Recent Minnesota Finance Trends Favour Incremental Facilities

Consistent with national and global trends, large corporates in Minnesota are increasingly utilising incremental credit facilities to incur additional tranches of term and revolving debt under their existing credit agreements given the limited conditionality and other flexible features inherent in incremental facilities. This market appetite for streamlined and innovative financing techniques is not surprising given that Minnesota boasts a thriving business landscape characterised by diverse industries, robust corporate presence and a strong economic foundation. Minnesota is ranked the sixth-best state for business and is home to 17 companies listed on the S&P 500 Index. In 2023, 38 of Minnesota’s largest public companies exceeded USD1 billion in revenue; and, in 2024, the 71 biggest public companies in Minnesota generated an aggregate market cap of over USD1 trillion, showcasing the state’s ability to support large-scale enterprises and sustained economic growth. Key industries driving Minnesota’s economy include healthcare, manufacturing and retail, each contributing uniquely to the state’s economic vitality and reputation as a hub for innovation and investment and a leader in industry and commerce.

While Minnesota-based corporations have generally experienced continuing growth through the last decade, they are not immune to recent volatility in the global financial markets driven by geopolitical tensions, inflationary pressures and shifting US monetary policies. With such uncertainty in the markets, Minnesota public companies are showing increased interest in credit provisions that provide them with flexibility to raise additional capital. Incremental facilities are a popular feature of large cap credit facilities in Minnesota (and elsewhere) due to their flexibility permitting a quick increase of the available capacity under a borrower’s existing credit facility. In a review of publicly filed credit facilities over the last two decades, Minnesota-based corporations have significantly increased their inclusion of provision in their credit facilities that permit incremental debt facilities, with the largest growth in the last five years. The shifting landscape is significant in the Minnesota-based secured lending market, but is indicative of the larger national and global trend towards inclusion of these facilities in facilities for mid and large cap companies.

This chapter of the guide will explore the general components of incremental credit facilities and the application of those components in credit facilities for Minnesota-based companies over the last five years.

Incremental Debt Topics and Terms

When borrowers seek flexibility in their credit agreements to incur incremental debt facilities, borrowers and lenders must negotiate terms to dictate the amount and under what circumstances incremental debt may be incurred as well as any additional requisite lender protections. Understanding the key terms is critical for borrowers seeking pre-approval of incremental debt. The key terms are set forth below, together with any notable deviations Minnesota-based companies have utilised in their facilities in recent years.

Incremental debt capacity: three baskets

Incremental debt capacity permitted under a credit agreement is generally governed by three distinct baskets (ie, negotiated provisions under the credit agreement allowing incremental debt capacity):

• a free and clear or fixed basket;
• a voluntary prepayment or buy-back basket; and
• a leverage ratio-based basket.

Each basket offers a different framework for determining the amount of incremental debt a borrower may incur and, in certain circumstances, the ability to reallocate among the baskets, providing additional flexibility and risk mitigation. 

Free and clear basket

A free and clear basket provides borrowers with an initial baseline amount of incremental debt that can be incurred without needing to satisfy specific financial ratios or tests, determined by a set dollar amount or as a percentage of trailing 12-month EBITDA. While the basket is simple to calculate and utilise, borrowers often negotiate caveats, carve-outs and other exceptions, including sub-baskets for incremental-equivalent debt, junior loans and unsecured debt facilities. Additionally, consistent with a larger US trend, Minnesota-based borrowers often agree to partially or completely exclude incremental debt used to finance an acquisition from the free and clear basket. 

Prepayment basket

The prepayment basket allows borrowers to incur incremental debt based on voluntary prepayments of existing loans, incentivising early repayment while offering the ability to access additional financing at a later time. The prepayment basket is particularly valuable for borrowers who can generate excess cash flow and use it to voluntarily prepay existing debt. By opening capacity for incremental debt under the prepayment basket, borrowers can unlock additional debt opportunities in compliance with their credit agreements when market conditions change. For instance, a company experiencing strong quarterly performance might use excess cash to prepay existing loans, thereby increasing its capacity to take on incremental debt for other capital expenditures. 

