Mitigate the Unexpected with Mezzanine Debt

Posted on: August 14th, 2020

Mitigate the Unexpected with Mezzanine Debt Mezzanine debt brings a multitude of benefits to a company, aside from the value of the loan itself. On its objective merits, mezzanine debt is a superior form of capital in the middle market, providing a flexible growth runway to growth companies. The inherent advantage of a mezzanine debt loan is
obvious – more capital than a bank loan, more time to repay the loan, little to no principal amortization during the term, and more flexibility with covenants. Beyond these terms lies a mezzanine debt structuring philosophy which reflects a balanced perspective as to the realities of middle market businesses.

While many middle market companies believe they are best in class companies, the reality is that few are. While many companies believe that achievement of the growth plan is inevitable, the reality is that it will take longer and cost more to achieve the growth plan.

When many companies see their fortunes as not connected to the macroeconomic environment, the reality is that most companies are. Business growth like many things is subject to unexpected surprises. Resiliency and grit are the key ingredients that ultimately determine if a company will successfully get to the finish line.

Mezzanine debt lenders understand these things and have lived through many tough times with their borrowers. Most have been lending on the mezzanine debt level for decades and have encountered every conceivable growth pitfall imaginable. This gives them a tremendous experience base to pull from to navigate any current issues their borrowers. They are not confrontational but constructive. They try to help management diagnosis the issue and address the real problem.

A Case Study For Mezzanine Debt Lenders

The current pandemic crisis has been a case study in how mezzanine debt lenders can help their borrowers. Most have been on the phone with borrowers helping them with PPP loans, cash flow forecasting and where needed, offering interest and principal payment deferrals and more capital. While the most seriously affected companies have breached covenants, mezzanine debt lenders have focused on the important thing of cash on hand liquidity to ensure continuity of operations.

Mezzanine debt lenders bring maturity and judgment to the relationship borne of many years of experience and keen appreciation of EBITDA volatility. They make their loan against the future cash flow of the business so it forces them to protect the cash flow so they will eventually recover their loan. Even if it means absorbing short term pain, mezzanine debt lenders will do what is needed to help reposition their companies for long term recovery. This mezzanine debt survival tendency works to the benefit of its borrowers, when they are trying to mitigate an unexpected negative event.

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.