Story

Equity on the call, coupon in the term sheet

I got invited onto a call I had no business being on. A friend from an investor group is raising preferred equity into a refinance of a mid-90s garden apartment property, about 180 units, and he wanted a second set of eyes because he knew I read documents for fun. So I sat there with the term sheet open and mostly listened.

The senior loan maturing was in the fours. New quote was over six. That gap is the entire reason the call existed. Senior lender would fund about 60 percent of value where the old loan was closer to 72, and somebody has to write the difference or the sponsor writes a check he doesn't have.

What got me was the vocabulary fight. The sponsor's lawyer said equity maybe fifteen times. Membership interest, distributions, no lien, remedies run through the LLC agreement. Then the investor's guy would answer and say coupon, accrual, current pay, minimum multiple. Same instrument, two dialects, and nobody stopped to reconcile them because everyone assumed everyone else knew.

Halfway through, the sponsor asked whether it would show up as debt on his reporting. Long pause. His lawyer said it's an equity interest in the borrower, and left it there. The investor's guy said nothing at all, which I thought was the most honest thing said on the call.

The part I wrote down: the investor asked for a minimum multiple on top of the rate, so if the sponsor pays them off in month nine they still clear a floor. Sponsor pushed back, investor said that's the price of not being a lender. Then they talked about who controls the property if distributions stop and I stopped taking notes because I couldn't keep up.

Still don't know if it closed.

11 replies

monica_tran3SF4CPRO6

The vocabulary fight is real and it isn't accidental. Calling it equity keeps it off the debt line and out of the senior lender's prohibited-indebtedness language. Calling it a coupon is how the investor thinks about getting paid. Both sides need their word to win in different documents.

samantha_ruizAU4APRO6

I sat through a version of this last year at a much smaller scale. Twelve units. The gap was $180k and it still needed a real document. What killed it for me was the removal rights. If I miss distributions for two quarters the pref holder can take over management of the entity, and my name is on everything. I walked.

omar_haddadActivePRO11

nine months and they still want their floor. that's the whole game right there

gregpowell66AG4BPRO8

@keystone that removal language is what my GC brain flags too. On the construction side I've seen a takeover happen mid-project and the new party had no idea what was half finished. Nobody's remedy contemplates a building with open walls.

bmoreno23AB1B

I understood maybe a third of this and I still read it twice. What does minimum multiple mean in plain words? Like 1.3 times whatever they put in, no matter how fast they get paid back?

aliyah_bAU2APRO6

@ember yes, that's it. If they put in a million and the multiple is 1.3, they get 1.3 million total before the sponsor sees profit, whether that takes four years or nine months. The short payoff is where it stings.

wendy_park48CapitalPRO7

The thing I'd want from that call is the LLC agreement, not the term sheet. Term sheet says priority return. The operating agreement says what priority actually means when cash is short, who signs, who controls, and what happens to the sponsor's interest. I've read term sheets that were perfectly reasonable sitting on top of documents that weren't.

paulgrant17PassivePRO5

The silence when the sponsor asked about reporting is the part I'd have remembered too.

diane_kowalskiPassivePRO9

@quill did anyone say what happens if the senior lender objects? I thought most senior loans have language about additional capital in the borrower.

renee_dubois Get yours

@arbor they did touch it, briefly. The investor's guy said the senior would want to review the structure and might require it be at a level above the borrower entity. Which as I understand it changes what the pref holder can actually reach. Someone correct me.

sonia_alvarez Get yoursPRO6

@cairn you're roughly right. Structuring it at the parent means the pref holder's interest is in the entity that owns the borrower, so remedies hit ownership of the borrower rather than the property itself. Senior lenders generally prefer that. It also means the pref investor is one step further from the asset, which is priced in.