How to Tame a Rouge Mezzanine Debt Lender

Posted on: September 13th, 2024

mezzanine-debt

Mezzanine debt lenders are usually passive with their borrowers once the deal closes. They typically fund transformative acquisitions or growth strategies for middle market companies and take a long view on principal repayment. Mezzanine debt lenders have increasingly migrated to funding companies on a direct basis where they are the primary provider of capital. These companies tend to be founder-owned or owned by independent sponsors as opposed to private equity-backed thereby offering a higher risk/return profile for the lender.

Sometimes mezzanine debt lenders like the returns of direct lending but are not set up to deliver the right portfolio management touch to the company. They use inexperienced, rookie talent with textbook approaches to manage a situation that requires high level business skills. Sometimes mezzanine debt lenders regret the fundamental risk-return profile of their loan, after the deal closes. If they underwrote their loan based upon the intrinsic value of rollover equity, post-closing they can suddenly see themselves as the only party with capital at risk, which seriously diminishes their view of the owner’s equity skin in the game.

How to get Protected from Rogue Mezzanine Debt Lender

This insecure view may lead them to think they should own more of the company; despite the fact they were perfectly content with their economic returns when the deal closed. This can lead to a mezzanine debt lender taking aggressive steps and ultimately acting in a way that they are not contractually authorized to act. When this happens, there are a number of ways a company should respond to protect themselves and ensure the rogue behavior of the lender does not damage the company.

Focus on gaining the support of your senior lender – most mezzanine debt deals have a bank loan and a subordination agreement between the bank and the mezzanine lender. If there is a default, the senior bank has the power to block interest payments and force the lender to a standstill.
Over communicate with the mezzanine lender – just because they are acting aggressively does not mean they are not due the same level of reporting required in the credit agreement. Make sure you continue to provide monthly financial reports.
Do not be afraid to document your defenses in a legal letter to them- Get an experienced work out lawyer who can document your view of their behavior and push back on them. Mezzanine debt lenders are not owners of the company and do not have the right to steer the company.
Refinance them out– Once a lender has gone rouge, it is best to turn the page and swap them out with a new lender.

In middle market finance, mezzanine debt lenders have their own unique communication style. Due to their position in the market and their hybrid debt-equity sensibility, their perspective straddles both the debt and equity world. While mezzanine debt lenders issue loans, they think more expansively about value like the way equity investors do. Their capital is used to accelerate growth resulting in increased levels of cashflow sufficient to repay the initial loan amount.

As a foolish consistency is the hobgoblin of little minds, so too are many of the acquisition financing myths that people hold. These acquisition financing myths are borne of cliches that arise in the wall street vocabulary and enter the archetypal story telling of acquirors. For some reason, very smart and serious business people adopt these myths without much assessment of the underlying logic.