The Direct Lending Impact of Mezzanine Debt Lender

Posted on: January 10th, 2022

mezzanine-debt

Mezzanine debt lenders have a low profile and are known for their functional role in leveraged buyout structures. To many private equity sponsors, they are a layer of debt that plugs a capital hole. Many mezzanine debt lenders are exclusively focused on private equity type deals, particularly larger funds of an asset under management fee pedigree.

Mezzanine debt lenders also play a less heralded but highly impactful role pollinating the growth capital and acquisition capital needs of middle market companies, outside of any private equity involvement. In this direct lender role, they work directly with borrowers to fund acquisitions, organizational scale-ups, and new product and market launches. This form of direct lending is akin to venture capital for established companies allowing them to grow at rapid rate, previously unachievable under their old capital structure.

Through this funding approach, companies strategically invest over the long-term horizon leading to innovation and scale thereby creating economic growth for all to participate in. In this type of arrangement, the mezzanine debt capital is not used to transfer ownership from one party to another as in a private equity deal. It is used as fuel to increase the size of the company through adding employees, locations, and new systems, all of which creates a ripple effect in the economy.

Role of Mezzanine Debt Lenders

Through lending directly to companies, mezzanine debt lenders take on the role of innovation capitalists without the expense associated with a venture capital investor who usually ends up owning a large percentage of the equity. Existing ownership has complete control with respect to governance and day to day management. This type of lending is practiced by an increasing number of mezzanine debt lenders, particularly those with operating backgrounds. Direct lending allows middle market companies to continue to grow unimpeded by capital constraints and become true leaders in their respective industries.

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.