Borrowers will often try to negotiate further flexibility with respect to the prepayment basket by including prepayments on other loans to expand their incremental debt capacities. This may be accomplished in one large basket or broken into sub-baskets by first liens, junior liens or unsecured loans. Borrowers may also negotiate terms that allow the inclusion of asset sale proceeds, excess cash flow or other liquidity events in the prepayment basket.

While not a standard term in credit facilities for most large cap companies headquartered in Minnesota, several Minnesota-based corporations have recently negotiated inclusion of voluntary prepayments on junior indebtedness under the prepayment basket. Whether the syndicate lenders accept this inclusion is largely dictated by a borrower’s credit profile as well as other market factors.

Leverage basket

The leverage basket ties incremental debt capacity to specific metrics, such as a borrower’s pro forma net leverage ratio or interest coverage ratio. These ratios are tested at the incurrence of the incremental debt and are not reported in a borrower’s compliance certificate or as part of the maintenance financial covenants included in a credit facility. This approach aligns lender risk with borrower performance. Borrowers often negotiate for sub-baskets, setting leverage ratios specific to each of first lien, junior lien and unsecured loans. When such sub-baskets are included, lenders frequently limit the total leverage risk by requiring an overall maximum leverage ratio giving pro forma effect to incurrence of all incremental debt types. Public companies in Minnesota frequently utilise these subcategories as part of their capital stack strategies.

The leverage basket is generally considered the most restrictive parameter since it ties debt capacity to specific financial metrics. However, borrowers typically allocate debt to this basket when they anticipate their leverage profile will improve, strategically utilising the basket to recoup leverage basket capacity when projected revenue growth improves leverage. This strategy, when employed properly, ensures compliance with lender requirements while maximising available capacity, but risks breaching financial covenants during a downturn. 

Reallocation across baskets

In addition to parameters for the above baskets, borrowers often negotiate the ability to allocate and reallocate debt among available baskets to optimise debt capacity as their needs and the markets evolve. For example, a borrower may seek to use the free and clear basket to quickly secure incremental debt and subsequently reallocate the incremental debt to the leverage basket when the borrower’s metrics improve. This would provide the borrower with additional free and clear capacity but, in turn, lenders may require satisfaction of certain conditions or consent before such reallocation is permitted. Lenders, on the other hand, need to be cognisant of any reallocation provisions because incremental debt under one basket does not limit a borrower from incurring debt under another.

In recent years, Minnesota-based borrowers have also negotiated provisions that:

• exclude incremental debt incurred under one basket from counting against capacity available in another basket;
• permit testing of leverage baskets without reference to incremental debt incurred under the other baskets; and
• auto-reallocate incremental debt from prepayment or free and clear baskets to the leverage basket after financial reports indicate such incremental debt could fit under a leverage ratio.

When negotiated successfully, these reallocation components can generate significant additional incremental capacity flexibility for borrowers. 

Conditions precedent for incremental debt

Incremental debt facilities are subject to various conditions precedent designed to protect lenders and ensure that borrowers meet predefined criteria prior to incurring additional debt. These conditions include:

• meeting capacity requirements;
• the absence of any current defaults;
• accuracy of representations and warranties; and
• pro forma compliance with financial covenants.

These provisions are generally not controversial and Minnesota-based companies have not deviated significantly from the typical conditions precedent for incurrence of incremental debt.

Basket capacity tests

To incur incremental debt, there must be available capacity. Timing for assessing capacity of each basket is crucial in determining whether a borrower meets the requirements of a basket. For example, financial metrics used to assess leverage basket capacity are typically evaluated at the time the incremental debt is actually incurred. Sometimes, however, borrowers may negotiate provisions allowing them to run a capacity test at an earlier date, such as the time of commitment, when they may have greater certainty that the test will be met.

