Posted on: February 20th, 2015

Lower Middle Market Mezzanine Debt The middle market can be divided into three distinct segments- lower middle market, core middle market and upper middle market. Companies with EBITDA below $10 million are generally classified as lower middle market. They are typically family or entrepreneur owned where individual customer wins and losses can greatly impact the company’s performance. The core middle market comprises of companies, which fall within $10 to $75 million of EBITDA and companies that fall in the above $75 million bracket of EBITDA or more are generally termed as upper middle market. They are most often publicly held or sponsor backed.

The importance of mezzanine debt for lower middle market companies

Lower middle market companies generally get their financial funding from local banking sources. However, very often when a growth opportunity or an acquisition deal presents itself, such companies often find a shortage of local capital sources. While senior debt may be difficult to obtain, opting for equity capital does not always present a favorable alternative. It is challenge for lower middle market companies to access government-sponsored entities such as Small Business Investment Companies (SBICs) or public entities such as Business Development Corporations (BDCs), due to their qualification requirements. In such situations, mezzanine debt, can prove to be the best choice for a lower middle market company.

Mezzanine loans come with the advantage of requiring no principal payments and only interest payments for the first 3 to 4 years. Furthermore, mezzanine loan structures are extremely flexible with the loan maturing in 5-7 years. Mezzanine providers generally provide mezzanine debt on an EBITDA multiple basis- the standard mezzanine debt multiple being 3.5 times EBITDA. The typical interest rate charged is approximately 12% per annum. The lender also receives additional return upside based on the future growth of the business. The amount of funding coupled with the low cost and structural flexibility, makes this a suitable option for a lower middle market company with a strong cash flow.

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.