Funding The Chasm Between Mezzanine Debt and SBA Loans

Posted on: March 14th, 2022

mezzanine debt

15 years ago, middle market business owners had limited loan options to fund their growing businesses. There were bank loans which needed collateral, and then more exotic loans such as mezzanine debt loans. The market has changed with the advent of the direct lending market. The SBA program has also become more attractive with the increase in loan sizes.

Today there are a multitude of options for growing companies to choose from, but the choices are still less than optimal for lower middle market deals. For deals of $10 million or less in financing size, acquirers are frequently faced with a choice between a mezzanine debt structure or an SBA loan. The SBA loan imposes a very onerous personal guarantee, which most owners would rather avoid. It also is non-scalable beyond the initial size limit of $5 million. So, if you need more financing to support a dynamic roll-up, this loan must be refinanced.

Flexibility of Mezzanine Debt Loans

Mezzanine debt loans are more flexible size-wise and are certainly scalable, but they are increasingly expensive, especially for deal sizes under $10 million. With an interest rate of 12% and an equity piece of 5%+, most mezzanine debt lenders are nearly twice the price of an SBA loan interest rate, before the equity is factored in. Most private debt funds, due to their size of assets under management, are not able to provide loans under $10 million. This has created a large void in the lower end of the middle market, a segment thirsty for growth capital.

With mezzanine debt loans too expensive and SBA loans insufficiently large and unattractive to the owner, there is a growing chasm of funding need for scale-up oriented businesses. This funding chasm is increasingly being filled by middle market, C&I lending groups within strong regional banks. These are not the megabanks, with trillions under management but much smaller, regionally focused banks typically with assets ranging from $10 billion to $100 billion.

If a company can present itself as a highly professional, growth platform similar to how a private equity backed company would present, these banks will likely have interest. These banks will provide a debt structure similar to a mezzanine debt loan, at pricing even lower than an SBA loan. Best of all, these banks will be able to support the future capital needs of the company through acquisition facilities and increased lines of credit.

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.