Why Transparency Pays with Mezzanine Debt Lenders

Posted on: March 23rd, 2023

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During strategic roll-ups, unusual events unfold that deviate from the original plan. A lot of the ultimate success of the rollup depends on how these events are perceived by the mezzanine debt lender. If the borrower manages the presentation of these surprises in a transparent and upfront manner, it helps the mezzanine debt lender build confidence. If these events come across as random, deus ex machina- type events occurring in uncontrolled fashion, the mezzanine debt lender expects more negative surprises in the future.

As in most things in life, how these surprises are contextually framed and communicated is of paramount importance. Most smart mezzanine debt lenders expect surprises post-closing as they do not expect their borrowers to be omniscient. They know markets change, employees leave and customers sometime leave as well. These are immutable laws of middle market companies following a major acquisition or sale of the company. These very dynamics are the risk factors that mezzanine debt lenders get paid to bear as part of their risk assumption in the transaction.

Seasoned mezzanine debt lenders look to back companies with highly experienced managers who are well versed in managing in unpredictable environments with a high degree of change. Most initial post-closing surprises are caused by something outside of the company’s control. While even the best management teams cannot control what goes on in the external environment, they absolutely do control how they engage with these events once they become problems. Management is 100% responsible for how they react including their speed, forcefulness, and sustainability of follow-up.

A quick response reaction shows they have a high level of situational awareness of the business. A forceful response shows they can gauge big problems quickly and act with intensity. Good management teams react intelligently to events and convey their operational engagement in a transparent light to their mezzanine debt lender. While the lender may not be happy with the company’s problem, they will continue to have faith in the management team, as long as they feel plugged into what is going on and where it is heading.

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.