Representations and warranties

Borrowers must reaffirm representations and warranties when incurring incremental debt, particularly regarding organisational status, compliance with laws, enforceability of loan documents, and solvency. In the case of incremental debt incurred to finance an acquisition, the list of representations and warranties subject to reaffirmation may be limited.

Financial covenants and events of default

Borrowers must generally demonstrate compliance with financial covenants before and after giving effect to a proposed incremental facility and certify that there has been no event of default prior to incurring incremental debt. Lenders are generally not willing to negotiate these conditions. 

Acquisition exceptions: financing acquisitions with incremental debt

Incremental debt is frequently used to finance acquisitions, and borrowers have often negotiated additional flexibility in their credit facilities to enable them to act quickly to make an acquisition without the typical incremental debt restrictions.

Capacity exception

The capacity exception for acquisition-related incremental debt often includes “no worse than” clauses and assumed debt exceptions. “No worse than” provisions may provide exceptions to incremental debt capacity limitations from any or all of the three baskets, so long as the borrower’s leverage ratio post-acquisition is no worse than it was prior to incurring the incremental debt. In scenarios where an acquisition includes assumed debt, borrowers often negotiate to exclude all assumed debt from capacity baskets. Minnesota-based corporations are frequently able to include these exceptions, which often take the form of absolute exclusions of assumed debt, with lenders occasionally including a provision requiring borrowers to specify the acquisition(s) that will trigger the exception.

Specified representations

Unlike other incremental debt, debt incurred in connection with acquisition financings may require only limited representations and warranties. Such limited representations are frequently referred to as “specified representations” or SunGard conditionality and are typically focused on fundamental issues such as:

• corporate status;
• enforceability of loan documents;
• conflicts;
• solvency; and
• lien status.

(While large sponsors have recently attempted to further pare back and qualify specified representations, lead arrangers have generally held firm as to their scope.) As a practical matter, by making only the specified representations, the borrower is able to act with expediency to effect an acquisition without first ensuring the full slate of typical credit agreement representations and warranties remain true.

Payment/bankruptcy defaults

Consistent with negotiating the specified representations, well-qualified borrowers may also pre-negotiate that lenders will only consider payment and bankruptcy defaults in the acquisition context so that borrowers can quickly effect an acquisition without encountering roadblocks in the form of less-material defaults. These types of more limited default blockers are usually reserved for investment grade credits; most credit agreements will also include default blockers triggered by a breach of financial covenants as well as reporting requirements. A few Minnesota-based borrowers have successfully negotiated such default carve-outs for incremental facilities for acquisitions, but such provisions have not been consistently adopted across the Minnesota market.

Lender protections

Lenders typically approach additional debt facilities incurred by borrowers with appropriate levels of caution. Given the risks involved with increased debt, lenders typically require certain protections be incorporated into the terms and conditions borrowers must meet to incur incremental debt facilities, ensuring new debt does not jeopardise the interests of existing lenders.

Loan maturity

One of the most critical protections involves maturity dates, and lenders often mandate that incremental debt does not mature prior to the existing debt or for 90 days or more after the maturity of the existing credit facility. This ensures that repayment of incremental debt does not take precedence over repayment of the original facility, preserving the seniority of existing lenders’ claims, and avoiding any preference claim in bankruptcy. Incremental facilities in large cap deals in Minnesota are generally required to mature after any existing facility, but some recent Minnesota facilities have included more flexible terms, such as for bridge debt, and a few deals in the last two years have expressly permitted maturity of incremental term loans prior to loans, particularly if the loans are under a certain percentage of consolidated EBITDA.

