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15 November 2021 / news

Equity Commitment Letters: 7 things to pay attention to

If the signing and closing of a transaction does not take place on the same day, the seller runs a debtor risk on the buyer. This risk is even greater if the buyer is a newly established acquisition vehicle, that has not yet been provided with financial resources. An Equity Commitment Letter (ECL) offers a solution. But what should you pay attention to when setting it up?

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Newco: initially an empty shell without financial resources

In private equity practice, it is common for a private equity investor to use an acquisition vehicle (often known as "SPV," "Bidco," or "Newco"). It acts as the buyer in the purchase agreement and is often incorporated shortly before the purchase agreement is being signed. The capital that is paid up on the shares upon incorporation of Newco is usually only one euro. The further financing of Newco – often a combination of equity and debt, together just enough to pay the purchase price and transaction costs – only takes place shortly before closing.

However, signing and closing do not always take place on the same day. For example, because the transaction is subject to the approval of competition authorities or other regulators. Sometimes there is even a period of several months in between. In that case, the seller will require that the buyer provides security for the fulfillment of its payment obligations under the purchase agreement. After all, Newco has been an empty shell without financial resources all this time. Investment companies generally provide this security by means of an ECL, whether or not in combination with Debt Commitment Letter(s) from financing bank(s).

Security through the ECL

By means of an ECL, one or more (indirect) shareholders of Newco (usually: the entities that together form an investment fund) commit themselves to make financing available to Newco – at exactly the right time (just before closing). Newco is thereby enabled to fulfill its payment obligations under the purchase agreement. Although an ECL is often a document of only a few pages, it is from a deal security perspective an extremely important contract for the seller.

Points of attention ECL

I identify seven topics to pay attention to when drafting or assessing an ECL.

  1. Preferably the ECL is addressed not only to Newco but also to the sellerin order to make sure that the seller also can derive rights from the ECL.
  2. The obligations included in the ECL should cover not only the provision of financing for payment of the purchase price, but also (the settlement of) any claims if the buyer fails to properly fulfill its obligations under the purchase agreement.
  3. The amount committed under the ECL must be sufficient to also fund any future payment obligations of Newco, for example if an earnout has been agreed.
  4. Sometimes conditions are attached to the commitment provided underthe ECL, for example that the conditions precedent in the purchase agreement have been met. These conditions may not lead to the fact that the ECL becomes unusable for the seller.
  5. Due to the structure of the investment fund, the ECL is sometimes entered into by fund entities located in exotic countries. In order to avoid any complicated summons procedures, it is advisable to make an explicit choice of domicile for the Netherlands in the ECL.
  6. The duration of the ECL is also important. The investment fund will require that the obligations under the ECL end at some point, while from the seller's point of view this should only take place when the buyer has fully complied with its payment obligations.
  7. Finally, it is important that the ECL is available at the latest at the time of signing of the purchase agreement.

Simple document with great value

In addition to the purchase agreement, it is recommended that a seller pays the necessary attention to carefully negotiating and agreeing the ECL; at first sight a relatively simple document that can be of great importance to the seller.

Would you like more information about ECL or a conversation about this topic? Don’t hesitate to contact me or my colleagues at Loyens & Loeff.

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This column by Anke van Holthe tot Echten appeared in M&A magazine #3. Her column can be found on page 82 and 83.