Designed to supplement limited amounts of first lien debt provided by banks, a first-in-last-out, or FILO loan, maintains a senior secured first priority lien on all assets of the borrower. As the name implies, FILO is the last to be repaid from the proceeds of the collateral, after all first-out bank debt is repaid in full.
Capital Type: First in Last Out Term Loan or FILO
Typical Use: Finance growth, mergers and acquisitions and dividends
Funding Mechanism: Fully funded at the close of transaction
Security: Senior secured first priority lien
Collateral: Typically, all assets of the company and pledge of equity. In certain circumstances, collateral can be limited to current assets (cash, accounts receivable and/or inventory) or fixed assets, such as M&E and real estate or intellectual property
Payment Priority: Usually last to be repaid from the proceeds of liquidation of its collateral, after other secured debt with a first lien on the same collateral is fully repaid
Who Should Consider a FILO Loan?
A FILO loan can be structured based upon a discount to the enterprise value of the borrower, or the value of certain assets or recurring revenues of a borrower. Given these options, borrowers that qualify for a FILO loan typically have the following characteristics:
- Limited current or fixed assets in comparison to their debt capital needs, which in turn reduces the amount of debt capital that can be provided by banks.
- Stable, largely predictive cash flows and a demonstrable track record of consistent financial performance, along with reasonable liquidity or line of credit availability, and ownership by a party that can provide ongoing capital support during downturns.
- First lien bank financing needs to be equal to, or less than, ~1.5x EBITDA.
- Total indebtedness should not exceed 65-70% of EV, while maintaining total debt to EBITDA under 6.0x in most cases.
- FILO is also relevant for borrowers that need 10-20% more capital than the amount that can be supported by an asset-backed structure. In such an instance, a direct lender will advance a larger amount after the advance applied by a bank. While the advance rates and LTV would vary, as a rule of thumb, a borrower can expect 10% more advance from direct lenders on the same assets, where banks are providing the asset-backed financing.
Advantages of a FILO Loan
A FILO loan is typically paired with debt capital provided by banks, where banks provide a limited amount of capital while maintaining a first lien on all assets of the company, and the FILO supplements bank debt while sharing in the first lien of the bank.
Accordingly, there are several advantages of a FILO loan:
- A FILO loan typically provides much more debt capital than a first lien debt provided by banks
- Full utilization of debt capacity when paired with an ABL–most non-bank institutions can lend up to the full value of collateral or maximum possible loan-to-enterprise value of the company, resulting in the maximum possible capitalization within a single tranche of debt
- Low maintenance–reporting obligations are limited to financials and covenant compliance certificates
- Typically, no amortization is required–meaning cash flow is available for other corporate needs
- Simpler legal documentation–a FILO loan requires a single credit agreement, supplemented by an Agreement Among Lenders (“AAL”), which is managed exclusively by capital providers
Drawbacks of a FILO Loan
Despite these numerous advantages, FILO borrowers should consider the following:
- Periodic appraisals are required for asset backed structures
- As the name suggests, FILO lenders get repaid last (amongst senior-secured, first lien borrowers), hence a FILO loan is relatively more expensive than first lien-only debt provided by banks
Underwriting Process for a FILO Loan
Capital Providers: Typically, non-bank credit funds and Business Development Companies (BDCs)
- Recovery through ongoing cash flow generation of Capital Seeker or through refinancing. In distressed situations, recovery through sale of Capital seeker as an ongoing business
- For asset backed structures, recovery through liquidation of collateral in a distressed situation
- For a recurring revenue-based structure, recovery through collection of ongoing contractual payments
- Confirmation of business’ ability to generate cash flow and repay debt, ability of owner or sponsor to inject additional equity and liquidity.
- For asset-backed structures, liquidity and value of the collateral
- For businesses with recurring revenues, e.g. software companies, validation of company’s ability to generate recurring revenues and maintain healthy contract renewal rates
- Typical credit underwriting process focuses on the ability of the business to generate consistent cash flow, and risks that may disrupt consistent cash flow generation. Underwriting involves analysis of business model, competitive dynamics, ownership history, customer base and commercial terms, historical financial performance as well as financial projections, operations and background of key stakeholders, including key executives
- Quality of earnings report produced by an accounting firm to validate the EBITDA of the business, as well as any adjustments and an industry study to validate the company’s competitive position, size of the market, customer feedback, etc.
- For asset-backed loans where a FILO is paired with an ABL, it essentially extends more capital on the ABL collateral. Accordingly, will require a collateral exam, as well as an appraisal of inventory by a certified appraiser to establish Net Orderly Liquidation Value (“NOLV”), which will govern the amount of capital that can be borrowed against such assets
- For asset-backed loans where a FILO is dependent on the value of fixed assets or intellectual property, such assets will be appraised by a certified appraiser to establish NOLV
Amortization: Typically, none
- Most commonly, leverage ratios (senior debt to EBITDA and total debt to EBITDA) and fixed charge coverage ratio.
- Covenants related to appraised value of the collateral for asset-backed structures
- When paired with an ABL, requirement for min. excess availability in ABL
- Total debt to recurring revenues ratio for structures focused on recurring revenues
- Company prepared, unaudited monthly financials, audited annual financials, annual financial projections
- Periodic appraisals of collateral for asset backed structures
- If paired with an ABL, periodic borrowing base
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