The Duality of the Mezzanine Debt Perspective

Posted on: November 9th, 2023

mezzanine-debt

Mezzanine debt lenders provide large capital infusions to businesses at a historically important point in their development such as an acquisition, new market launch, or buy-out. Intelligent use of a mezzanine debt structure can provide a large capital boost at a lower cost than raising equity from investors. Mezzanine debt use is particularly impactful as a one-stop source of capital, providing a company valuable growth capital that is a hybrid of a loan and equity.

In certain situations, mezzanine debt lenders can be a long-term source of funding for a company, scaling to meet financing needs over the course of many years. A dual risk is assumed by the mezzanine debt lender, a risk of default and a risk of growth. They worry about the company being able to service the debt. They also worry about the company’s EBITDA not growing fast enough.

How Mezzanine Debt Lenders Think

Given this duality, mezzanine debt lenders often shift from thinking like a lender to thinking like an equity investor and back again over the course of a lending relationship. Sometimes borrowers receive mixed messages that make it hard to discern what the lender really thinks. This duality of mezzanine debt lender perspective is normal and is caused by the changing risk profile of the company as it goes through its lifecycle.

Early on, scaling up and gaining mass is important to the lender. Later, increasing margins and profitability become paramount. Borrowers should maintain a healthy relationship with their mezzanine debt lender so you can understand the shifts in perspective. Sometimes these shifts occur for market reasons and are outside of the control of the borrower. Over the long term, the duality of mezzanine debt perspective is a positive influence on the company’s growth strategy. It forces the borrower to focus as much on profitability as it does on scalability and mitigates the tendency to grow at all costs.

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.