Mezzanine Debt Accordions & Acquisition Growth

Posted on: February 21st, 2023

mezzanine-debt

Most companies pursuing roll-ups seek rapid fire acquisitions with footprint expansion and revenue aggregation as twin goals. Roll-up acquirers frequently turn to mezzanine debt lenders due to their ability to underwrite complex deals with many moving parts. Mezzanine debt lenders analyze more deeply and have more direct operational experience than other lenders giving them an advantage assessing the integration risk inherent in a roll-up.

Mezzanine Debt and Acquisition Growth

Well-resourced acquirers with prior acquisition experience know how to manage integration risk to maintain the velocity of growth scale-up. One key scaling factor is the ease of capital access to fund acquisitions. Smart acquirers use acquisition facilities known as accordions to provide future capital, according to agreed-upon criteria. This gives the acquirer capital firepower and confidence in the market when competing for deals, especially in the lower middle market. Most mezzanine debt accordions allow for 100% financing of add on acquisitions if the company is in compliance with the leverage and debt service covenant, on a pro forma basis. If the company has performed above average relative to budget, and the acquisition is within agreed upon valuation parameters, the acquiring company will be able to draw on the accordion for funding.

Usually, the amount of the accordion ranges from 50% to 100% to the original funding amount, giving the company significant capital runway. The pricing of the accordion is comparable to the original loan amount as it relates to interest rate and any equity participating. Accordion facilities are a win-win for both the mezzanine debt lender and the acquiring company. The mezzanine debt lender gets the ability to provide more meaningful capital support to a company that performs, thereby building their asset base. The acquiring company gets greater scalability value from their capital provider, allowing them to build EBITDA more quickly and grow into a highly valuable platform company. While the accordion availability is not guaranteed, but earned through financial and acquisition performance, it is well worth pursuing as part of a large-scale financing structure due to its strategic value and operational flexibility.

As the Fed decides to ease interest rates, middle market acquisition financing structures will benefit in a number of ways. The underlying values of middle market companies will increase leading to a higher enterprise value and lower loan to value ratios for existing portfolio companies of acquisition financing lenders.

The role of acquisition financing is infrequently elevated above a functional transactional one. When a business needs financing to acquire, they go to the market and source acquisition financing to supplement their equity investment to close the deal. Despite existing in many different forms, acquisition financing is rarely explained in terms of the value it brings to the acquirer.

Acquisition financing underwriting usually focuses on business and financial issues that underpin the stability of cash flow. Providers of acquisition financing usually validate the durability of a company’s competitive advantage and the depth of its resource base. Environmental issues are usually not a major part of the analysis in today’s service and technology-based economy.