Go Long with Mezzanine Debt and Growth Equity

Posted on: December 21st, 2020

All businesses go through growth spurts. Some are temporary and others, long lasting and transformative. Temporary growth usually occurs due to a market shift that provides a short-term window of opportunity. Long lasting growth usually occurs due to proactive business development strategy where a company attacks a new market or launches a new product or service.

Temporary growth may be strong for a few quarters and can usually be financed through internal sources through cash flow or a line of credit. With strategic growth, the company adds a new layer to the business model. New products need investment in R&D and new channel partners. New distribution approaches need new systems and people with the requisite expertise. Companies must invest in their infrastructures to widen their resource bandwidth and diversify their specialization to ensure they are equipped to manage strategic growth.

These investments cannot be funded solely through cash flow or the line of credit but require stable, long term forms of finance such as mezzanine debt and growth equity. Strategic investments require investors with long term hold horizons with capital repayment flexibility. Mezzanine debt lenders and growth equity investors understand the delicate process of strategic growth. Their capital is perfectly suited for businesses with heavy investment needs who need a few years for the investments to bear fruit. These investors exist to fund businesses because of their cash flow growth potential. They play further down the risk spectrum than banks, and receive a higher risk adjusted rate of return because they add more value.

Where a bank wants principal payments to start in the first year, mezzanine debt lenders usually start in the year 3, giving the company valuable breathing room. Mezzanine debt lenders fund at higher EBITDA multiples than banks, giving their borrowers more capital to invest and allow for longer repayment terms, giving them more time to repay the loan. The amplification of loan size and loan tenor gives borrowers a double benefit. This is why capital providers such as mezzanine debt lenders and growth equity investors, are strong long term funding partners. They allow companies to go long and fund their transformative, strategic growth visions.

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.