The landscape of private credit is evolving, with sponsors of private equity firms increasingly negotiating for greater flexibility in their debt agreements. A key development in this arena is the growing prevalence of the "freebie basket," a provision that allows borrowers to incur additional debt post-closing without triggering a leverage ratio test or other restrictive covenants. This trend, driven by intense competition between broadly syndicated loans and direct lending markets, is reshaping how private credit deals are structured, particularly in the core and upper mid-market segments.
Understanding the mechanics and implications of freebie baskets is essential for market participants. These provisions are not universally available; they are typically reserved for the strongest credits backed by the most reputable sponsors. The negotiations surrounding their inclusion highlight the balance lenders and borrowers must strike between flexibility and financial prudence. As the market adapts, the freebie basket is becoming a significant tool for sponsors seeking to fund future acquisitions or operational needs without returning to the negotiating table.
The Rise of Freebie Baskets in Private Credit Contracts
Private equity sponsors are actively pushing for provisions that mirror those commonly found in the high-yield bond and syndicated loan markets. The freebie basket, a staple in high-yield deals, provides a cash-capped allowance for incurring additional debt within the credit agreement, bypassing the standard leverage ratio test. This flexibility is particularly valuable for sponsors employing "buy-and-build" strategies, which involve regular increases in committed debt to fund an active merger and acquisition pipeline.
Market sources indicate that tough negotiations over the implementation of freebie baskets are widespread in new core and upper mid-market private credit deals. A number of lenders have already conceded to these terms, signalling a shift in the private credit market. According to Megan Lawrence, a leveraged finance partner at Proskauer, "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." She further notes that in the large-cap private credit space, legal document terms are, in some instances, converging with those of the syndicated loan markets.
The push for these terms is a direct result of the fierce competition for new business between the broadly syndicated loan and direct lending markets. As sponsors gain more power in the leveraged finance landscape, they seek to limit the application of other restrictive covenants, such as the Most Favoured Nation (MFN) provision. The freebie basket is one mechanism through which they aim to secure greater operational and financial agility post-acquisition.
Mechanics and Typical Sizing of the Freebie Basket
The freebie basket is designed to provide headroom for additional debt under a Credit Facilities basket. Its primary function is to grant borrowers the ability to increase leverage after a deal has closed, which is a common requirement for funding follow-on acquisitions. The amount of additional leverage requested by sponsors varies from deal to deal, but market sources suggest that sponsors typically seek flexibility to add between 0.5 and 1.0 times the company's EBITDA.
Activating the freebie basket is contingent upon the positive EBITDA performance of the company in question. This condition ensures that the borrower is generating sufficient cash flow to service the additional debt. The inclusion of this flexibility in the legal documents can significantly streamline future financing needs. Henri Lusa, managing director of private debt Europe at Partners Group, explains that having this provision pre-negotiated "can cut out further rounds of negotiations between parties if new capital is needed for an acquisition, because the documents are already in place."
This preparedness is particularly valuable in a dynamic M&A environment. As Alexander Griffith, private credit partner at Proskauer, observes, there has been an increasing number of deals over the past 18 months that have added freebie flexibility to certain provisions. Assuming an uptick in M&A activity, the capacity to add new debt means both lenders and sponsors are ready to move quickly when opportunities arise.
Negotiation Dynamics and Lender Reluctance
Despite the increasing number of requests, freebie baskets are not a standard feature in private credit agreements. Market sources indicate that these provisions are currently restricted to the strongest, best-known credits in the private credit space, backed by the biggest sponsors. For the most part, the majority of direct lenders remain reticent to offer the provision to would-be-borrowers.
Lenders who are willing to include the provision often suggest a compromise. Mark Bickerstaffe, co-head of direct lending at Hayfin, states, "We are very focused on the ability of borrowers to incur additional debt. Sometimes we 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 financial maths must also be sound. In a 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. Lenders must be confident that the borrower can handle the additional load and trust the sponsor to provide support in times of stress.
The negotiation over freebie baskets often intersects with other covenant discussions, such as the Most Favoured Nation (MFN) clause. In the United States, it is common for sponsor-friendly deals to contain a freebie basket, and sponsors frequently propose that any incurrence under this basket should fall outside the scope of the MFN. The likelihood of lenders accepting this depends on the size of the freebie basket and other de minimis thresholds. Aggressive sponsors may seek a de minimis quantum, with a common sizing range of 0.5 to 1.0 times consolidated group EBITDA, such that any incremental debt incurrence below that level does not trigger the MFN.
The Broader Context: Private Credit and Leveraged Finance
The rise of freebie baskets cannot be viewed in isolation; it is part of a broader evolution in the leveraged finance market. Global financial markets are currently contending with challenges such as higher interest rates and lower valuations, which are affecting both the leveraged loan and high-yield bond markets. Private credit has grown in influence within this space, offering an alternative source of financing for sponsors and borrowers.
Moody’s research provides insights into how these changes are affecting leveraged finance markets, including default trends, spec-grade liquidity, and the state of covenants. The growing influence of private credit is evident as it continues to compete with traditional syndicated loans and high-yield bonds. For subscribers, extensive overviews of leveraged finance markets across the globe are available, including key publications on private credit, covenants, and refunding risk.
The interplay between private credit and the broader leveraged finance market is also evident in pricing dynamics. Provisions like the MFN are designed to protect lenders against pricing risk. For instance, if a subsequent loan is advanced at a higher margin, the original loan may be repriced to ensure a buffer is not exceeded. This mechanism offers lenders protection and "anti-embarrassment" protection in the event that incremental debt is incurred which prices above the original loan. Given the prevalence of private equity "buy-and-build" strategies, these provisions are material business points for both borrowers and lenders.
Strategic Implications for Sponsors and Borrowers
For sponsors, the inclusion of a freebie basket represents a strategic advantage. It allows them to plan for future growth without being constrained by the initial debt structure. This flexibility is crucial for executing acquisition-led growth strategies, where the ability to move quickly can determine the success of a deal. Sponsors will remember which private credit fund managers have accepted freebie basket provisions on larger deals and are likely to request the same terms on smaller deals, potentially expanding the availability of this provision over time.
For borrowers, the freebie basket can reduce the need for multiple rounds of negotiations and the associated costs and delays. However, it also introduces a degree of complexity and potential risk. The ability to incur additional debt must be managed carefully to avoid over-leveraging the company. Lenders, in turn, must perform rigorous due diligence to ensure that the borrower's business model and cash flow can support the additional debt, both at inception and under potential future scenarios.
The negotiation process for freebie baskets is a testament to the evolving power dynamics in the leveraged finance market. As sponsors gain more influence, they are successfully pushing for terms that were once the preserve of the high-yield market. This convergence of terms between private credit and syndicated loans suggests a maturing market where best practices are being adopted across different financing channels.
Conclusion
The freebie basket has emerged as a critical point of negotiation in private credit contracts, offering sponsors and borrowers valuable flexibility to increase leverage post-closing. Driven by competitive pressures and the strategic needs of private equity sponsors, this provision is becoming more common in deals with strong credits and reputable sponsors. However, its adoption is not universal, and lenders remain cautious, often seeking compromises and ensuring that the financial maths support any additional debt.
The trend towards greater flexibility in private credit agreements reflects broader changes in the leveraged finance landscape, where private credit is playing an increasingly prominent role. As the market continues to evolve, the freebie basket will likely remain a key feature for sponsors seeking to fund future acquisitions efficiently. For participants in the private credit market, understanding the mechanics, negotiation points, and strategic implications of this provision is essential for navigating the complex world of leveraged finance.