Unitranche Debt Financing: How it Works

Key Takeaways

• These loans target companies that lack access to traditional financial institutions, with the average loan size being around $100 million, and are commonly used to finance private equity acquisitions and other leveraged buyouts.

• The hybrid loan structure permits banks to improve their competition with private debt funds and adds flexibility to debt-financing terms.

• With such loans, the borrower must pay an interest rate that blends the highest and lowest rates of the subordinated and senior debt.

It has been nearly 20 years since unitranche debt began in the U.S., and the type of financing has not waned in popularity. Mostly used in institutional funds, unitranche debt permits funding from multiple parties, which can benefit the borrower.

Here is a comprehensive look at how unitranche and how the debt financing works.

What is Unitranche Debt?

This type of debt is mainly offered by debt funds and other nontraditional institutional lenders that focus on middle-market lending and acquisition finance. It combines subordinated debt and senior debt into a single instrument.

Such a loan structure permits banks to improve their competition with private debt funds and adds flexibility to debt-financing terms.

These loans target companies that lack access to traditional financial institutions, with the average loan size being around $100 million. They are commonly used to finance private equity acquisitions and other leveraged buyouts.

Unitranche lending gained popularity amid the financial crisis and subsequent credit crunch when distressed companies could not access loan facilities from traditional credit markets.

How Does Unitranche Debt Work?

Companies are increasingly turning to unitranche financing for its one-stop-shop appeal rather than to traditional credit facilities.

In such a financing arrangement, two tiers of debt tranches are combined into one offering. Such loans are governed by a single credit agreement and transform subordinated debt and senior debt into a single credit facility.

Thus, the first and second lien facilities act as one secured loan facility. To the borrower, this kind of debt has just one lender with one set of terms.

What is the Difference Between Unitranche Loan and Traditional Loan Term?

It is true that the interest rate on unitranche term loans is generally higher than traditional term loans. However, the higher pricing is generally offset by the ease of access to capital, short time frames to close, and flexibility in debt structuring. 

What is the Difference Between Unitranche Debt and Syndicated Loans?

There are cases in which a syndicated loan may be deemed a type of unitranche debt. The loan types are similar in that they both involve multiple lenders. In addition, both loans involve a protracted underwriting process as well as underwriters. In all, though, compared to unitranche debt, syndicated loans are usually less complex.

Unitranche Loan Types

• Straight. As an alternative to first- or second-lien structure, this is a senior stretch loan that provides at least five or six turns of leverage.
• Bifurcated.  This kind of unitranche divides the loan into first-out and last-out tranches. If triggering events such as bankruptcy occur, the first-out portion gets priority of payment.

What are the Benefits of Unitranche Debt?

There are definitе advantages to unitranche debt, including:

• It helps companies, especially those that are small and medium sized, that do not have easy access to the credit facilities of traditional banks.
• Unlike with traditional credit facilities, there is only one approval process, making just one set of documents for lenders necessary.
• This kind of debt instrument that combines two debt types lowers the number of legal reports the borrower must prepare. Such a simple and stream-lined process is why many borrowers are amenable to paying a premium fee.
• Because the borrower is dealing with a single lender, they can negotiate for flexible amortization rates, covenant documentation, and prepayment terms. Also, the transaction is usually closed quicker.
• A single lender also means lower administrative costs.

What are the Risks of Unitranche Debt?

There are risks and drawbacks involved with every investment. For unitranche debt, they chiefly are:

• The call protections that typically come with unitranche debts require the borrower to repay the loan for a specified predetermined period. Such protections lock borrowers in debt for at least that period, during which they may not clear the debt in voluntary lump sums using excess cash reserves.
• Generally, risk levels can vary markedly in a structured unitranched debt deal, with borrowers agreeing to multiple repayment priority levels in the case of default.
• It is unclear how the bankruptcy court treats unitranche debt since bifurcated unitranche debt appears as a single tranche of lenders.

What is the Interest Rate of Unitranche Debt?

With such a loan, the borrower must pay an interest rate that blends the highest and lowest rates of the subordinated and senior debt. That rate is typically higher than traditional loan terms.

Generally, the rate is more than or equal to the traditional senior debt interest rate, and less than a second lien or subordinated debt interest rate. 

How Can One Invest in Private Debt?

Private debt is a type of financing offered by private entities, including private equity firms, to finance business growth, buy-outs, and real estate development. 

It is relatively popular. In fact, financial analysts forecast that private debt under management will reach $2.6 trillion in the next three years. After all, private debt can provide better returns away from stocks and bonds and provide access to a myriad of global investment opportunities. 

Private debt strategies, with their disparate risks and returns, include direct lending, distressed debt, mezzanine lending, and special situations (merger, acquisition, bankruptcy, litigation, etc.) lenders.

Before private debt became an asset class, debt strategies were a sub-category of private equity. While PE investments generally carry a higher risk than private equity, they offer opportunities for higher returns.   

Those opportunities can include investments in alternative assets such as venture capital, real estate, and private debt. Yieldstreet is a leading platform for alternatives, which can shield against inflation and reduce portfolio volatility due to their low correlation to public markets. Its offerings include a number of PE investment opportunities, with early liquidity options and accessible minimums.

Alternative Investments and Portfolio Diversification

Such investments also serve another crucial purpose: portfolio diversification. Holdings that contain a mix of asset types can mitigate overall risk, which is vital to successful investing. Alternative investments can be a good way to help accomplish this. 

Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Unitranche debt mainly benefits middle-market corporate borrowers that have sales of less than $100 million and an earnings before interest, taxes, depreciation, and amortization (EBITDA) of under $50 million. Private debt investing also relates to private equity investments, which can also serve to diversify portfolios.