Guarantees/collateral

Incremental debt facilities typically require that new loans share the same guarantees and collateral packages as the existing loans, ensuring parity in security interests. This requirement applies when lenders are not taking all assets for their collateral, or for all-assets creditors that permit the exclusion of certain assets from the collateral package. Minnesota-based companies have received very few, if any, exceptions to the requirement that incremental debt share guarantors and collateral where such loans or notes are secured.

Mandatory prepayments

Incremental debt facilities are typically included in mandatory prepayment clauses, but only up to the same extent as any existing loans, to avoid prepayment of the incremental facility prior to any existing obligations. Recent debt facilities involving Minnesota-based borrowers have followed suit by including provisions that restrict mandatory prepayments of incremental facilities to a pro rata prepayment with existing facilities, with some Minnesota facilities including carve-outs allowing lenders to accept lesser payments.

Events of default and financial covenants

Existing lenders have an interest in ensuring their borrowers are not being required to meet extensive terms, conditions or other requirements outside those the existing lenders impose. For this reason, existing lenders typically do not permit incremental debt to dictate events of default and financial covenants that are materially more restrictive than those of the existing debt. Such limitations are standard in recent Minnesota-based credit agreements, with limited exceptions.

Most-favoured-nation clauses

Most-favoured-nation (MFN) clauses provide critical protections for lenders permitting incremental debt facilities by ensuring incremental debt facilities do not receive materially better terms than the existing loans. Borrowers and lenders typically negotiate what constitutes materially better terms, when the MFN clause will sunset, and other limitations and exceptions.

Pricing/effective yield

To define what materially better terms means for incremental debt, MFN clauses often require that the effective yield on incremental debt does not exceed the pricing of existing debt by more than a specified margin. A typical threshold margin is 50 basis points across the US markets, and Minnesota public companies have received similar margins, with a small number of outliers stretching to 75 basis points. The determination of the effective yield is generally determined by the borrower and lenders, but some have permitted the borrower to determine the yield on “good faith”. MFN clauses are not limited to interest rate pricing, but account for all interest margins and floors, original issue discount, and upfront and other fees. Consistent with the general market, MFN clauses in Minnesota typically do not consider any arrangement fees, structuring fees or other fees that are not shared with all lenders.

Sunsetting/term

Borrowers and lenders have a particular interest in negotiating the term of MFN protections. Borrowers typically seek to limit the duration of the MFN clause, while lenders want to ensure initial protections will remain in place, so borrowers are not providing substantially better terms to other lenders. Market conditions have dictated typical sunset provisions around 12–18 months, but Minnesota companies have recently successfully negotiated decreased sunsetting terms for large cap deals, landing between 6 and 12 months. On the other hand, some recent Minnesota-based deals have not included a sunset provision for MFN clauses.

Additional borrower limitations

As a result of MFN clauses restricting borrowers’ ability to raise new capital, borrowers have negotiated a number of additional exclusions and limitations on MFN clauses. Exclusions may include:

• incremental loans made in a foreign currency;
• loans of a certain size; and
• incremental debt for acquisitions.

Other provisions may remove MFN clauses for incremental loans:

• with maturity dates that extend a certain time beyond the existing debt;
• that accrue at a fixed rate of interest; or
• that are incurred under the leverage ratio basket.

Minnesota-based borrowers have seen recent success in negotiating additional limitations to MFN clauses, curbing the scope of their effectiveness. Such limitations include:

• restricting MFN clauses to only secured incremental loans that are pari passu with the existing debt in payment rights and security interest in collateral;
• size baskets that exclude incremental loans under a certain dollar amount;
• excluding incremental debt incurred under the free and clear incremental capacity basket; and
• exclusions for certain uses of incremental debt, like bridge loans and acquisition debt.

Conclusion

Incremental credit facilities will continue to evolve to reflect market innovations as lenders respond to the ongoing capital needs of their borrowers. Streamlined efficiency and operational flexibility are key hallmarks of incremental facilities, and their usage by Minnesota corporations as well as borrowers and financial sponsors throughout the market strata will likely further increase their utilisation in the coming years.