Does my Company Qualify for Mezzanine Debt

Posted on: March 17th, 2021

mezzanine-debt

This question gets posed quite frequently, as there is little definitive industry guidance on mezzanine debt for non- Private Equity backed deals. Usually, mezzanine debt is suggested by a company’s banker or accountant when a company needs more financing than their bank can deliver. Often the disconnect between the capital need and bank capital available can be large. As companies become more service and tech focused, their balance sheet assets tend to contract and banks struggle to find collateral to lend against.

Mezzanine Debt and Cash Flow

Independent business owners see mezzanine debt as a loan against their cash flow, as way to close their funding gap. Then comes their introduction to the criteria of middle market mezzanine lenders when theory gives way to reality. In theory, the concept of mezzanine as financing predicated on a multiple of EBITDA can be applied to any company or financing situation. In reality, there are a number of qualifying criteria, that businesses need to be aware of.

Here are the top 6 screening criteria for middle market mezzanine debt deals.

Company size – most middle market mezzanine lenders will use revenue as the yardstick for company size. Their minimum revenue level is $10 million. Some lenders will dip below that situationally, but most mezzanine debt funds, particularly SBIC’s require at least $10 million in revenue.
Company EBITDA – most mezzanine lenders use a minimum EBITDA level of $2 million. Some will dip down to $1.5 million but most stay at the $2 million level. This level of EBITDA is a function of their view of the credit risk of small businesses as an asset class.
Minimum Loan size – The minimum loan size is in the $4 to $5 million range. This is the ticket size for most middle market funds. As funds become more successful, they usually raise successively larger funds, and they tend to increase their minimum level. It takes the same amount of work to do a $5 million deal as it does a $10 million deal, so it is more economic for funds to make the jump to larger loan sizes.
Industry type – most mezzanine funds will consider a broad range of industries but there are several disfavored industries. These include real estate, commodities, lending, gambling, and start-ups.
Business Model – if the business is too cyclical, too concentrated on a few customers or a region, or a turnaround, then it is likely not a deal for a mezzanine debt lender.
Margin Structure – mezzanine debt lenders are keenly focused on the EBITDA and gross margin percentages of a business. For them, this is an indication of specialization and market power. If a business has an EBITDA percentage of greater than 10% or gross margin percentage of greater than 30%, then it is likely a fit for a mezzanine debt lending approach.

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.