Mezzanine Debt Lenders’ Favored Industries

Posted on: January 8th, 2022

mezzanine-debt

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.

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.