The Grey Zone: What’s Quasi-Debt Anyway?

Posted on: October 25th, 2016

Quasi debt, whose examples include mezzanine financing or subordinated debt, is defined as a category of debt that has some traits of equity either through an unsecured loan, or via a flexible loan repayment schedule.

However, very often investors and entrepreneurs are wary of quasi-debt thinking it belongs in the grey zone. This article seeks to discover the features of quasi-debt, the role it plays and whether it deserves to be placed in the grey zone.

What exactly does quasi-debt mean?

Firstly, quasi-debt, by filling the gap between debt and equity reflects some of the characteristics of both. To some investors it is more of an equity instrument, whilst to others, it is more of a long term loan. Quasi-debt is a loan that is flexible and which has alignment with long term growth of the borrower.

When can quasi-debt be used?

Quasi-debt is most suitable when a bank loan will not provide enough capital or where equity capital is too expensive or dilution. It often bridges the loan structure and the equity structure in a transaction.

It is well suited for acquisition financing, growth capital or refinancing needs of middle market companies.

What are the features of quasi-debt?

Quasi-debt is usually a cash flow based loan which means its repayment is based on future cash flow. If the company is not successful long term, the repayment of quasi debt is at risk.

The term is often 5 years or greater and the principal repayment is usually a balloon on the maturity date. Typically, the quasi debt provider has some return kicker in the deal such as warrants to provide them additional return tied to the increase in underlying share value.

Can quasi-debt be placed in the grey zone?

Not necessarily. Quasi-debt comes with its own set of advantages for both the investor and entrepreneur.

Quasi-debt provides a more equal sharing of risk and reward between investor and investee. It also offers a valid financial structure for those unable to secure a bank loan or are unwilling to lose control of their company through equity.

As the Fed decides to ease interest rates, middle market acquisition financing structures will benefit in a number of ways. The underlying values of middle market companies will increase leading to a higher enterprise value and lower loan to value ratios for existing portfolio companies of acquisition financing lenders.

The role of acquisition financing is infrequently elevated above a functional transactional one. When a business needs financing to acquire, they go to the market and source acquisition financing to supplement their equity investment to close the deal. Despite existing in many different forms, acquisition financing is rarely explained in terms of the value it brings to the acquirer.

Acquisition financing underwriting usually focuses on business and financial issues that underpin the stability of cash flow. Providers of acquisition financing usually validate the durability of a company’s competitive advantage and the depth of its resource base. Environmental issues are usually not a major part of the analysis in today’s service and technology-based economy.