner, BDT & MSD, according to S&P Global and Moody’s.

The provision reads that “the borrower may deem Ebitda to be the highest amount of Ebitda achieved for any test period after the closing date . . . regardless of any subsequent decrease in Ebitda after the date of such highest amount”, text seen by the Financial Times showed.

“If you didn’t ask for those terms in a negotiation you didn’t do your job,” one private equity executive said. “You always want to give maximum flexibility to your businesses.”

The high-water concept is not foreign to creditors; it is far more prevalent in European leveraged finance markets. And some bankers and lawyers argue the idea is rooted in common sense.

In certain loans, the amount of future debt a company can borrow or the sums it can dividend out to its owner is set as a percentage of earnings. Companies like that flexibility, because if they are growing they do not have to keep amending their loan documents if they would like to borrow or distribute more cash. Investors said savvy lawyers decided to push that concept one step further.

The high-water provision creates a threat for would-be investors, particularly if a business begins to slow before a loan matures.

“Over time the protections that were built into credit agreements by commercial banks have deteriorated,” said Tom Shandell, Investcorp Credit Management’s head of US CLOs and broadly syndicated loans. “Private equity [firms], which can afford the best and brightest attorneys, have little by little put terms into credit agreements that weaken the protections.”

The ebb and flow of the global economy means that, as some people migrate to the UK, others leave it, creating opportunities for international financial advice.

The new Labour government has confirmed that the current tax regime for non-UK domiciled individuals will be replaced with a residence-based test from 6 April 2025, so international advice firms can expect more enquiries.

If UK advice firms want to develop a global presence, how should they go about it?

Working out the options

Branching out internationally is not something that can be achieved on a whim. Advisers must obtain the relevant permissions to advise in different parts of the world, and know how to navigate the quirks of various tax jurisdictions.

We’ve all heard horror stories of people moving out [of the UK] and it not being what they expected

Qualifications and regulatory requirements can vary greatly between countries and the location in which an adviser is based will also have practical implications for the areas they can cover.

“If I wanted to live in the US, doing a load of Australian exams would be pointless,” says Chris Ball, co-founder of international advice firm Hoxton Capital Management.

“It would be impossible — or at least very difficult — to be on the same time zone. But I could do the UK and Europe from there.”

One way for UK firms to start out is by partnering another firm that is already established in the international advice market. But this market comprises a wide range of businesses, with varying reputations and ways of operating, which means that, to do it properly, there is no fast-track entry.

A basic UK Level 4 qualification would be expected by most companies now

“You’ve got companies that are very commission and sales driven; then you’ve got companies that are fee based and more financial planning focused,” says Ball.

Being selective

Ball says UK advisers should ensure they do their homework on prospective partners and be wary of whom they get into bed with.

“I think a lot of people do that, but we’ve all heard horror stories of people moving out [of the UK] and it not being what they expected,” he says. “No one wants to be in that position.”

According to Academy of Life Planning chief executive Steve Conley, the advice industry in some countries resembles that of the UK as it was 20 years ago, with product sales being incentivised by commission, and ‘bad apples’ appearing in different guises through phoenix firms.

You’ve got companies that are very commission and sales driven; then you’ve got companies that are fee based and more financial planning focused

Conley believes international advice firms should charge fixed fees for financial planning to “eliminate conflicts of interest, promote trust and advocate market integrity”. He suggests UK advice firms seek to partner a well-established firm that has highly qualified advisers and good, independent customer reviews.

“Don’t go by the awards they have won because there are a lot of vanity awards in this industry. They can be paid for rather than be voted for by the public,” he says.

A question of quality

Diane Bentley, a former nurse, lost half her pension when an international advice firm advised her to transfer her National Health Service pot to an overseas Qrops pension scheme when she moved to France. Now back in the UK, she runs a Facebook group providing support to others who have experienced bad offshore advice.

Bentley says that, because the international advice market is commission led, the incentive to get more UK pensions offshore becomes extremely risky.

The stereotype of a second-hand car salesman going to Dubai to become a financial adviser is pretty much gone

“It is poorly regulated and the advisers are badly trained. We want them trained to the UK standard — a minimum of Level 4,” she says.

“Why shouldn’t we expect the same standards as people onshore are getting?”

Ball acknowledges that the international advice market has had its problems, but says it is cleaning itself up.

“A basic UK Level 4 qualification would be expected by most companies now,” he says.

“And the stereotype of a second-hand car salesman going to Dubai to become a financial adviser is pretty much gone. The quality of people here in the Middle East and in Australia advising British expats is really good.”

This article featured in the September 2024 edition of Money Marketing. 

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Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

UK government borrowing sharply overshot expectations in August in a blow to chancellor Rachel Reeves as she prepares for her first budget next month.

The public sector borrowed £13.7bn, the highest August shortfall since 2021, according to the Office for National Statistics.

That was £3.3bn higher than August last year, and £2.5bn higher than had been forecast by the Office for Budget Responsibility, the fiscal watchdog.

Government net debt was provisionally estimated at 100 per cent of gross domestic product at the end of August 2024, the ONS added.

This is a developing story

The Taiwanese government has said components in thousands of pagers used by the armed group Hezbollah that exploded in Lebanon earlier this week were not made on the island.

The comments come after Taiwanese company Gold Apollo said it did not make the devices used in the attack.

The Lebanese government says 12 people, including two children, were killed and nearly 3,000 injured in the explosions on Tuesday.

The incident, along with another attack involving exploding walkie-talkies, was blamed on Israel and set off a geopolitical storm in the Middle East.

