Mezzanine Debt Participation in the Post Covid Deal World

Posted on: November 27th, 2020

mezzanine debt participation in post covid deal world

As the mergers and acquisition market rolls to the end of 2020, deals that were once straightforward have acquired a few twists. Pre-Covid, Banks were aggressive with commercial and industrial lending, especially with acquisition loans. They would fund 3 times to 3.5 times EBITDA on a senior debt basis for middle market deals, with 5 to 7-year amortization. For independent buyers, this became a one stop source of debt capital for their acquisitions. When this happens traditional middle market mezzanine debt lenders are not part of the conversation and resort to other more equity-like strategies to deploy capital.

Mezzanine Debt Lenders in Middle Market Funding

With banks now retrenching, mezzanine debt lenders are suddenly stepping back into the front lines of middle market deal funding. Many have brand new funds and can lend at debt multiples that buyers need to get their deals done. Whereas a bank would have provided a debt facility of $10 million including a line of credit of $3 million and a term loan of $7 million last year; this year the banks can only do a line of credit of $3 million and a term loan of$2 million, creating nice $5 million opening for enterprising mezzanine debt lenders flush with dry powder.

The mezzanine debt approach is different from a bank. Their lack of a personal guarantee from the buyer forces them into more rigorous cashflow and balance sheet underwriting. Whereas a bank may look to overall asset values and high-level financial analysis, the mezzanine debt lender will care more about the company’s ability to manage its working capital and produce cash flow.

Most mezzanine lenders over the last 10 years self-selected into one of two camps. Those that do PE backed deals and those that do independent deals. Independent oriented mezzanine lenders are the ones being most aggressive right now, as they see a great entry point to generate good returns. Mezzanine debt is likely to continue to have a strong run into 2021 and beyond, as long as Covid -driven economic volatility is a reality. The underwriting rigor and flexibility of the mezzanine lenders will serve them and their independent buyers well during this uncertain time.

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.