Mid-market lenders are using a position of relative strength in a risk-off environment to hit back at over-engineered EBITDA adjustments that were the norm in dealmaking barely a year ago.  

The global pandemic ushered in widely accepted operational cost – and synergy-adjustments to EBITDA calculations as sponsor-led deals flourished. But now, amid increased interest rates, rising macro-economic uncertainty and a dearth of deals, lenders hope to soften the blow by both curtailing leverage and the EBITDA it is ultimately based on.  

With fewer deals and less cherry-picking available to all, financiers are reining in control on EBITDA hard caps, which are expressed as a percentage of EBITDA prior to relevant adjustments. Where previously 25% of EBITDA was acceptable, now lenders are willing to swallow only 10%–20%, market participants have said.  

The inclusion of some cost savings and synergies will still be permitted but not all cost control, restructuring and operational improvements will make the cut.  

“Vendors are scaling back EBITDA exceptionals. There are clearer caps that we are seeing with banks and funds. Both are coming back to 10%; 20%, at the maximum, is what they will reasonably accept,” one European lender said. “They (vendors) can't do anything with an adjusted and real EBITDA that are too far apart. They have woken up.”  

Sectors that have been hit particularly hard include healthcare, favoured by investors on both sides of the aisle. Large swaths of adjustments related to cost synergies vendors hoped to achieve in some uncertain future based on a buy-and-build strategy, sources noted.   

More broadly, buy-and-build cases required lenders to take a leap of faith on reaching the proposed adjusted version of EBITDA in some uncertain future, sources said.  

“People have realised that there is a lot of nonsense, particularly in their portfolio, let's say with credits from around 2021,” a financier at a major European bank said. “I think experience and circumstances are making it clear that it can't go on like this.”  

A case in point is the ongoing sale of German RFID-specialist Elatec, where the vendor broke out adjustments to the EBITDA amounting to less than EUR 200,000, a source familiar with the situation said. Leverage pitches on the business landed at around 4.75x with the jury out on structuring earnings as forward looking FY23 EBITDA was projected to reach EUR 26.9m, a 50% increase on last year’s reported figure, as reported.  

An auction for UK’s dentistry chain Clyde Munro was parked in March by sponsor Synova as the financing environment remained challenging, as reported by Debtwire sister publication Mergermarket. Here, too, lenders were structuring off GBP 5m of EBITDA and scaling back adjustments related to synergies from potential acquisitions: a far cry from the GBP 10m it was being marketed off. 

The sale of Rad-x hit a snag late last year with aggressive EBITDA adjustments related to a buy-and-build plan that didn’t reflect its actual performance, as reported. Many sponsor buyers backed out of the process to acquire the Gilde Healthcare-backed German radiology business, as it was marketed off EUR 25m to EUR 30m of EBITDA while its real EBITDA lay closer to EUR 13 to EUR 15m. 

“The equity people will assume they will achieve everything they say they are going to achieve,” a European debt investor said. “That is their upside, but the debt guys will be more cautious and assume that they won’t achieve all of what they are saying and structure the leverage off a lower EBITDA number.”  

Lenders are unlikely to push back on tangible adjustments such as those related to a factory closure, reducing headcount or restructuring-related operational cost reductions, the debt investor noted. It gets trickier when synergy costs related to future benefits get spun out.  

“This is often where we start to say ‘hang on, no, not really. Two years is a long time. I don’t know if you will be able to fully realise this,’” the investor noted.

Those same adjustments also won’t be accepted on an unreasonable time scale. “It was common to see that people were allowed to use the adjustment for 18 months – sometimes even 24 months – this is almost certainly now back to 12 months,” another mid-market direct lender noted.