The dedicated basket is a floor: general investments, the builder basket and the J.Crew trapdoor decide how much can leave the credit group.
Add up every investment basket that can be used for an investment in an unrestricted subsidiary, not just the basket with that name, and then check whether a trapdoor lets the non-guarantor basket pass through as well. On an illustrative borrower with 100 of EBITDA, the dedicated unrestricted subsidiary basket is 20.0, the direct stack of baskets is 75.0 and, with a trapdoor, 115.0, 5.75 times the basket lenders usually look at. Moved at ten times EBITDA, that takes 11.5 of EBITDA outside the covenants and lifts leverage from 5.00x to 5.65x.
Worked in full in How to Read a Credit Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
An unrestricted subsidiary sits outside the credit agreement: it does not guarantee the loan, its assets are not collateral, its EBITDA does not count in the covenants and it can borrow on its own account against whatever it holds. Designating a subsidiary as unrestricted, or transferring assets to one, is treated as an Investment, so the question “how much can leave?” is answered by the negative covenant on Investments. That covenant is a list of baskets, and most of them are not labelled “unrestricted subsidiaries”.
| Input | Value |
|---|---|
| Consolidated EBITDA | 100.0 |
| Total debt | 500.0 |
| General investments basket | greater of 30.0 and 30% of EBITDA |
| Investments in unrestricted subsidiaries | greater of 20.0 and 20% of EBITDA |
| Investments in non-guarantor restricted subsidiaries | greater of 40.0 and 40% of EBITDA |
| Available Amount (builder basket) usable for investments | 25.0 |
| Unlimited investments if pro forma total leverage is at or below | 4.00x |
| Value of the asset moved, multiple of its EBITDA | 10.0x |
Unrestricted subsidiary basket = max(20.0, 20% × 100.0) = 20.0
This is the figure that appears in most term sheets and credit memos. It is a floor, not the answer, because the agreement almost always lets the borrower use any basket that permits Investments generally.
General investments basket = max(30.0, 30% × 100.0) = 30.0
Available Amount = 25.0 (see how builder basket capacity is calculated)
Ratio basket: pro forma leverage 500.0 ÷ 100.0 = 5.00x, above 4.00x, so closed
Direct capacity = 20.0 + 30.0 + 25.0 = 75.0
The baskets are cumulative unless the agreement says otherwise, and most agreements also let the borrower reclassify an investment from one basket to another later, which frees the first basket again as EBITDA grows. Both points are in the definitions and in the “for purposes of determining compliance” paragraph that usually closes the negative covenants.
Loan parties invest 40.0 in a non-guarantor restricted subsidiary under its own basket.
A clause permitting investments by non-guarantor restricted subsidiaries “made with the proceeds of Investments received from” loan parties lets that subsidiary pass the 40.0 on to an unrestricted subsidiary, without limit.
Total capacity = 75.0 + 40.0 = 115.0, 5.75x the dedicated basket
This is the structure that became known as the J.Crew trapdoor, after a retailer moved trademark rights to an unrestricted subsidiary through exactly this route. Where the non-guarantor basket is itself uncapped, the trapdoor makes capacity unlimited.
| Reading of capacity | Value moved | EBITDA leaving | EBITDA remaining | Leverage after |
|---|---|---|---|---|
| Dedicated basket only | 20.0 | 2.0 | 98.0 | 5.10x |
| Direct stack | 75.0 | 7.5 | 92.5 | 5.41x |
| Stack plus trapdoor | 115.0 | 11.5 | 88.5 | 5.65x |
Leverage on the restricted group rises from 5.00x to 5.65x without a euro of new debt, and the covenant test follows it. On collateral, at an illustrative enterprise value of 8x EBITDA, or 800, the 115.0 is 14.4 per cent of the value; loan-to-value moves from 62.5 to 73.0 per cent. And the unrestricted subsidiary can then raise new debt against the asset, ranking ahead of the existing lenders in respect of it.
Investments are measured at fair market value at the time they are made, usually as determined in good faith by the borrower. The lower the value placed on an asset relative to its earnings, the more EBITDA fits through the same capacity:
| Value / EBITDA of the asset | EBITDA leaving | Leverage after |
|---|---|---|
| 6x | 19.2 | 6.19x |
| 10x | 11.5 | 5.65x |
| 15x | 7.7 | 5.42x |
The greater-of baskets also grow with EBITDA, and the ratio basket opens once leverage reaches 4.00x, which happens at EBITDA of 125.0:
| EBITDA | Leverage | Dedicated basket | Direct stack | With trapdoor | Ratio basket |
|---|---|---|---|---|---|
| 80 | 6.25x | 20.0 | 75.0 | 115.0 | closed |
| 100 | 5.00x | 20.0 | 75.0 | 115.0 | closed |
| 125 | 4.00x | 25.0 | 87.5 | 137.5 | open: unlimited |
| 150 | 3.33x | 30.0 | 100.0 | 160.0 | open: unlimited |
The fixed floors keep capacity at 115.0 even when EBITDA falls to 80, which is precisely when a borrower is most tempted to use it. The grower basket mechanics explain why the floor, not the percentage, is the number to negotiate.
Reading the unrestricted subsidiary basket as the limit. A lender who sized the risk at 20.0 has missed 95.0 of capacity on this agreement. The protections that actually bind are drafting points: a cap on aggregate investments in unrestricted subsidiaries from all sources, a J.Crew blocker that bars material intellectual property from leaving and bars designating any subsidiary that owns it, removal of the trapdoor language, and a requirement that the borrower's valuation be tested against a fairness opinion above a threshold.
Capacity to move value to an unrestricted subsidiary is the sum of every basket that permits Investments, plus anything a trapdoor routes through non-guarantor subsidiaries: here 115.0 rather than 20.0, enough to raise leverage from 5.00x to 5.65x. The basket and MFN workbook on the companion page for the book lays the baskets of a full facility side by side.
A clause letting non-guarantor restricted subsidiaries make unlimited investments with the proceeds of investments they received from loan parties. It turns the non-guarantor basket into extra unrestricted subsidiary capacity. In the illustrative case it adds 40.0 to a 75.0 direct stack, for 115.0 in total.
Yes. The unrestricted subsidiary's EBITDA drops out of Consolidated EBITDA while the debt stays. Moving 115.0 of value at 10x EBITDA removes 11.5 of the illustrative borrower's 100.0 and lifts leverage from 5.00x to 5.65x with no new borrowing.
An aggregate cap on investments in unrestricted subsidiaries from all baskets, a J.Crew blocker on material intellectual property, deletion of trapdoor language and limits on reclassification. Without them, the illustrative agreement allows 115.0 to leave, 5.75 times the 20.0 dedicated basket.
This article is one calculation from How to Read a Credit Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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