Factoring as part of an acquisition financing? Here is how to avoid some pitfalls!

Factoring can be used in M&A transactions to finance working capital requirements of the target companies. It is pretty straightforward to implement, can achieve a true sale, may work for target groups with lower credit ratings and can therefore be an alternative to a trade receivables securitization. But the carve-outs negotiated in the loan documents must address the particularities of factoring to avoid renegotiations, waiver processes and unnecessary costs.

Representations and warranties, undertakings and the relevant definitions must be adjusted:

• The description of the factoring facility as “Permitted Indebtedness” and the relevant baskets must appropriately consider the particularities of factoring.
• Do not forget: factoring must also be permitted as a “Permitted Disposal”.
• Mandatory prepayment provisions must allow for factoring proceeds to be used to satisfy suppliers.
• Security interests created in respect of the factoring facility must be excluded as “Permitted Security”.

The receivables must be released and reassigned by the Security Agent, acting as trustee for the other syndicate banks:

If factoring is clearly permitted under the terms of the loan agreement, the Security Agent is typically authorized to release and reassign the receivables, but flaws in the documentation may require Majority Lenders’ consent.

• Avoid conditions to the release – for example, an assignment of purchase price claims against the factor as a trade-off for the release does not work: according to the German Federal Court of Justice, this may be considered as an act of bad faith vis-à-vis suppliers of the seller of receivables.
• Consider involving the factor already in the negotiations of the loan agreement and the security documents. This will avoid surprises and allow managing the lenders’ expectations. Having a factoring facility in place at closing may also increase the degree of certain funds.

Interested in the details? I have published a German language article in the M&A Review.