Funding Leveraged Dividends through Mezzanine Debt Capital

Posted on: March 21st, 2024

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Business owners are increasingly turning to mezzanine debt-based, leveraged dividend deals as a stopgap measure for liquidity in lieu of selling into a lukewarm market. This makes complete sense given the abundance of debt capital in the form of unitranche financing, mezzanine debt and structured equity. Leveraged dividends give the owner a cash out without giving up significant equity and can be combined creatively with other uses of funds such as growth capital, acquisition financing and working capital support.

Evolution of Mezzanine Debt: Enabling Holistic Capital Solutions and Liquidity Needs

This transaction structure can function as a holistic capital solution to both the needs of the owner and the liquidity needs of the business. The emergence of structured equity funds which provide an integrated package of debt and equity, provide another source of funding for this type of transaction. Historically, mezzanine debt lenders were less likely to consider large scale leveraged dividends due to their lack of alignment with the owner. They would fund dividends but usually on a small scale and as an adjunct to a more substantial pro-growth capital investment. With fewer sell side deals to fund, and a growing focus on founder owned companies, non-control capital providers are actively pursuing these deals as a way to deploy capital and build relationships that may convert to full sell-side financing opportunities down the road.

For companies with EBITDA greater than $10 million, these deals get done in the 4.0 to 4.5 times EBITDA leverage range. They tend to be for companies that have referenceable market valuation benchmarks. The goal of mezzanine debt lender or structured equity provider in these types of deals is to co-exist with the senior lender and be in a non-controlling, passive position. They are unsecured or in a second position and influence the company through covenants set a discount to the bank levels. Mezzanine debt lenders continue to adapt to the changing middle market and have proven their adeptness at developing value added approaches that keep them at the forefront of relevance as valued capital providers.

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.