“The components for Hezbollah’s pagers were not produced by us,” Taiwan’s economy minister Kuo Jyh-huei told reporters on Friday.

He added that a judicial investigation is already underway.

“I want to unearth the truth, because Taiwan has never exported this particular pager model,” Taiwan foreign minister, Lin Chia-lung said.

Earlier this week, Gold Apollo boss Hsu Ching-Kuang denied his business had anything to do with the attacks.

He said he licensed his trade mark to a company in Hungary called BAC Consulting to use the Gold Apollo name on their own pagers.

The BBC’s attempts to contact BAC have so far been unsuccessful. Its CEO Cristiana Bársony-Arcidiacono told the US news outlet NBC that she knew nothing and denied her company made the pagers.

The Hungarian government has said BAC had “no manufacturing or operational site” in the country.

But a New York Times report said that BAC was a shell company that acted as a front for Israel, citing Israeli intelligence officers.

In another round of blasts on Wednesday, exploding walkie-talkies killed 20 people and injured at least 450, Lebanon’s health ministry said.

Japanese handheld radio manufacturer Icom has distanced itself from the walkie-talkies that bear its logo, saying it discontinued production of the devices a decade ago.

Iran-backed Hezbollah has blamed Israel for what it called “this criminal aggression” and vowed that it would get “just retribution”.

The Israeli military has declined to comment.

The two sides have been engaged in cross-border warfare since the Gaza conflict erupted last October.

The difficulty in identifying the makers of the devices has highlighted how complicated the global electronics supply chain has become.

Good morning. A scoop to start: The EU could bar imports of coffee from a number of countries within weeks unless Brussels delays a ban on products from deforested areas, commodity companies and governments have warned.

Today, the head of the International Energy Agency tells our energy correspondent that Europe isn’t doing enough to protect Ukraine’s power infrastructure, and our competition correspondent reveals a demand from 20 EU capitals for the European Commission to cut more red tape than it has already promised.

Have a great weekend.

Cold comfort

The head of the IEA has accused Europe of being too reticent in its support for Ukraine, calling for more generators and repair equipment for the war-torn country ahead of a difficult winter, writes Alice Hancock.

Context: Ukraine has suffered heavy attacks on its energy infrastructure by Russia, particularly in late August in retaliation for its incursion into Russia’s Kursk region. Half of all Ukraine’s energy infrastructure has been destroyed, roughly equivalent to the capacity of Latvia, Lithuania and Estonia.

In a report published yesterday, the IEA said Ukraine’s electricity deficit this winter could reach as much as 6GW, around a third of anticipated peak demand. The power shortfall this summer was 2.5GW when Kyiv was already enduring long blackouts.

“It’s time for everybody to understand that this winter could be consequential in Ukraine,” Fatih Birol, director-general of the IEA, told the FT. “It is the most pressing energy security issue today in the world.”

A lack of energy supplies meant a knock-on impact on the operation of hospitals, schools, water supplies and other “major implications”, Birol added.

European Commission president Ursula von der Leyen will meet Ukrainian President Volodymyr Zelenskyy in Kyiv today to discuss the situation. They will also talk about where to direct €100mn the EU has given Ukraine for repairs and renewable energy, which came from the profits from immobilised Russian assets in the EU.

The EU will also provide €60mn in humanitarian aid for shelters and heaters. Average winter temperatures in Ukraine vary between -4.8C and 2C, according to World Bank figures.

Birol said there were “major shortages” of many crucial parts, including transformers, grid equipment and diesel generators. He said Europe had been too “conservative” in sending electricity to Ukraine and could step up exports without jeopardising European supply.

European consumers could help by cutting their own electricity demand, allowing more power to go to their eastern neighbour. This would be a “very decent way of showing solidarity”, Birol said.

Ukraine should have enough gas to see it through early winter, but the IEA said that once current contracts expire at the end of the year, there could be a need to increase west-to-east gas flows to Ukraine from central and eastern European neighbours.

Chart du jour: Rising tide

The Alternative for Germany looks set to win another state election in Brandenburg on Sunday, just weeks after the far-right party won its first regional poll in Germany’s postwar history. But the Social Democrats are closing in.

Cut it

If Europe wants to be globally competitive, it needs to go further than what Brussels plans to boost the single market, says a paper co-authored by 20 member states, including the Netherlands and Germany, writes Javier Espinoza.

Context: Two recent landmark reports — by former Italian leaders Mario Draghi and Enrico Letta — spelt out the stark risks of failing to reform the single market. They highlighted the need to reduce regulatory pressure on companies and to make it easier for businesses to access funding in order for the bloc to compete with the US and China.

Ursula von der Leyen’s second term at the head of the European Commission had to “continue to cut red tape . . . going beyond the announced 25 per cent reduction of reporting requirements”, the joint document states, referring to an existing promise.

She should also back “specific digital tools” that would allow companies to focus less on regulatory reporting.

The signatories, which also include Luxembourg and the Czech Republic, called on the commission to provide “an enabling and transparent regulatory environment” — technical language for forcing capitals to align their rules.

Lex Delles, Luxembourg’s economy minister, pointed to persistent barriers within the single market where “retailers cannot pick their suppliers in the country of their choice because of territorial supply constraints imposed by wholesalers”.

He added: “By prohibiting such practices, we would show businesses and consumers that the EU can deliver concrete results for them.”

What to watch today

1. European Commission president Ursula von der Leyen travels to Kyiv.

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