Difficult Deal Types for Mezzanine Debt Lenders

Posted on: May 20th, 2023

mezzanine-debt

Mezzanine debt is a superior form of capital replete with flexibility, patience, and situational versatility. It unlocks greater funding availability for companies in need of scale-up capital for transitional periods. Unlike more staid loans such as bank and asset-based loans which help fund day to day capital needs, mezzanine debt is like jet fuel in its ability to fund large growth steps, such as acquisitions and accelerated growth. Despite its clear advantages in the lending market, it has very particular use cases.

Many new sponsors or entrepreneurs are instantly attracted by the prospect of a larger loan size and try to apply a mezzanine debt framework to their growth plans. This is a judicious exercise to undertake, and has big educational value for the participant. Nonetheless, their deal’s use case falls short of qualifying for mezzanine debt for several reasons. Often it is a startup which is too risky to underwrite. Other times it is the type of business, in an industry, that is off limits. Here are profiles of deals that middle market mezzanine debt lenders generally avoid.

Real estate or big project-based businesses.
Overly concentrated customer or regional businesses.
Commodity-type businesses.
E-Commerce businesses with overly virtualized business models.
Firearms or Ammunition businesses.
Start up or loss-making businesses.

Real estate development or acquisition businesses are a different field of finance and not focused on by middle market, corporate focused mezzanine debt lenders. Overly concentrated businesses lack the all-important spread of risk that mitigates downside. Commodity businesses are generally low value added, and not differentiated enough. E-commerce businesses are generally highly competitive and lack long-term staying power. Firearms or Ammunition business are prohibited per their limited partners. For a deal to work, a mezzanine debt lender must see stable historical cash flow and a high likelihood of cash flow growth in the future. If your deal profile aligns, a mezzanine debt structure will provide significant value to your acquisition strategy.

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.