In the previous Covington alerts published on March 25 and April 7, we gave an overview on the various German State aid programs that are available for German companies facing liquidity difficulties due to the COVID-19 pandemic, and subsequent shutdown measures. It was clear from the beginning of the pandemic that many German companies would quickly face serious liquidity shortages, therefore, the German Federal State acted quickly to implement an unprecedented large-scale State aid package, accompanied by government officials' relentless assurances that the State aid would be granted in an "un-bureaucratic" way. Several weeks into the pandemic, what does this State aid process look like in practice?
Three major instruments for COVID-19 German State aid
- The major instruments for granting financial aid to distressed companies are:
- The KfW special loan program with various options for different sizes and classes of companies. KfW loans are granted via the house banks, with KfW backing 80% or even 90% (for SME) of the credit risk (for a more detailed description see our alert dated April 7);
- the various guarantee programs at Government and federal state level which in practice are more flexible than the KfW loan program; and
- the state guarantee and direct participation program administered by the Economic Stabilization Fund (ESF); essentially a department of the Federal Ministry of Economics and Technology (for a more detailed description see our alert dated April 7).
Shareholder structure does not affect eligibility for State Credit Programs
Generally, these programs are available for all German-based companies, regardless of their ownership structure. It does not matter where shareholders are located, or whether and to what extent shareholders are private persons, strategic investors, funds, or financial investors. Private equity-backed German companies, in general, also qualify for these programs. According to a recent statement of the KfW, these companies can be supported regardless of the size of the private equity stake. However, in the case of a significant influence of private equity investors—i.e., 20% or more of the voting rights—KfW requires that no dividends to or withdrawals for the investors are made during the term of the new loan. These requirements do not pose actual restrictions to existing private equity structures.
LBO-financing structure may prevent granting of State aid
However, most private equity-owned companies are already highly leveraged. Therefore, the German state/KfW, depending on the actual existing leverage ratio, often asks for a "super senior" status for the new loan. This means that the state/KfW loan has to be repaid before the existing debt facilities (“last-in, first-out”). Further, the state/KfW often expects to be secured pari passu with the same security package as the existing lenders.
To grant this super senior status, the unanimous consent of all existing lenders is required. Not only is it often impossible to get consent from each lender, in particular, in the case of a large credit consortium, lenders may not be willing to grant a super senior status to state/KfW loans from a commercial perspective.
In practice, this means that the state loan/guarantees are often not accessible to private equity-backed companies. Consequently, at least for the time being, the strategy for many private equity-backed companies seems to be not to raise additional debt during the pandemic. However, it is likely that many private equity-backed companies will not be able to avoid a debt restructuring in the near future. Therefore, we anticipate a restructuring wave in the second half of the year.
If you have any questions concerning the material discussed in this client alert, please contact the following members of our Private Equity practice.
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