The Dark Side of Mezzanine Debt Financing

Posted on: November 27th, 2024

Mezzanine Debt

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.

Occasionally, a loan will blow up in the lender’s portfolio making them highly suspicious of all companies they have loans to, even the performing loans that are paying interest. Disastrous deals exert powerful aftereffects that ripple through all new investment decisions, making it harder for the mezzanine lender to make loans with a balanced perspective. This means they may make a loan and convince themselves it is a good one when they are closing it, but they harbor negative thoughts about the deal down deep.

If the company struggles for any reason, the mezzanine debt lender is quick to pounce, immediately assuming the worst-case scenario. This puts the borrower on edge, not knowing where they stand but eventually seeing the dark side of the mezzanine debt lender. When the mezzanine debt lender reacts in this overly negative way, it completely shatters the borrower relationship and creates a struggle where the lender prioritizes its position at the expense of the borrower’s need to preserve their business.

The dark side of mezzanine debt lending is a place that no borrower wants to be and it hard to dig your way out of. While this happens infrequently, it is more prone to happen with inexperienced and immature funds, where the decisionmakers are green. The best mezzanine debt lenders are highly seasoned professionals who have strong track records of assisting companies in a constructive way. They are smart enough to realize that they need management to get repaid and never want to push a company that is performing into threatened state.

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.

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.