Introduction
Most acquisition debt is raised for a target someone has already chosen. Debt for add-on acquisitions often works the other way round: much of it is negotiated at the buyout, before any target is known, as room inside the platform's credit agreement or as a delayed-draw term loan (DDTL) that lenders commit to fund later. When Instructure, the education software company then controlled by Thoma Bravo, agreed in October 2023 to buy Parchment for about $835 million, it needed no new financing package: $685 million arrived as an incremental term loan under its existing agreement. A financial sponsors group (FSG) shapes that result with the sponsor through three choices, made at entry and revisited during the hold: the route for each add-on, the capacity the plan needs, and the conditions that could block a draw.
Four Routes to Fund an Add-On
The four routes trade certainty against cost. Two are prepared at entry: a fungible add-on to the existing term loan within pre-agreed room, and a DDTL committed at closing. Two are arranged when the target appears: a new incremental tranche on terms the market sets that day, or a full refinancing.
| Route | Set up | What is certain | Main cost | Fits when |
|---|---|---|---|---|
| Fungible add-on to the term loan | Room agreed at entry | Permission to borrow, not the lenders | Fees, any discount to match the market | A market as strong as at entry |
| DDTL | Commitment at closing | The money, subject to draw conditions | Ticking fee while undrawn | A visible pipeline in the next year or two |
| New incremental tranche | When the target appears | Terms only once priced | Wider margin; old loans may reprice | Investors want different terms |
| Full refinancing | When the target appears | Nothing until signed | Highest fees, any call premiums | The add-on outgrows the documents |
Permission Versus Commitment
Incremental room is a permission, not a promise: the agreement lets the borrower add debt up to a fixed amount and then while a leverage ratio stays below a limit, as explained alongside the incremental and most-favored-nation (MFN) terms of the buyout package, but no lender must provide it.
- Incremental Facility (Accordion)
A provision in a credit agreement that lets the borrower add term loans or revolving commitments under the same documents, guarantees and collateral, within agreed limits and without a vote of the existing lenders.
A fungible add-on works only while investors will buy more of the same loan near its margin. If they want more, original issue discount (OID) or a separate tranche closes the gap, and the MFN clause may lift the old loans' margin too.
What a Delayed-Draw Commitment Costs
A DDTL turns capacity into committed funding for an availability period after closing, and each draw becomes part of the term loan.
- Delayed-Draw Term Loan (DDTL)
A term loan commitment that a borrower may draw, in one or more amounts, during an agreed period after closing, usually for acquisitions or capital spending. Draws are subject to conditions such as a pro forma leverage test, and undrawn commitments lapse when the period ends.
Lenders charge a ticking fee on undrawn amounts, so the instrument suits a pipeline the sponsor can already see.
What the Banker Pre-Wires at Entry
Debt capacity is cheapest to win while lenders compete for the buyout. Sizing starts from the acquisition plan in numbers: how many targets, how large, at what prices.
Sizing Capacity Against the Add-On Pipeline
Leverage tests usually run on pro forma EBITDA, earnings before interest, taxes, depreciation and amortization restated as if the target had been owned all year. A platform earning $200 million with $900 million of first lien net debt (4.5x) under a 5.0x limit can add $100 million on its own earnings. Crediting a target earning $30 million lifts the room to $250 million; at 11x, or $330 million, the other $80 million comes from cash or sponsor equity.
Leverage then sits at the limit, so the next add-on needs growth, the fixed amount or a "no worse" test, which allows acquisition debt that does not raise leverage: a target earning $20 million could bring $100 million. The gap between price and capacity, the $80 million above, is what a buy-and-build plan must budget; sector versions appear in the industrials guide's roll-up economics.
Conditions on the Day of the Draw
Room on paper fails if the conditions fail on the day, so the most valuable protection fixes the test date.
- Limited Condition Acquisition (LCA) Provision
A credit agreement term letting the borrower test leverage ratios, baskets and the absence of defaults when it signs a purchase agreement rather than when the acquisition closes. It protects an add-on not conditioned on financing from a fall in earnings between signing and closing.
It mirrors the certain-funds terms in sponsor commitment letters: a seller wants a buyer whose lenders cannot back out. DDTL draws usually require no default, repeated representations and pro forma leverage at or below the opening level, a draw test worth negotiating as hard as the size.
Instructure and Parchment: An Add-On Inside the Agreement
Thoma Bravo, which still held about 84% of the votes at the end of 2023, financed Instructure's 2020 take-private with private credit and moved to a syndicated loan after relisting it in 2021, its 2023 annual report shows.
| Date | Step | Terms |
|---|---|---|
| March 2020 | Take-private financing | $775 million term loan, Golub Capital agent |
| October 2021 | Syndicated refinancing | $500 million term loan, $125 million revolver, JPMorgan agent |
| October 30, 2023 | Parchment purchase agreement | About $835 million, cash plus incremental debt |
| February 1, 2024 | Second amendment and closing | $685 million incremental term loans |
The 2021 credit agreement set the incremental capacity: the greater of $204 million and 100% of EBITDA, plus unlimited first lien debt while pro forma first lien net leverage stayed at or below 5.00x or, for an acquisition, no higher than before. Its 100 basis point MFN cushion excluded acquisition debt, and acquisitions could be tested at signing.
Instructure's announcement of the deal put the net price, after a tax benefit, at about 16 times Parchment's expected 2024 adjusted EBITDA including cost synergies. Under the second amendment, Instructure treated the deal as a limited condition transaction, and the new loans paid 2.75% over the Secured Overnight Financing Rate (SOFR), matching the existing term loan: one fungible class, nothing for an MFN to catch. Thoma Bravo's own exit followed within the year, a sale to KKR and Dragoneer completed in November 2024.
Syndicated Loans, Unitranche and the Bank's Seat
The lender base decides how an add-on is negotiated and who can compete to arrange it.
Add-Ons for a Unitranche Borrower
A unitranche borrower deals with a few funds that hold their loans, so new debt is a negotiation with known lenders rather than a market test; the debt capital markets guide's unitranche article compares the structures. Risk Strategies, an acquisitive insurance broker then owned by Kelso & Company, shows the incumbent lender at work. In August 2023 Golub Capital, its lender since 2015, led a new delayed-draw term loan of $700 million, upsized from $500 million, taking the unitranche to $4.45 billion while keeping a meaningful share.
Where the Bank Earns and Whom It Competes With
An incremental pays an arrangement fee, usually smaller than a buyout financing's, but it sits beside advice on the add-on and the refinancing that follows. Incumbency helps without guaranteeing anything: Instructure's agreement states that the borrower need not approach any existing lender and may appoint any incremental arranger after consulting the agent.
Against a direct lender, a bank's opening comes when the platform outgrows its unitranche and syndicated loans would cut the spread, as weighed in the sponsor's choice between the two lending markets. Until then, capacity left, ticking fees running and test headroom belong in the bank's periodic portfolio review.
Well-prepared add-on financing leaves little trace. Instructure's $685 million appears in its filings as a second amendment to an existing agreement, not as a new financing; the work was done two years earlier, when the refinancing set the baskets, the MFN exceptions and the limited-condition test date. An add-on that needs a new package usually means the entry documents were written for a smaller plan than the one the sponsor is running.
