Important Features of Mezzanine Financing

Posted on: June 21st, 2018

features of mezzanine financing Mezzanine financing is a distinctive form of capital that has more in common with equity than it does with a bank loan. From a practical standpoint, mezzanine financing resembles a loan as it carries an interest rate, a repayment term and places covenants and restrictions on the borrower.

Conceptually, the DNA of a mezzanine loan has more in common with preferred equity, due to its focus on cash flow, enterprise valuation and long term investment horizon.

Mezzanine is best understood through a holistic assessment of its defining features as opposed to contrasting it with a simple bank loan. The wide delta between interest rates on a bank loan and a mezzanine loan instantaneously creates pushback from a prospective borrower, if one is overly fixated on price.

Mezzanine is a sophisticated form of financing delivered through a high touch relationship-based process. It brings a high level of momentum to a borrower, enabling them to navigate a capital-demanding growth transition, be in an acquisition or an intense growth phase.

Mathematically, the navigational incline is too daunting for the company to bear through its own cash flow or a bank loan. Mezzanine financing provides the thrust for growing companies due to its large loan sizes, patient repayment term and supportive relationship approach.

Due to its cost and its requirements, it is meant for companies that have a dramatic growth opportunity that can use it to significantly scale the size of their business.

There are 5 important features of mezzanine financing that make it unique:

Mezzanine loans are based on cash flow growth as opposed to the static asset base of a business

Mezzanine lenders are able to qualify a borrower on its historical and future cash flow growth. They structure the loan as a multiple of EBITDA, or a percentage of the borrower’s cash flow value.

This is a major differentiator that allows asset light companies to qualify for financing significantly in excess of their hard assets. This creates valuable capital availability for headroom constrained growth companies.

Mezzanine loans require interest only to be paid over the term of the loan

Unlike virtually every other form of lender, mezzanine financing providers prefer to have 100% of their principal repaid at the maturity date. This lets the company keep the cash in the business and use it productively to scale up.

Mezzanine lenders do not require a personal guarantee from the owner of the business

Mezzanine lenders rely on the cash flow value of the business and do not require a secondary source of repayment such as a guarantee to extend the loan.

Mezzanine financing providers prefer basic, niche type businesses to lend to

Given the need for stable cash flow over the life of the loan, mezzanine providers prefer businesses with good margins, long term customers in healthy industries. They avoid commodity, real estate or customer concentrated situations.

Mezzanine loans adjust to your specific need

They can play multiple roles for a company including supplementing a bank loan or providing all of the funding needed. Their role is entirely dictated by the borrower as there is no limit as to how you can utilize the proceeds of their loan.

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.