Change of Control Provisions

Ownership threshold triggers: Most common definition: sponsor ownership falling below 35% of voting equity (some deals 40-50% threshold). Example: PE firm owns 60% of company post-LBO. Sells 30% through secondary sale to new investor. Sponsor now owns 30% (below 35% threshold) → change of control triggered. Alternatively, sponsor sells company entirely to strategic buyer → clear change of control regardless of percentages.

Board control tests: Alternative definition focuses on board composition. Change of control if sponsor loses right to elect majority of board or designate key officers (CEO, CFO). Useful for structures with dual-class shares or complex voting arrangements. Example: Sponsor owns 40% equity but maintains 60% voting rights through Class B shares. Selling Class B shares triggering board loss constitutes change of control even if economic ownership stable.

Asset sale triggers: Sale of 'substantially all' assets typically defined as >35-50% of consolidated assets or >50% of EBITDA. Prevents borrower from avoiding change of control by selling company in pieces rather than single transaction. Example: Company with three divisions generating $10M EBITDA each. Selling two divisions ($20M of $30M EBITDA) triggers change of control even though parent company continues operating remaining division.

Permitted transfers and exemptions: Typically exclude from change of control: (1) Transfers among sponsor's affiliated funds, (2) Public market purchases by unaffiliated investors below 10% threshold, (3) Estate planning and charitable transfers by founders, (4) Pledge of equity to secure sponsor-level debt (as long as no foreclosure), (5) IPO or SPAC transaction where sponsor maintains >35% ownership post-transaction. These carve-outs provide sponsor operational flexibility without triggering provisions.

Mandatory prepayment offers: Most common remedy—borrower must offer to prepay 100% of outstanding principal at 101-102% of par within 30-60 days of change of control. Each lender decides individually whether to accept. Example: $100M loan outstanding. Borrower offers 101% prepayment ($101M). 70% of lenders accept ($70.7M payment), 30% remain ($30M outstanding). Borrower must fund accepted amounts from transaction proceeds or equity.

Consent rights and event of default: Some facilities make change of control an event of default requiring affirmative lender consent (majority or supermajority). Gives lenders negotiating leverage—can demand fee (25-50 bps), interest rate increase (25-50 bps), or amortization schedule changes as condition of consent. Sponsor faces binary choice: meet lender demands or restructure transaction to avoid trigger.

Automatic acceleration provisions: Aggressive terms make change of control an automatic event of default triggering immediate acceleration of all debt. Rare in modern sponsored deals but common in non-sponsor middle market. Creates blocking right—transaction cannot proceed without refinancing entire debt stack. Forces borrower to refinance at market rates (often higher than existing deal), potentially killing transaction economics.

Step-up pricing: Alternative to prepayment—interest rate increases 200-300 bps upon change of control. Allows transaction to proceed with debt remaining in place but at penalty rate. Example: Existing loan at L+400. Upon change of control, rate increases to L+650 for remaining loan life. Present value loss to borrower ~$10M on $100M loan over 5 years—substantial penalty but avoids upfront repayment.

Sponsor-to-sponsor portability: Allows debt to transfer to qualified buyers without triggering change of control. Typically requires: (1) Buyer is 'approved sponsor' (institutional PE firm with $1B+ AUM), (2) Pro forma leverage maintained or reduced, (3) No diminution in collateral value, (4) Buyer assumes all borrower obligations. Example: Apollo sells portfolio company to KKR for $200M. Debt portable, transfers to KKR without prepayment. Seller receives full $200M, buyer assumes $100M debt.

Restricted vs unrestricted portability: Restricted portability limits transfers to pre-approved sponsor list or sponsors meeting credit criteria. Unrestricted portability allows transfers to any buyer maintaining financial covenants. Unrestricted typically costs 50-75 bps in upfront fees or ongoing spread. Restricted more common—balances sponsor flexibility with lender credit protection.

Strategic buyer exclusions: Portability often excludes strategic/corporate buyers—only allows sponsor-to-sponsor transfers. Rationale: corporate buyers may have existing debt obligations, integration risks, or weaker covenant packages. Lenders prefer portfolio company maintaining standalone credit profile with financial sponsor backing. Strategic sale triggers full repayment offer.

IPO carve-outs: Portability may extend to IPOs if sponsor maintains minimum ownership (35-40%) post-transaction. Allows company to go public without prepaying debt. Example: Sponsor takes company public, retains 45% ownership. Loan remains outstanding as public company debt. If sponsor subsequently sells below 35%, change of control triggers. Creates two-step exit path—IPO first, sponsor sell-down second after debt refinanced in public markets.

Leverage in negotiations: Sponsor leverage strongest in competitive deals with multiple lender bids. Can negotiate full portability, high prepayment premiums (102-103%), and wide permitted transfer exceptions. Lender leverage strongest in sole-source situations or when borrower needs lender relationship for future financings. Results in restrictive change of control with limited portability and event of default triggers.

Market standard evolution: 2010-2015: Change of control typically event of default, limited portability, 101% prepayment. 2016-2022: Portability became standard for institutional sponsors, prepayment offers instead of defaults. 2023-2025: Pendulum swinging back to lenders—restricted portability (pre-approved list), lower premiums (101%), more transfer restrictions. Reflects lender negotiating power in tighter markets.

Strategic considerations: Sponsors evaluate change of control provisions at portfolio company acquisition. More restrictive provisions reduce exit optionality and increase hold period risk (if can't sell without refinancing debt). Sponsors may pay 25-50 bps higher interest rate for portable debt—present value ~$5M cost on $100M loan but worth it for $50.5M prepayment savings at exit. Math: 50 bps × 5 years × $100M = $2.5M cost vs $50.5M prepayment = obvious benefit.

Lender mitigation strategies: Direct lenders protect against portability risk through: (1) Minimum equity requirements for transferee (40%+ sponsor equity), (2) Financial covenant tightening upon transfer, (3) One-time consent fees (25-50 bps), (4) Approval rights over transferee identity, (5) Enhanced reporting requirements post-transfer. These provisions balance sponsor flexibility with lender credit protection—allows transfers but with guardrails ensuring credit quality maintenance.