Mezzanine Debt Lenders’ Favored Industries

Posted on: January 8th, 2022

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Most mezzanine debt lenders are self-described generalists when it comes to investment preferences. There are bright line disfavored segments such as gambling, real estate, and commodities. Often mezzanine debt lenders bandy about the term “industry agnostic” when describing their investing style.

This description is elliptical and really says nothing of value to a company trying to find the right mezzanine debt lender. Rather than sounding over-inclusive, mezzanine debt lenders would benefit from saying what industries they truly prefer and have been successful with. Most middle market funds have track records with certain industry segments where they have had either positive or negative experiences.

A negative experience may have been caused by a sub-par management team or a growth plan gone awry, having nothing to do with the industry dynamics. Yet this often leaves a bad taste in the mouth of the mezzanine debt lender for the specific industry, notwithstanding the underlying reasons. This is completely understandable, but it also underscores the need for mezzanine debt lenders to be forthright in their articulation of not only favored industries but also industries they tend to shy away from.

Mezzanine Debt as an Option for Companies

Most companies seeking a mezzanine debt lender rank industry experience extremely high on their list of requirements. They understand that each fund’s investment philosophy is a bit different due to prior performance and lessons learned. Mezzanine debt lenders that clearly and comprehensively communicate industries they excel in as well as those they tend to avoid, provide valuable transparency to prospective middle market borrowers. The following are mezzanine debt lender’s favored industries:

Business Services and Technology Companies – these types of companies usually have large backlogs, high total contract value and revenue visibility coupled with strong margins.
Manufacturing Companies – these types of companies usually have a multi-stepped production process combined with strong distribution channels coupled with gross margins in excess of 30% are favored.
Healthcare Companies – these types of businesses combine a strong referral network with an integrated delivery system and elevated levels of operating efficiency.
Distribution Companies – these types of businesses have product breadth combined with strong channel presence leading to gross margins in excess of 20%.
Retail or Direct Response Companies – these companies usually have a dominant presence in a niche product.

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.