The private credit market in Europe is witnessing a significant shift as sponsors increasingly negotiate for greater flexibility to increase leverage after an M&A deal has closed. A key provision at the heart of these negotiations is the "freebie basket," a mechanism that allows borrowers to incur additional debt without triggering a leverage ratio test. This development, driven by fierce competition between broadly syndicated loan markets and direct lending, is reshaping covenant packages in core and upper mid-market private credit deals, with lenders in some instances agreeing to terms that mirror those found in the high-yield bond market.
The Rise of the Freebie Basket in Private Credit Contracts
Traditionally, the freebie basket has been a staple of the high-yield bond market, providing headroom for additional debt under a Credit Facilities basket. It has become a cornerstone of additional debt flexibility for borrowers needing an extra turn of leverage. Its prevalence, under the "freebie basket" moniker, has also increased in mid-cap leveraged loan documents. Now, sponsors are pushing for these more flexible terms in private credit deals.
Market sources indicate that tough negotiations over the implementation of the freebie basket are rife in new core and upper mid-market private credit deals. A number of lenders have already agreed to these new terms. Megan Lawrence, leveraged finance partner at Proskauer, noted, "In some instances, on very good credits with strong sponsors, we are seeing unitranche and private debt deals done with high-yield style covenant packages." In the large-cap private credit space, she says legal document terms, in some instances, are converging with the syndicated loan markets.
Alexander Griffith, private credit partner at Proskauer, confirms an increasing number of deals over the past 18 months have added freebie flexibility to certain provisions. This trend is a direct response to the competitive landscape, where sponsors seek to replicate the flexibility they might obtain in other financing markets.
How the Freebie Basket Operates
The freebie basket is a cash-capped basket for debt incurrence within the credit agreement without needing to comply with the applicable leverage ratio test. This means borrowers can incur debt under the freebie basket even if they are above the ratio, allowing the total debt capacity to exceed the headline leverage ratio.
In the US, it is commonplace for more sponsor-friendly deals to contain a freebie basket. Sponsors commonly propose that any incurrence under this freebie basket would also fall outside the scope of the most-favoured-nation (MFN) provision, which typically ensures lenders receive terms no less favourable than those offered to other lenders. The likelihood of lenders accepting this may hinge on the size of the freebie basket.
The amount of additional leverage requested by sponsors varies from deal to deal, though sponsors are typically seeking flexibility to add 0.5x to 1.0x of leverage. Activating the freebie basket will be dependent on positive EBITDA performance of the company in question. Having this flexibility in the documents can cut out further rounds of negotiations between parties if new capital is needed for an acquisition, as the documents are already in place.
Eligibility and Restrictions
Despite the increasing number of requests, freebie baskets are currently restricted to the strongest, best-known credits in the private credit space, backed by the biggest sponsors. Market sources indicate that for the most part, the majority of direct lenders are reticent to offer the provision to would-be-borrowers. Those that are willing to include the provision may suggest a compromise.
Mark Bickerstaffe, co-head of direct lending at Hayfin, stated, "We are very focused on the ability of borrowers to incur additional debt. We sometimes see sponsors preferring a lower opening leverage with the ability to increase post-closing, for example to fund an acquisition. Subject to the right controls, we are open to providing that flexibility in the docs."
The maths must work too. Despite the highly competitive financing environment, neither banks nor debt funds can accept the prospect of higher debt in documents if the opening leverage has already reached a critical level at closing of the deal. Lenders must be confident that borrowers can handle the load and trust the sponsor to jump in to help in times of stress.
Broader Context of Incremental Debt Flexibility
The freebie basket is part of a wider suite of incremental debt incurrence permissions. Other mechanisms include the general debt basket and potentially the "local lines" basket, which can be added to other debt incurrence permissions to increase the total amount of incremental debt capacity. This capacity could be used irrespective of the leverage ratio.
Another relevant provision is the flexibility to allow borrower groups to "assume" debt existing in any acquired company. This is relatively customary, usually subject to conditions such as requiring acquired debt to be refinanced a certain period after the acquisition completes—often six months. It may be allowed to remain outstanding if the debt could have been incurred under other permissions. There may also be a "freebie" basket applicable to the acquired debt permission, in addition to the main incremental freebie basket.
For ratio testing purposes, acquired debt constitutes unsecured or non-collateral indebtedness, although creditors are unlikely to be required to accede to the intercreditor agreement, irrespective of the quantum of the debt.
Market Implications and Future Outlook
Assuming an uptick in M&A activity in the coming months, the capacity to add new debt means both lenders and sponsors are ready to move quickly. Sponsors will remember which private credit fund managers have accepted the freebie basket provisions on larger deals, and they will ask that same lender to accept the provisions on a smaller deal, too. For now, activity is restricted to all but the private credit market behemoths, but the door is ajar for smaller borrowers who may want to get in on the freebie action in the months ahead.
The increasing prevalence of freebie baskets signals a maturation of the private credit market, where covenant packages are becoming more nuanced and tailored to sponsor needs. As competition intensifies, lenders may need to offer more flexible terms to win business, potentially leading to a broader adoption of freebie baskets across the private credit spectrum.
Conclusion
The freebie basket has emerged as a critical tool for sponsors seeking post-closing leverage flexibility in private credit deals. Driven by competition and sponsor demand, it allows for additional debt incurrence without triggering a leverage ratio test, typically in the range of 0.5x to 1.0x of EBITDA. While currently restricted to the strongest credits and biggest sponsors, its adoption is increasing, with lenders showing willingness to compromise under the right conditions. As the private credit market evolves, the freebie basket represents a shift towards more sponsor-friendly covenant packages, aligning private credit terms more closely with those of the high-yield and syndicated loan markets.