4 Reasons Why Mezzanine Debt is a Great Form of Transitional Capital Post Covid19

Posted on: May 7th, 2020

Transitional capital is extremely important now as businesses recover from the Covid-19 crisis. Many companies have stretched their working capital and incurred losses as the first quarter ended and the crisis extended into the second quarter. When working capital is burned on funding losses, liquidity is compromised. The longer the loss-making period, the further the strain on working capital, until the point of illiquidity is reached. Eventually, working capital needs to be built back up to normal levels in order to resume revenue growth. As companies plan to restart, they need to raise adequate transitional capital to restock working capital and to absorb monthly losses until breakeven is achieved. Mezzanine debt lenders are ideal capital sources to fund your restart.

Mezzanine debt lenders can see beyond the initial period, and structure loans around equilibrium levels of revenue and EBITDA. This ability to fill both the working capital and growth capital has huge value for a capital depleted business. Mezzanine debt lenders excel in this role due to their ability to structure loans on forward levels of cash flow in the form of pro forma EBITDA. Their ability to use the historical pre and post covid-19 EBITDA as reference points in their structuring decision enables them to make larger dollar loans that cover the full transitional capital need. This is not the case with most asset – based lenders, who can only lend an advance rate against eligible collateral.

In addition, because mezzanine debt lenders provide loans with long dated terms and back ended maturities, they are attuned to level of time needed to restart a business. As a cash flow lender, they know full well that things do not always go according to plan. Mezzanine debt lenders can fund the cash flow gap and extend your runway as you scale up to your equilibrium level of revenue. Their lending decision will evaluate the operational risk factors and amount of capital needed to get back to the pre-crisis level of EBITDA. They are keyed into your businesses’ long-term equity value and understand the start up is an unfolding process over time. Due to their usual lack of collateral in deals and dependence on long term cash flow generation, they are a patient lender who understands that ultimate repayment of their loan is through strong cash flow growth.

Here are the Attract Capital 4 Reasons why Mezzanine debt Lenders are a Great Source of Transitional Capital:

One Stop Shop – They can bundle working capital and growth capital into one loan structure, which makes it easier to close and deal with post-closing. Rather than have two lenders with two separate loan agreements, they can provide one integrated loan.
Cash Flow vs. Collateral Focus – Their loan will be dependent on cash flow growth, not collateral and will give you all important time to be able to get back on your feet.
Patient Approach – Mezzanine debt lenders are long term lenders and will allow you to grow beyond your historical baseline. They do require short term loan repayment, which allows you to keep more cash flow at work in growing the business.
Not Afraid of Temporary Losses – Due to their flexible underwriting approach, mezzanine debt lenders will not hold temporary extraordinary losses against you. They will look to the future, guided by your pre-crisis performance when evaluating your creditworthiness.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.